• Shuffle
    Toggle On
    Toggle Off
  • Alphabetize
    Toggle On
    Toggle Off
  • Front First
    Toggle On
    Toggle Off
  • Both Sides
    Toggle On
    Toggle Off
  • Read
    Toggle On
    Toggle Off
Reading...
Front

How to study your flashcards.

Right/Left arrow keys: Navigate between flashcards.right arrow keyleft arrow key

Up/Down arrow keys: Flip the card between the front and back.down keyup key

H key: Show hint (3rd side).h key

A key: Read text to speech.a key

image

Play button

image

Play button

image

Progress

1/111

Click to flip

111 Cards in this Set

  • Front
  • Back
asset market approach to exchange rates
Explains exchange rates in terms of demands and supplies of all assets denominated in different currencies. The monetary approach to exchange rates is a variant of this approach in which only demands and supplies of the money asset are considered.
bandwagon
A situation in which investors expect the recent trend in exchange rates to extend into the future.
law of one price
Asserts that a single commodity will have the same price everywhere once the prices are expressed in the same currency. This is another way of stating the purchasing power parity hypothesis. It seems to be true chiefly for commodities that are standardized and heavily traded internationally.
monetary approach to exchange rates
Seeks to explain exchange rates by focusing on the demands for and supplies of national monies.
nominal bilateral exchange rate
The exchange rate we see quoted in foreign exchange markets.
nominal effective exchange rate
The weighted-average exchange value of a country’s currency, where the weights reflect the importance of the other countries in the home country’s total international trade.
overshooting
When the exchange rate is driven past its ultimate equilibrium rate (usually thought to be the PPP level), and then back to that rate later, during the adjustment of the macroeconomy to an exogenous shock. This effect is the consequence of goods prices that are sticky in the short run.
purchasing power parity
In its absolute form, this hypothesis says that the exchange rate will equal the ratio of the domestic price level to the foreign price level, or e = P/Pf. (In its relative form, the hypothesis states that the difference over time in inflation rates will be offset by changes in the exchange rate over that period)] An approximation of relative purchasing power parity is [efuture – etoday] = [(inflation rate at home) minus (inflation rate in the foreign country]).
quantity theory of money
Theorizes that, in any country, the money supply is equal to the demand for money, which is directly proportional to the value of nominal gross domestic product. This is symbolized as M = kPY. Here, money’s only role is as a medium of exchange.
real exchange rate
A way of measuring the price of foreign goods, not just in currency-adjusted terms, but also in price-level-adjusted terms. The real exchange rate on a currency at any moment in time is calculated as: [(foreign cost of home currency) x (P/Pf) x (100)]. If purchasing power parity holds between the two countries, the real exchange rate will be 100. When the real exchange rate is above 100, the home currency is overvalued and the foreign currency is undervalued; when the real exchange rate is less than 100, the home currency is undervalued and the foreign currency is overvalued.
speculative bubble
A self confirming upward or downward movement in a price (here, the exchange rate) that is out of line with the changes in the fundamental factors that determine the price of that object.
adjustable peg
A system in which a country tries to keep its exchange rate fixed for long periods of time and only changes the pegged rate when there is a substantial payments disequilibrium at that rate.
beggar-thy-neighbor
Policies such as devaluations or tariffs intended to benefit one country’s economy at the expense of another. Such policies were widespread during the Great Depression of the 1930s.
Bretton Woods system
Under this post World War II agreement organizing international financial affairs between 1944 and 1971, countries were allowed devaluations and revaluations of an adjustable peg exchange rate when faced with fundamental disequilibria that would otherwise require drastic domestic adjustment to keep the exchange rate fixed. Keynes was one of the architects of the Bretton Woods system.
capital controls
Government limits placed on the use of the foreign exchange market to make payments related to international financial activity (as opposed to payments for goods and services).
clean float
Exchange rates determined by a freely-functioning foreign exchange market.
crawling peg
An exchange rate system in which the pegged rate is changed frequently according to a set of indicators or in response to monetary authority direction.
deficits without tears
A situation in which a country’s currency is considered an international reserve so that the country can finance its official settlements deficit by issuing its own currency. The U.S. had extraordinary leeway to finance its payments deficits by issuing dollars in the 1950s and 1960s.
