Transcript Document 7122284

ECONOMICS
what is it and
why study it?
Social Science
Efficiency
How to increase output
Output  f (resources , state of production technolog y)
• Economic Resources
– Anything that can be used to produce output can be
viewed as a resource (input, or factor of production)
– Main categories of resources:
• Land (inclusive of natural resources)
• Physical Capital (productive capital)
– Encouragement of saving (IRAs)
• Labor
– Immigration
• Human Capital
– Subsidized education
• Entrepreneurship
– Development of favorable business environment
efficiency
Output can be increased through increases in the
resource base, but it can also be increased or
“improved” through efficiency
• Fundamental Economic Questions:
– What to Produce (allocative efficiency)
– How to Produce (productive efficiency)
– For Whom to Produce (allocative efficiency)
• The Society answers these questions in large part
through the choice of the economic system
Economic systems
• Capitalism
• Socialism
• Communism
These systems differ in the allocation of the ownership
of productive resources
The differences in these systems can also be
formulated in terms of how they address the
fundamental questions (e.g. command economy
versus market economy)
• Feudalism
• Mercantilism
Capitalism
–Natural emergence
• Adam Smith’s “invisible hand” concept
–Simplified role of the government
• Institutional support for economic activity
– Property rights laws
– Stable political system
– Well defined legal system
– Transparent business regulations
– System of checks and balances for gov’t officials
Socialism
• Philosophical Foundation
• Socialist Movement of the mid XIX century
• Role of the government
– Includes economic decisions in terms of
allocation of resources and output, and
possibly production
Modern Economies
• Mixed system (capitalism + socialism)
– EU versus US versus RU versus China
General government final consumption expenditure (% of GDP) in 2001
Switzerland
13.31
China
13.69
United States
14.23
Russian Federation
14.32
Italy
18.47
Germany
19.06
France
23.27
Sweden
26.66
Source: World Bank, WDI 2003
Unemployment rate comparison
Unemployment, total (% of total labor force), 2000
Switzerland
2.7
China
3.1
United States
4.1
Sweden
5.1
Germany
8.1
France
10.0
Italy
10.8
Russian Federation
11.4
Source: World Bank, WDI 2003
The Concept of Cost in Economics
• Every undertaken activity has a foregone
sacrifice associated with it
• Opportunity Cost
– The value of the next BEST (highest valued)
alternative (the value of the sacrifice that
would have become the next choice)
– E.g. opportunity cost of this class
– E.g. Opportunity cost of the Colander’s book
(relative price)
– E.g. Opportunity cost of physical capital
The world of trade-offs
• Budget Constraint and Relative Price
• Production Possibilities Frontier
Gains from Trade
• Specialization and increased output
• Two-country two-product world
• Absolute advantage principle
– Why specialize in the production of something that is
cheaper to purchase from abroad?
• Comparative advantage principle
– Specialize in the production of those products in which
you have the lowest relative (opportunity) cost of
production
• Shape of PPF and lack of complete specialization
• US trade data available on BEA website at:
http://www.bea.gov/bea/di/home/trade.htm
Share of US exports for top US trading partners
Source: GSU Economic Forecasting Center
% of US
Top US Trading Exports
Partner
2003 Q2
Canada
Mexico
Japan
UK
Germany
South Korea
France
Netherlands
China
Taiwan
EU
23.4
13.3
7.9
6.1
4
2.7
2.6
2.6
2.5
2.3
21.8
Blue Chip Forecast for
Real GDP growth (%)
2003
2004
2.4
3.2
2.1
3.5
0.9
1.1
1.8
2.6
0.2
1.5
3.4
5.2
0.8
1.8
0
1.5
7.4
7.5
2.6
3.9
0.6
1.9
Markets
• Defining a market
– Product definition (and competition)
– Geographical boundaries (internet, shipping
cost reduction – globalization and
outsourcing)
• Market forces: Buyers (demand) versus
Sellers (supply)
– Price and quantity as the outcome
demand
• Quantity = f (price, other factors)
• Price and the Law of Demand
• Other factors
– Income (normal versus inferior)
– Related in consumption goods
• Substitutes
• Complements
– Expectations about the future
– OTHER FACTORS ………
supply
• Quantity = f ( price, other factors)
• Price and the Law of Supply
• Other factors
– Costs of Production (MC, and price as MB)
– Goods related in production
• Substitutes: (agricultural products)
– Note, identical to costs of production since is based on
opportunity cost concept
• Complements: (like gold and silver)
– Producer expectations of future prices
• Other factors…
Market equilibrium
• Qs = Qd
• Shortage and surplus as unstable states
and the stability property of the equilibrium
• Market efficiency
• Shifts in demand and supply
• Is the equilibrium really efficient?
