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48 Cards in this Set

  • Front
  • Back
Macroeconomic Policy Trilemma:
What are the three desirable policy choices?
1. fixed exchange rates
2. free movement of capital
3. independent monetary policy
What is the macroeconomic policy trilemma?
Only two of the three desirable policy choices can be attained simultaneously.
Who is Robert Mundell?
1999 Nobel Prize winner for International Economics, described "The Impossible Trinity" of policy trilemma
Free Movement of Capital: In order to free up its financial markets and join world financial & monetary system, a country needs to:
1. Open up currency transactions
2. Open up capital movements
3. Open up movement of goods
If US interest Rate > German interest rate then...
EX of Uncovered interest Parity
Dollar expected to depreciate
If German interest rate > US interest rate then...
Euro expected to depreciate
Do Central Banks set interest rates?
How do central banks affect interest rates and exchange rates?
Buy & Sell government securities
What is domestic credit?
value of domestic securities held by a central bank
What are the central bank's assets?
domestic credit & foreign reserves
Free Movement of Capital: Free to invest in ____ and ____ assets.
Free to invest in DOMESTIC and FOREIGN assets.
Free Movement of Capital: Hold both ______ and ______ Treasury bills.
Hold both US and GERMAN Treasury Bills.
Free Movement of Capital: Expected returns must be ______.
Expected returns must be EQUALIZED.
Free Movement of Capital: Uncovered Interest Rate Parity
Relates exchange rates and interest rates..equal interest rate, equal return... depreciation of a dollar would have to be matched by interest rate change in a country to equalize returns
Free Movement of Capital:
Interest rate differential equals___________________
Interest rate differential equals expected rate of depreciation
Free Movement of Capital: Fixed _______ rates
Fixed Exchanged rates
Free Movement of Capital: No expectations of _________________
No expectations of depreciation
Free Movement of Capital:__________ rates equal between countries.
INTEREST rates equal between countries.
What is an example of a capital control?
Is it used today?
Restrictions on the amount of foreign currency that domestic residents can purchase.
YES, by small countries
Capital Controls permit the ________ rate to be different from the world rate with fixed exchange rates.
What is the disadvantage of capital controls?
Reduce the efficiency of international capital markets
How are exchange rates fixed?
Capital & Exchange Controls:
1.fixed by fiat
2.countries announce exchange rate
3.not necessarily rates that people conduct trade
4.parallel or "black" markets
Fixed Exchange Rates: How are exchange rates fixed?
Free movement of capital, expected depreciation must be zero, domestic interest rate must equal world rate
What policy is necessary to fix exchange rates?
Monetary policy
Foreign securities are denominated in ___________ currency. Frequently, take form of ______ issued by foreign govts.
Foreign Securities are..
What are the liabilities of the Central bank?
currency in circulation, bank reserves held by commercial banks (mostly required by the Fed)
What are Open market operations?
central bank purchases domestic credit with currency
What is Foreign Exchange Intervention?
central bank purchases foreign reserves with currency
open market operations and foreign exchange intervention affect the ___________ and __________
MONEY SUPPLY & Interest Rates
Open market operations and foreign exchange intervention increase the money supply to...
decrease interest rates
Open market operations and foreign exchange intervention decrease the money supply to...
increase interest rates
Monetary Policy: How to fix exchange rates with free movement of capital?
1. Central bank directs monetary policy towards keeping the domestic interest rate equal to the world interest rate.
2. keep expected depreciation zero
3. cannot direct monetary policy towards other objectives
Cannot have independent monetary policy when...
fixed exchange rates and free movement of capital
With fixed exchange rates & free movement of capital, independent monetary policy is not possible because...
monetary policy is directed towards fixing the domestic interest rate at the world interest rate & not towards other objectives such as inflation or unemployment
Cannot have free movement of capital when...
there are fixed exchange rates and independent monetary policy
No free movement of capital w/ fixed exchange rates & independent monetary policy bc
monetary policy does not necessarily set domestic interest rate equal to world interest rate, can't allow exchange rate to be market determined
Cannot have fixed exchange rates when...
independent monetary policy and free movement of capital
Independent monetary policy & free movement of capital allows no fixed exchange rates bc
country must allow its exchange rate to be market determined - free to move
What is the United States policy choice?
independent monetary policy, free capital mobility, flexible exchange rate
What countries have a macroeconomic policy similar to US
Australia, canada, United Kingdom
What 12 countries joined by combining their national currencies to form the Euro in January 1999 and 2001?
Austria, belgium, france, finland, germany, ireland, italy, luxembourg, netherlands, portugal, spain...Greece
What are these countries known as?
Eurozone, Jan2002 elimnated indivdual currencies in favor of EURO notes & coins, European Central Bank conducts monetary policy for the EUROZONE
What is the internal policy of the Eurozone?
free movement of capital, fixed exchange rates, no monetary policy (Same as US)
What is the external policy of the Eurozone?
independent monetary policy, free movement of capital, flexible exchange rates, same as US
What is China's macroeconomic policy?
Fixed exchange rates, independent monetary policy, but controls on capital
China has pressure to allow more _______ __________ flexibility
exchange rate, by US to let YUAN appreciate, not much response so far (2%)
China is fueled by a trade _____