dirty float
Also known as managed float. An exchange rate which is generally floating but with government willingness to intervene to attempt to influence the equilibrium value of the rate.
dollar crisis
Denotes the situation prevailing toward the end of the Bretton Woods era, with the excessive build up of dollar reserves in the hands of foreign central banks due to the large and persistent U.S. payments deficits. The gold backing of the dollar was questioned, and ultimately the dollar was allowed to float freely starting in 1973.
domestic adjustment
Refers to the necessary changes in the level of a country’s aggregate demand to ensure that supply and demand for foreign exchange are back to equilibrium at the fixed exchange rate, thus avoiding any further pressure on the exchange rate.
EURO
The currency of the European Union. As of 2008, 15 of 27 EU countries have replaced their national currencies with the euro.
ERM of the EMS
Predecessor to the euro zone, the exchange rate mechanism (ERM) of the European Monetary System (EMS) maintained pegged exchange rates among ERM members’ currencies with currencies floating as a bloc against outside currencies such as the U.S. dollar. Some EU member states participate in a modified ERM in which their currencies are pegged to the euro.
foreign exchange controls
Restrictions on the ability of individuals to freely dispose of foreign exchange earned abroad and to acquire foreign exchange for spending abroad. For example, the excess demand for an officially undervalued foreign currency is dealt with by rationing the scarce supply available through exchange controls.
fundamental disequilibrium
A balance of payments surplus or deficit too great and/or enduring to be financed. It is easy to detect with hindsight, but difficult to detect at the outset.
"Gnomes of Zurich"
Epithet coined by Britain’s Chancellor of the Exchequer for the speculators he thought were abandoning the British pound and making it increasingly difficult to defend a pegged exchange rate in the mid 1960s.
Gold standard era
From about 1870 to WWI, most nations tied their currency values to gold and allowed unrestricted import and export of gold. Officials were expected to adjust the whole economy to defend the exchange rate.
IMF
An institution created by the Bretton Woods agreement in 1944, the IMF aims to promote orderly foreign exchange arrangements and to limit exchange rate manipulation. It also lends reserves to its members (185 countries as of 2008) to finance temporary international payments difficulties.
leaning against the wind
Government intervention in the foreign exchange market to moderate current movements in floating exchange rates.
official intervention
Government attempts to influence the market exchange rate by buying or selling foreign currency in exchange for the domestic currency.
one-way speculative gamble
A bet which entails minimal or zero risk of loss for the gambler. A persistent payments imbalance under the Bretton Woods system, for example, clearly signaled the likelihood of a devaluation in the case of a deficit or a revaluation in the case of a surplus. There was, therefore, little risk of losing money by moving funds away from the currency to be devalued and toward the one to be revalued. At worst, speculators had to shoulder the transaction costs.
par value
The value of the exchange rate that government officials try to target. Often the government will allow some flexibility of the actual exchange rate in a “band” around the par value.
parallel market
A rather nice way of saying “black market.” In countries with exchange controls, economic agents often find it profitable to circumvent official restrictions on buying and selling foreign currencies through the use of parallel markets.
pegged exchange rate
Term used in place of “fixed exchange rate” because, in practice, no exchange rate stays fixed forever, but can be changed by government action. This is a common exchange rate regime in developing countries.
price discipline effect
The argument that a fixed exchange rate system results in reduced inflation rates globally, largely because high-inflation countries become less competitive and run out of reserves needed to finance payments deficits. Those countries ultimately must tighten their domestic money supply to maintain the fixed exchange rate. As a result, inflation decreases.
"snake in the tunnel"
A system set up by members of the EEC in 1971, whereby each currency would float inside a specified band against every other member currency (the snake), and a maximum limit was set on the difference between the most appreciating and most depreciating currencies (the tunnel). This was a predecessor to the EMS.
Special Drawing Rigths
Reserve assets created by the IMF, beginning in 1970 as a supplement to existing reserve assets. The value of one SDR is determined by the weighted average of a basket of the currencies of the five countries with the largest share of world exports of goods and services—the U.S. dollar, the Japanese yen, the British pound, and the Euro (representing France and Germany).