– Productive and allocative efficiency
Market example: ForEx
• How can the US run a trade deficit
consistently? Or, differently put, can one
live on credit forever?
Demand for the dollar
different economic agents that purchase the dollar:
•Foreigners who wish to purchase US goods or services, foreign
tourists who wish to travel to the US (US exports)
•Foreigners who wish to invest in the US (higher US interest rate,
attractive US stock market returns)
Supply of the dollar
different economic agents that sell the dollar:
•US consumers/firms that want to purchase foreign goods or services,
US tourists who wish to travel abroad (US imports)
•US residents who wish to invest abroad (higher interest rates abroad,
etc.)
The dollar will appreciate if demand exceeds supply at the current exchange rate.
Note that when you purchase a foreign made product, the cost of the production of that
product is paid in foreign currency, hence somewhere between the production process
and your purchase someone would have to convert your currency into that foreign
currency in order to pay for the production.
Demand and supply: the USD
• US trade deficit -> sale of USD ->dollar
depreciation
• US borrowing from abroad -> purchases of
USD -> appreciation of the USD
• 1990’s and the post 9/11framework
• US balance of payments: BEA
Measuring Economic Activity
• OUTPUT
• EMPLOYMENT
• INFLATION
• Gross Domestic Product
the total market value of all final goods and
services produced by factors of production
located within a nation’s borders over a
period of time (usually one year)
• Gross National Product
the total market value of all final goods and
services produced by factors of production
owned by a nation over a period of time
(usually one year)
Output
• Measuring production
–
–
–
–
Time period
Final goods and services (value added)
Market prices
Defining an economy (geographical boundaries
versus resource ownership)
• Gross Domestic Product
• Gross National Product
• www.bea.gov Table 1.7.5
http://www.bea.gov/bea/dn/nipaweb/TableView.asp?SelectedTable=43&FirstYear=2003&LastYear=2005&Freq=Qtr
Net income from abroad in 2001 (current US$) (mill)
United States
United Kingdom
Switzerland
Russian Federation
Pakistan
India
France
Mexico
Japan
China
European Monetary Union
High income
Low income
-12,100.00
10,907.59
25,209.39
-9,793.48
-872.918
-2,698.42
4,911.81
-13,741.58
68,421.59
-19,173.22
-33,802.12
41,967.63
-23,770.11
Equivalence between expenditure and
income approaches in GDP computation
• Circular flaw concept
– Production of output creates income
– Income finances consumption of output
Labor, capital…
Input markets
Wages, interest, profits
Businesses
Households
prices
Output markets
output
Income = output
• GDP = GNP – NET FOREIGN INCOME
• NI = GNP – depreciation – indirect business taxes
• PI = NI - (Transfer payments from Gov’t, net nonbusiness interest income) + (Social Insurance tax,
corporate retained earnings)
• DI = PI – Personal Taxes
• See Table 1.7.5 (www.bea.gov)
Income approach
• Disposable Income (in 2004: 8,646.9 billion $)
– Income that households actually receive
– Available for consumption and saving
• Personal Income (in 2004: 9,689.6 billion $)
– Household income prior to personal taxes and transfers
– PI= DI + Personal Taxes
• National Income
– Summation of factor payments
•
•
•
•
Employment compensation
Interest received from private business
Profits
Rental income
– NI = PI + (Transfer payments from Gov’t, net non-business interest
income) – (Social Insurance tax, corporate retained earnings)
• Gross National Product
– GNP = NI + Dep.Allowance + Indirect Business Taxes
• GDP = GNP - Net Foreign Income
Expenditures Approach
•Personal Consumption
–Goods
•Durable
•Non-durable
–Services
•Gross Private Domestic Investment
–Fixed Investment
•Non-residential
–Structure
–Equipment and software
•Residential
–Business
–Government Spending (all levels)
–Exports of goods and services
–Imports of goods and services
http://www.bea.gov/bea/dn/nipaweb/TableView.asp?SelectedTable=35&FirstYear=2003&LastYear=2005&Freq=Qtr
Table 1.5.5
employment
• Labor force
– Labor force participation rate
• Unemployment
– Unemployment rate
BLS www.bls.gov US statistics
Industry data: ftp://ftp.bls.gov/pub/suppl/empsit.ceseeb3.txt
• Categorizing unemployment
–
–
–
–
Cyclical
Structural
Seasonal
Frictional
More on unemployment
• Accuracy of unemployment statistics
– Discouraged worker phenomenon
– Two surveys
Statistics for the US economy
For March-July 2003 (seasonally adjusted). Source: BLS
Emploment values are in 000's
Total nonfarm Employment in 000's
Total Employment
Total Unemployed
Civilian Labor Force
Labor Force Participation Rate
Unemployment Rate
March
130084
137348
8445
145793
66.2
April
130062
137687
8786
146473
66.4
May
129986
137487
8998
146485
66.4
June
129914
137738
9358
147096
66.6
July
129870
137478
9062
146540
66.2
0.05792459 0.05998375 0.06142608 0.06361832 0.06183977
Discouraged Worker Phenomenon
%
Labor Force
Participation Rate
1997
67
For the month of January
1998
1999
2000
2001
2002
2003
67.1
66.4
66.3
67.3
67.3
67.2
Historical unemployment rate in the US
inflation
• Rate of growth of the average of all prices
– Average price: weighted price
• Weight represents relative importance of the good
• Average price converted into index: price index
• Measuring inflation
– Consumer Price Index (CPI)
• www.bls.gov (http://www.bls.gov/news.release/cpi.t01.htm)
– Producer Price Index (PPI)
• www.bls.gov
Real versus Nominal Measures
i N
GDP  i 1 PiQi
US Real and Nominal GDP. Source: BEA
Real GDP
Nominal GDP
1992
6,880.00
6,318.90
1998
8,508.90
8,781.50
1999
8,859.00
9,274.30
2000
2001
2002
9,191.40 9,214.50 9,440.20
9,824.60 10,082.20 10,445.60
Costs of (unanticipated) Inflation
•
•
•
•
•
•
Menu Cost
Redistribution of Wealth
Changes in Standard of Living
Inflation and relative prices
High inflation tends to be more volatile
Increased Uncertainty in Forward Looking
Financial Arraignments
• Impact on the Exchange Rate (Purchasing Price
Parity for internationally traded goods)
The Business Cycle
• Glut of goods and subsequent reduction in production
Real GDP
(per capita)
time
Recession – a period of two or more consecutive quarters of decline in real output
Business Cycle
• Relationship between Output, Employment, and
Inflation
– Causes of inflation
• Natural unemployment
• Other sources: monetary policy, currency depreciation,
decreases in the supply of resources [oil] ….
– Business Inventories and start of recession
– Deflation in the costs of production
• Foreign economy effect
• Change in confidence
This slide merely provides you with some
definitions and a basic discussion (for your reading)
business cycle, unemployment and inflation
•
•
Inflation and unemployment are related. Inflation will decline, and even deflation may
begin when unemployment rate is above the natural rate of unemployment. In fact,
the natural rate of unemployment is defined as the rate of unemployment at which the
inflation rate remains constant. Another way of defining the natural rate of
unemployment is to simply tie it to the level of real GDP. Natural rate of
unemployment is the rate of unemployment that occurs when the real GDP is at its
long term trend. Note that at the start of a recession the unemployment rate may still
be above the natural rate of unemployment and hence the rate of inflation may
continue to increase. Similarly, early in the recovery, unemployment rate remains
higher than the natural rate of unemployment which may further reduce inflation.
Inflation is dependent on unemployment. If unemployment is high then there is little
pressure on prices to go up, but if unemployment is low, then people can bid up
prices because they have disposable incomes. There are some additional factors that
can change inflation, including currency fluctuations, but that topic will be covered
later in the semester when we get to the international finance section.