sterilization
Using monetary policy to offset the impact of official intervention on the domestic money supply. For example, a government might purchase its own currency to support its exchange value, but then purchase domestic bonds to restore the domestic money supply. The intent is to manipulate currency values without affecting the domestic economy.
Brady Plan
A method devised by the U.S. Treasury for resolving the 1980s debt crises. Bank borrowing of 18 debtor countries was restructured with some debt reduction and some repackaging of loans as Brady bonds.
Conditionality
The “strings” attached by the International Monetary Fund to loans it makes to a country in financial crisis; these are intended to address and correct the fundamental problems that caused the crisis. Such strings include fiscal and monetary restraint and liberalization of the country’s domestic and international markets.
Debt Overhang
The amount by which a borrower’s debt exceeds the present value of future transfers that will be made for debt service. For example, if a loan is made for current consumption or for low quality investment, today’s value of the future income streams from those uses will be much less than the amount the borrower owes.
Debt Restructuring
A general term for changing the details of an existing loan. “Debt rescheduling” modifies the due date (or “maturity”) of the loan; “debt reduction” modifies the amount (or “principal”) of the loan.
Debt Service
Repayments of principal and interest. The debt service ratio is a measure of a country’s debt burden and expresses debt service as a percentage of total export revenues or GDP.
International Capital Flows
Financial flows of credit and ownership claims between countries. Flows of physical capital goods are typically treated as ordinary trade flows, not capital flows, in the balance of payments accounts.
Moral hazard
A situation in which someone insured against risks will purposely engage in risky behavior, knowing that any costs incurred will be compensated by the insurer. A financial system that offers “rescue packages” may encourage borrowers and lenders to undertake low quality or high risk investments, thus increasing the likelihood of a crisis.
nationally optimal tax on fund flows
As with an optimal tariff, a large country may be able to exert market power and turn the terms of trade in its favor. For example, if a lending country taxes the outflow of funds, it will raise the price that borrowers have to pay. The country’s lenders earn a higher rate of return and the government collects the tax revenues. Although this may increase welfare in the lending country, it always reduces world welfare.
sovereign
Someone or something that has legal independence. This usually refers to national governments because (as in the case of debts they owe) they cannot be forced to repay, be sued, or have their domestic assets seized.
tequila effect
When investors recall loans from all developing countries rather than only from the particular country facing the debt crisis.
external balance
Performance goal in which the country’s economy has an overall balance of payments that is sustainable over time.
FE Curve
This curve shows all combinations of interest rate and income which result in a zero balance in the country’s overall international payments position (its official settlements balance is zero). The FE curve usually slopes upward because, as income rises, the demand for imports rises; interest rates must also rise to attract capital so that the current account deficit is offset by a financial account surplus. The FE curve is horizontal if there is perfect capital mobility between countries
foreign-income repercussions
When country J’s income rises, it is likely to increase imports from its trade partner, country K. Country K, in turn, experiences an increase in its income. As a result, Country K is likely to import more from country J, raising country J’s income even further. The increase in country K’s income is referred to as a “spillover effect”; the subsequent increase in country J’s exports (and so income) is called a “foreign-income repercussion.” Spillovers and foreign-income repercussions raise the open-economy spending multiplier of a country.
internal balance
A performance goal in which the country’s economy is producing at the full employment income level with price stability.
IS curve
This curve shows all combinations of interest rate and income that equilibrate the market for goods and services. The IS curve slopes downward because, as interest rates fall, the demand for goods and services rises; output must rise to re-equilibrate the market for goods and services.
LM curve
This curve shows all combinations of interest rate and income that equilibrate money demand and money supply. The LM curve slopes upward because, as national income rises, so does money demand; with a fixed money supply, interest rates must rise to re equilibrate the money market.