Can future be predicted? Magical
art of forecasting
• Examples of Leading Indicators
–
–
–
–
–
–
–
Average work hours in manufacturing
Business inventories
New orders for non-defense capital goods
Sales tax receipts
Stock index (index futures)
Construction Employment
Residential permits
• Examples of Coincident Indicators
– Total Tax Receipts
– Corporate Income Tax Receipts
– Average weekly claims for unemployment insurance
• Examples of Lagging Indicators
– Unemployment Rate
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
Real GDP Growth
5
4
3
2
1
0
-1
GDP Grow th in US 1992-2002
7.0
6.5
6.2
6.0
5.9
5.6
5.6
5.1
5.6
5.6
4.9
5.0
4.4
4.3
4.0
4.0
4.1
3.8
3.6
3.6
3.0
3.0
2.7
2.7
2.6
2.4
2.0
1.0
0.3
0.0
1992
1993
1994
1995
1996
1997
Nominal
1998
1999
2000
2001
2002
Real
1994 – Mexican currency crisis
1997 - Asian financial crisis
1998 – Russian currency crisis
Recession in Japan
Slow Growth in Europe
20
20
20
20
20
19
19
19
19
19
19
19
19
19
19
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
Consumption Spending Growth
6
5
4
3
2
1
0
-5
-10
20
20
20
20
20
19
19
19
19
19
19
19
19
19
19
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
Gross Domestic Investment Growth
15
10
5
0
Average Growth Rates by
Component, 1996-2000
8%
4
Grow th of Com ponents of GDP, 1995-2002
15
10
5
0
1995
1996
1997
1998
1999
2000
2001
-5
-10
-15
Personal Consumpt ion
Privat e Invest ment
Export s
Import s
Government Expendit ures
2002
Growth in components of Real GDP, 2000-2003
Seasonally adjusted at annual rates
2000
I
2000
2000
2000
II
III
IV
2001
2001
2001
2001
I
II
III
IV
2002
I
2002
2002
2002
II
III
IV
2003
I
2003
II
GDP
2.6
4.8
0.6
1.1
-0.6
-1.6
-0.3
2.7
5
1.3
4
1.4
1.4
2.4
Consumption
5.3
3
3.8
2.1
2.4
1.4
1.5
6
3.1
1.8
4.2
1.7
2
3.3
17.8
-3.7
8.1
-5.3
11.5
5.3
4.6
33.6
-6.3
2
22.8
-8.2
-2
22.6
Nondurable goods
2.2
4.9
2
2.7
2.3
-0.3
1.3
3.6
7.9
-0.1
1
5.1
6.1
0.1
Services
4.4
3.6
3.9
3.3
0.6
1.5
0.9
2.1
2.9
2.7
2.3
2.2
0.9
1.5
2.3
17.3
-6
-3.4
-19.7
-17.6
-5.2
-17.3
18.2
7.9
3.6
6.3
-5.3
1.3
Fixed investment
13.3
6.7
0.2
-2.4
-2.2
-11.1
-4.3
-8.9
-0.5
-1
-0.3
4.4
-0.1
6.6
Nonresidential
15
10.2
3.5
-3.2
-5.4
-14.5
-6
-10.9
-5.8
-2.4
-0.8
2.3
-4.4
6.9
Structures
13.8
8.2
12.1
3.6
-3.1
-8.4
2.9
-30.1
-14.2
-17.6
-21.4
-9.9
-2.9
4.8
Equipment and soft
15.5
10.9
0.9
-5.4
-6.3
-16.7
-9.2
-2.5
-2.7
3.3
6.7
6.2
-4.8
7.5
8.3
-3
-9.3
0
8.2
-0.5
0.4
-3.5
14.2
2.7
1.1
9.4
10.1
6
Exports
7.7
14.6
11.6
-4
-6
-12.4
-17.3
-9.6
3.5
14.3
4.6
-5.8
-1.3
-3.1
Goods
6.7
16.1
19.5
-7.1
-6.1
-16.1
-18.6
-7.9
-3.4
15.9
4.1
-11.5
1.9
-2.6
10.2
11.2
-5.9
4.4
-6
-2.5
-13.9
-13.8
21.7
10.7
5.9
8
-8
-4.2
Imports
14.7
18.6
13.8
-1.6
-7.9
-6.8
-11.8
-5.3
8.5
22.2
3.3
7.4
-6.2
9.2
Goods
13.7
20.3
13.6
-1.8
-9.2
-9.4
-9.6
-3.3
3.7
27.9
3.4
6.2
-6.7
15.7
Services
20.6
9.6
15.1
-0.5
0.3
8.5
-23.2
-16.5
35.7
-2.1
3.1
13
-4
-17.6
-1.2
4.6
-1
2.9
5.7
5.6
-1.1
10.5
5.6
1.4
2.9
4.6
0.4
7.5
-13.2
16
-7.2
2
9.5
6
1.2
13.5
7.4
7.5
4.3
11
0.7
25.1
-19.9
15
-6.1
4.7
8.3
2.7
4.6
14.3
11.6
7.8
6.9
11
-3.3
44.1
0.3
17.9
-9.2
-2.6
11.8
12
-4.5
12.1
0.4
6.9
-0.3
11.1
8.4
-4.1
Durable goods
Gross Priv. Investment
Residential
Services
Gov't expenditures
Federal
National defense
Nondefense
Jobless Recovery
Seasonally adjusted US unemployment rate
Source: BEA
Economy of Atlanta in the recession and jobless recovery
Source: BLS
A side-note: Job recovery in Atlanta
Employment changes in 000's in Atlanta and the US during the 18 month period
following the recession
Source: GSU Economic Forecasting Center
Atlanta
US
weekly
Sector
wages 1990-91
2001
1990-91
2001
Manufacturing
Local Government
Professional and Business services
Business services
Mgmt/Sci/Tech
Construction
Trade
Hospitality
Education and Health
Transportation
Information
Other Services
883
672
907
508
1304
818
460
324
704
739
1097
479
11
-3
20
10
1
0
7
8
11
7
8
3
-12
6
21
22
-1
2
0
6
9
-9
-6
18
-274
255
516
396
38
-152
-39
303
567
45
-25
42
-1011
25
-102
81
-3
17
-110
117
607
-97
-240
-10
total
739
79
33
1135
-699
Classical View
• The Invisible Hand logic
• Flexible Economy
–
–
–
–
Dominated by small firms
Recessionary pressure translates into deflation
Price mechanism as a corrective tool
Rapid price adjustments
• Say’s Law: Supply Creates Its Own Demand
Keynesian Points
• Price flexibility is too strong of an assumption
– Non-flexible input prices in the short-run leading to
output adjustments
• Decline in Expenditures Components of the
GDP (Aggregate Demand)
– The Thrift Paradox
– Consumption spending and other factors
• Under-Production as an equilibrium in the shortrun
Aggregate Framework
• (GPD) Income defined in terms of aggregate
expenditures
Y=C+I+G+X–M
• Consumption Function
C = a + mpc (Y – TAX)
– Induced versus autonomous expenditure
• Multiplier effect
1
a  mpc(TAX )  I  G  x  m
Y
(1  mpc)
Autonomous Expenditures
•
Independent of current income
Autonomous Consumption
–
•
Domestic Investment
–
•
Is not a function of current income,
but may be a function of future
income, expected profitability,
relative profitability, interest rate…
Government Spending
–
•
Consumption that does not depend
on current income but depends on
other factors (like future income,
confidence, subsistence needs)
Function of policy, and hence should
not be considered as induced
spending
Exports
–
Exports tend to be a function of
economic condition of the importing
country. The wealthier it is, the more
likely it is to purchase more
Induced Expenditures
•
Function of current income
Induced Consumption
– Consumption that is driven by current
income
•
Imports
– note that imports do depend on the
current income level. We will buy more of
all goods, domestic or foreign in our
incomes increase. Thus, it is an induced
expenditure, but we will ignore this in our
class and treat it as autonomous! There
are also other factors (other than income)
that influence imports: relative prices, and
hence the exchange rate, preferences…)
More on the multiplier – simple example
• Consider the following case
– The level of private consumption spending is 500 million
– The level of investment is 100 million
– Current government spending is 100 million
– Exports: 100 million; Imports: 50 million
• Given this information we can conclude that the level of the GDP is 750
million. Now imagine that the government wants to increase that level to
800 million. What can the government do?