locomotive theory
Argues that growth in the largest countries may be sufficient to raise world growth overall. This theory comes from the observation that growth in the U.S., Europe, and Japan tends to result in growth of other countries because these large countries import more when their incomes rise. Some suggest that China may now be a locomotive country.
marginal propensity to import
The ratio of a change in import volumes to the change in real national income causing the import change. Graphically, it is represented by the slope of the import function.
open economy spending multiplier
This takes into account the leakage from the spending stream caused by the marginal propensity to import. Whereas the simple closed economy multiplier is [1/marginal propensity to save], the open economy multiplier is [1/(marginal propensity to save + marginal propensity to import)]. For a small economy, the open economy multiplier is smaller than the closed economy multiplier. For a large country, however, the open economy multiplier may be augmented by foreign¬ income repercussions as income increases in the large country induce income changes in trade partners and so have feedback on the large country’s exports
spending multiplier
The ratio of a change in national income to the change in autonomous spending that caused the income change. It is greater than one because an initial increase in autonomous spending (independent of income) generates many successive changes in induced spending (dependent on income).
sterilized/unsterilized intervention
Under a fixed or managed exchange rate regime, the monetary authorities have to intervene in the foreign exchange market to satisfy any private excess demand for, or supply of, foreign exchange. If the monetary authorities allow such operations to affect the money supply, it is called unsterilized intervention. If, instead, they undertake offsetting purchases or sales of government bonds in the open market, so as to prevent a balance of payments surplus or deficit from having any net effect on the domestic money supply, it is called sterilized intervention.
rules of the game
Also known as “classical medicine.” Under fixed exchange rates or the gold standard, the “rules of the game” require monetary authorities to refrain from sterilizing payments imbalances. Instead, they should actively push their domestic lending in the same direction as the payments imbalance, so as to speed up the elimination of payments imbalances, even if this requires sacrificing the goal of internal balance in the short run.
perfect capital mobility
In this situation, a practically unlimited amount of lending moves between countries in response to the slightest change in one country’s interest rate.
monetary-fiscal policy mix
A short run solution to the aggregate demand policy dilemma; it exploits the opposite impacts of fiscal and monetary policies on the interest rate and, in consequence, on the balance of payments. Under fixed exchange rates and with imperfect capital mobility, the policy mix suggested by the assignment rule will allow a country to achieve both internal and external balance in the short run.
monetary base
Currency and deposits at a country’s central bank; they provide the pool of funds used in sterilization.
J curve
When the price effect of a currency devaluation occurs more rapidly than the volume effect, the initial impact of a devaluation is to worsen the current account. After a period of months, the volume of imports falls and the volume of exports rises, causing the current account to improve. A trace of this time pattern in the current account results in the “J” shape.
internal shocks
Sudden changes in domestic spending or in the financial sector (money demand or supply).
external shocks
Sudden changes in international capital flows or in international trade.
sterilized/unsterilized intervention
Under a fixed or managed exchange rate regime, the monetary authorities have to intervene in the foreign exchange market to satisfy any private excess demand for, or supply of, foreign exchange. If the monetary authorities allow such operations to affect the money supply, it is called unsterilized intervention. If, instead, they undertake offsetting purchases or sales of government bonds in the open market, so as to prevent a balance of payments surplus or deficit from having any net effect on the domestic money supply, it is called sterilized intervention.
exogenous shocks
Shocks caused by factors outside a model that are independent of other factors in the model or system.
rules of the game
Also known as “classical medicine.” Under fixed exchange rates or the gold standard, the “rules of the game” require monetary authorities to refrain from sterilizing payments imbalances. Instead, they should actively push their domestic lending in the same direction as the payments imbalance, so as to speed up the elimination of payments imbalances, even if this requires sacrificing the goal of internal balance in the short run.
endogenous shocks
Shocks caused by factors within the model or system.