– Natural conclusion is to increase the government spending by 50 million to
close the gap between the actual and targeted GDP, but that actually is
wrong. This ignores the multiplier effect. Assume that the MPC is 0.8, in other
words, 80% of the marginal dollar earned is directed into consumption, and
hence becomes an income to someone else. In this case, using the math
from our previous slides, the multiplier is 1/0.2=5. Thus, an increase in
government spending (autonomous expenditures component) will increase
the GDP by 5 times the initial change through the multiplication effect. In this
case, an increase in government spending of only 10 million to 110 million
would suffice.
More on the previous example
• Now consider the example from the previous slide, but assume that
the investment level declines by 5 million what will the implication to
the GDP will be and what should the government do?
– Note that investment is an autonomous component, and hence its
decline will create a multiplication effect. The total decline will be 25
million, hence the GDP declines to 725 million
– If the government selects to offset this change in investment spending
through government spending, the change would have to be exactly
equal to the drop in investment, i.e. 5 million. Note that although this
policy will cure the recession caused by the investment decline, it will
create another problem, the size of the government sector relative to the
private sector has just increased…
Further complication – note this slide will not appear on the
exam
• Now, let’s introduce income taxes….
• C = a + mpc (Y – t Y)
– Here t represents the income tax rate, the rest of the
function is the same
• The new multiplier is: 1/(1-mpc[1-t])
– Note that income tax tends to reduce the multiplier
effect as it increases the flow out of the consumption
cycle.
– Income taxes also present a second fiscal policy
instrument: change in taxes
• More complications can be introduced into the
model, but as you can see their introduction
does not complicate the math of the model
Multiplier
• Dollar spent on domestic consumption
becomes an income of domestic
workers/capital owners…
• Marginal propensity to consume – fraction
of the next dollar earned that will be
directed into consumption
• Multiplier = 1 / marginal leakage rate from the consumption stream
Representing Aggregate Framework as
Demand – Aggregate Demand
• GDP expenditures as Aggregate Demand
• Choice of axis variables: Output, Price Level
• Nature of the slope of AD
–
–
–
–
Wealth effect (real balances effect)
Interest rate effect
International substitution effect
Multiplier effect
Shifts in the AD
Anything that changes autonomous expenditures shifts the AD
• Consumer spending
– Expectations about future (consumer confidence)
• Investment
– Interest rate (foreign rates)
– Business confidence (stock market?)
• Exports/Imports
– Exchange rate
– Foreign economic conditions
– International regulations….
• Government Spending
– Fiscal policy
Aggregate Supply
• Long-Run
– Classical view
– Capacity level
– Long-term Growth
• Short-Run
– Fixed input prices
– Relationship between the price level and the
output: CPI and Q
equilibrium
• Long-Run and Short-Run
• Demand Driven Recession
– Deflationary pressure
– Long-run input cost adjustment
– Possible need for government intervention in the
short-run
• Supply Driven Recession
– Input cost rise
– Inflationary pressure
• Eliminating Recession through Demand Side
Policy
Fiscal Stabilization Policy
• Instruments
– Government Spending
– Taxes
– Transfers
– Budget
• Ability to be targeted
– State level
– Municipality level
Drawbacks of Fiscal Expansion
note that this is in chapter 30
• crowding-out effects [these refer to the replacement of
one sector by another, in the case of expansionary fiscal
policy, the public sector displaces the private sector]
– direct [direct provision. GSU reduces the demand for
Emory]
– indirect [this works through the interest rate
mechanism, expansionary fiscal policy results in
government borrowing, the current tax cut and budget
deficit is a perfect example of that, government
borrowing may lead to an increase in the interest rates
and hence higher costs for private sector investment]
– open-economy effect [an increase in the interest rate
due to government borrowing may cause an influx of
foreign investment and therefore drive up the value of
domestic currency]
– Time lags (decision, recognition, effect)
Ideally the second exam will be here
Monetary Side
MONEY
• Functions of money
– Medium of exchange
– Unit of account
– Store of value
• Measuring the supply of money (liquidity and
transaction principles)
– M1
• Cash, checking accounts, traveler’s checks
– M2
• M1+savings accounts, CD accounts, money market accounts
Money Creation by Banks
• Creation of money balances by banks
– Fractional reserve system and lending
– Money multiplier
• Potential
• Actual
• Regulatory institutions
– Federal Reserve Bank
– FDIC
Monetary Policy
• Federal Reserve Bank of the US (Central Bank)
• Goal of the Policy
– Influence consumption and investment spending
– Change the exchange rate  side effect more than a goal
• Policy Instruments
– Open Market Operations
– Discount Rate
– Reserve Requirements
• Policy Operating Targets
– Federal Funds Rate
• Weaknesses of the Policy
– Liquidity trap
– Recognition/time lags
3/2/05
1/2/05
11/2/04
9/2/04
7/2/04
5/2/04
3/2/04
1/2/04
11/2/03
9/2/03
7/2/03
5/2/03
3/2/03
1/2/03
11/2/02
9/2/02
7/2/02
5/2/02
3/2/02
1/2/02
11/2/01
9/2/01
7/2/01
5/2/01
3/2/01
1/2/01
Does Dollar Matter?
EURO/USD
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
Should We Be Concerned With The
Fluctuating Dollar?
• TRADE and Currency Fluctuations
– Price Changes
– Standard of Living
– Commodity Prices
Date
USD per EURO
USD Price of OIL
Euro Price of OIL
March 1, 2002
0.8652
22.40
25.89
March 3, 2003
1.0835
35.88
33.11
March 1, 2004
1.2431
36.86
29.65
March 1, 2005
1.3189
51.68
39.18
% change over the
period
52.44
130.71
51.35
The ForEx market
• Supply of the USD
– Imports to the US
• Goods (trade)
• Services (tourism)
– US investment abroad
• Foreign Financial
Markets
• Direct investment
abroad
– Central Banks
– Speculation
• Demand for the USD
– US Exports
• Goods
• Services (tourism)
– Foreign Investment
into US
• US Financial markets
• Direct investment
– Central Banks
– Speculation
The Interesting 90’s
• 1991-92: Collapse of the USSR Block, beginning of the Transitional
Recession in Eastern Europe
• 1994 Mexican Currency Crisis
• 1991(2)-95 The Balkan Wars
• 1998 Recession in Japan
• 1997 (July) Beginning of the Asian Financial Crisis
• 1998 major Rouble Crisis
US ECONOMY
average % rates
19922000
20012004
Real GDP
3.7
2.5
Gross Domestic Private
Investment
8.7
1.8
Non-Residential Investment
9.1
0.2
The market for USD in the 90’s
P of USD
Influx of investment stimulated Demand
D
S
Increase in imports stimulated Supply
Demand Effect Dominated
(thus positively effecting consumers’
standard of living)
The post 90’s era
• United Europe
– 10 New Countries Entered the Union on May 1st of
2004, bringing the total number of member states to
25, with combined population of over 430 million (US
population is 293 million).
•
•
•
•
•
Strong Growth in Russia and China
Emerging Economies of Brazil and India
Threat of Terrorism to the US
Continuous Growth in US Trade Deficit
More Recently, the French and Dutch
Referendums on the EU Constitution
The BIG picture
•
•
•
•
Rise in Imports  Increase in Supply  Depreciation
Rise in Exports  Increase in Demand  Appreciation
Influx of Investment  Increase in Demand  Appreciation
Outflow of Investment  Increase in Supply  Depreciation
• BALANCE OF PAYMENTS – An Economy’s International
Balance Sheet (www.bea.gov)
Balance of Payments
• Current Account
– Trade
– Income flow
• Financial Account
– Investment Flow
• Paying for Foreign Goods with Domestic Financial
Assets – the US Example
(US BoP)
Currency Trade and Exchange
Regime
(History – optional)
Floating Exchange Rate Regime
– Currency Trade by Central Banks
– (Forward looking instruments – optional)
Fixed Exchange Rate Regime
– Does Recent Dollar Depreciation Impact the Trade
Deficit with CHINA?
– Price Stabilization and Fixed Exchange Rate Regime
– Risk to CB