perfect capital mobility
In this situation, a practically unlimited amount of lending moves between countries in response to the slightest change in one country’s interest rate.
monetary-fiscal policy mix
A short run solution to the aggregate demand policy dilemma; it exploits the opposite impacts of fiscal and monetary policies on the interest rate and, in consequence, on the balance of payments. Under fixed exchange rates and with imperfect capital mobility, the policy mix suggested by the assignment rule will allow a country to achieve both internal and external balance in the short run.
monetary base
Currency and deposits at a country’s central bank; they provide the pool of funds used in sterilization.
J curve
When the price effect of a currency devaluation occurs more rapidly than the volume effect, the initial impact of a devaluation is to worsen the current account. After a period of months, the volume of imports falls and the volume of exports rises, causing the current account to improve. A trace of this time pattern in the current account results in the “J” shape.
internal shocks
Sudden changes in domestic spending or in the financial sector (money demand or supply).
external shocks
Sudden changes in international capital flows or in international trade.
exogenous shocks
Shocks caused by factors outside a model that are independent of other factors in the model or system.
endogenous shocks
Shocks caused by factors within the model or system.
central bank
The official authority that controls monetary policy and (usually) undertakes the official intervention in the foreign exchange market.
capital flight
When investors flee a country (taking their capital with them) because of doubts about government policies.
assignment rule
A guideline for assigning goals to fiscal and monetary policies. Fiscal policy should aim at achieving internal balance, while monetary policy should aim at achieving external balance.
central bank
The official authority that controls monetary policy and (usually) undertakes the official intervention in the foreign exchange market.
aggregate demand policy dilemma
Refers to the difficulty of improving the levels of both national income and the balance of payments by manipulating only the level of aggregate demand.
G-8 Countries
Canada, France, Germany, Great Britain, Italy, Japan, Russia, and the United States. These countries (initially known as the G-7 countries when Russia was not yet a member) first coordinated to intervene in exchange rate markets with the Plaza Accord in 1985.
capital flight
When investors flee a country (taking their capital with them) because of doubts about government policies.
international macroeconomic coordination
The joint determination of several countries’ macroeconomic policies to improve joint performance. An example is the 1987 Louvre Accord among the G 7 countries.
assignment rule
A guideline for assigning goals to fiscal and monetary policies. Fiscal policy should aim at achieving internal balance, while monetary policy should aim at achieving external balance.
currency board
One system for fixing a country’s exchange rate. The board stands ready to exchange domestic currency for foreign currency at a rate specified and fixed, and can issue new domestic currency only in exchange for foreign reserves. In essence, the domestic currency is fully backed by reserves of foreign exchange. Currency boards are popular in emerging economies.
aggregate demand policy dilemma
Refers to the difficulty of improving the levels of both national income and the balance of payments by manipulating only the level of aggregate demand.
dollarization
An extreme form of fixed exchange rate system. A country surrenders its own currency and uses as its medium of exchange the currency of a foreign nation. A dollarized country has no independent money supply or monetary policy. Ecuador dollarized in 2000; El Salvador dollarized in 2001.
G-8 Countries
Canada, France, Germany, Great Britain, Italy, Japan, Russia, and the United States. These countries (initially known as the G-7 countries when Russia was not yet a member) first coordinated to intervene in exchange rate markets with the Plaza Accord in 1985.
international macroeconomic coordination
The joint determination of several countries’ macroeconomic policies to improve joint performance. An example is the 1987 Louvre Accord among the G 7 countries.
European Central Bank
This supra national bank took over monetary policy in the EMU “euro zone” in 1999. Policy will be made by a council comprised of executive committee members and the directors of the member countries’ national banks. A key concern for the ECB is how to balance goals of price stability versus growth and employment.
currency board
One system for fixing a country’s exchange rate. The board stands ready to exchange domestic currency for foreign currency at a rate specified and fixed, and can issue new domestic currency only in exchange for foreign reserves. In essence, the domestic currency is fully backed by reserves of foreign exchange. Currency boards are popular in emerging economies.
European Monetary Union
Outlined by the Maastricht Treaty in 1991 and ratified by the EU countries in 1993. One of its goals was to create a single Europe-wide currency. To join, EU countries had to meet macro criteria regarding exchange rate stability, inflation and interest rates, and government finances. In 1998, 11 EU countries joined the EMU. Britain, Denmark, and Sweden chose not to join, while Greece did not qualify. As of 2008, 15 EU countries have become full members of the EMU and have adopted the euro as their currency.
dollarization
An extreme form of fixed exchange rate system. A country surrenders its own currency and uses as its medium of exchange the currency of a foreign nation. A dollarized country has no independent money supply or monetary policy. Ecuador dollarized in 2000; El Salvador dollarized in 2001.
central bank
The official authority that controls monetary policy and (usually) undertakes the official intervention in the foreign exchange market.
European Central Bank
This supra national bank took over monetary policy in the EMU “euro zone” in 1999. Policy will be made by a council comprised of executive committee members and the directors of the member countries’ national banks. A key concern for the ECB is how to balance goals of price stability versus growth and employment.
capital flight
When investors flee a country (taking their capital with them) because of doubts about government policies.
assignment rule
A guideline for assigning goals to fiscal and monetary policies. Fiscal policy should aim at achieving internal balance, while monetary policy should aim at achieving external balance.
European Monetary Union
Outlined by the Maastricht Treaty in 1991 and ratified by the EU countries in 1993. One of its goals was to create a single Europe-wide currency. To join, EU countries had to meet macro criteria regarding exchange rate stability, inflation and interest rates, and government finances. In 1998, 11 EU countries joined the EMU. Britain, Denmark, and Sweden chose not to join, while Greece did not qualify. As of 2008, 15 EU countries have become full members of the EMU and have adopted the euro as their currency.
aggregate demand policy dilemma
Refers to the difficulty of improving the levels of both national income and the balance of payments by manipulating only the level of aggregate demand.
G-8 Countries
Canada, France, Germany, Great Britain, Italy, Japan, Russia, and the United States. These countries (initially known as the G-7 countries when Russia was not yet a member) first coordinated to intervene in exchange rate markets with the Plaza Accord in 1985.
international macroeconomic coordination
The joint determination of several countries’ macroeconomic policies to improve joint performance. An example is the 1987 Louvre Accord among the G 7 countries.
currency board
One system for fixing a country’s exchange rate. The board stands ready to exchange domestic currency for foreign currency at a rate specified and fixed, and can issue new domestic currency only in exchange for foreign reserves. In essence, the domestic currency is fully backed by reserves of foreign exchange. Currency boards are popular in emerging economies.
dollarization
An extreme form of fixed exchange rate system. A country surrenders its own currency and uses as its medium of exchange the currency of a foreign nation. A dollarized country has no independent money supply or monetary policy. Ecuador dollarized in 2000; El Salvador dollarized in 2001.
European Central Bank
This supra national bank took over monetary policy in the EMU “euro zone” in 1999. Policy will be made by a council comprised of executive committee members and the directors of the member countries’ national banks. A key concern for the ECB is how to balance goals of price stability versus growth and employment.
European Monetary Union
Outlined by the Maastricht Treaty in 1991 and ratified by the EU countries in 1993. One of its goals was to create a single Europe-wide currency. To join, EU countries had to meet macro criteria regarding exchange rate stability, inflation and interest rates, and government finances. In 1998, 11 EU countries joined the EMU. Britain, Denmark, and Sweden chose not to join, while Greece did not qualify. As of 2008, 15 EU countries have become full members of the EMU and have adopted the euro as their currency.
monetary union
A collection of nations in which exchange rates are permanently fixed and a single monetary authority conducts a common monetary policy for the countries of the union.
price discipline
The notion that a fixed exchange rate system reduces inflation globally. High-inflation countries become less competitive and run out of reserves to finance payments deficits. They must tighten the domestic money supply to maintain the fixed exchange rate; lower inflation results.
trilemma
The recognition that a country cannot, simultaneously, maintain a fixed exchange rate, free capital mobility, and independent monetary policy.