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Summary Lecture notes Week 1-3 - Intermediate Macroeconomics (ECB2VMAE) $5.57   Add to cart

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Summary Lecture notes Week 1-3 - Intermediate Macroeconomics (ECB2VMAE)

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Intermediate Macroeconomics (ECB2VMAE) Lecture notes weeks 1-3 Chapters 4, 5, 6, 7, 12, 14

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  • November 15, 2022
  • 31
  • 2020/2021
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Intermediate Macroeconomics Notes 2020-2021
WEEK 1:
Chapter 4: Exchange rates and the Balance of Payments
Exchange rates

E = nominal exchange rate

E = tells how much foreign currency can be exchanged for a unit of domestic currency




Depreciation occurs when there is an increase in E

Appreciation occurs when there is a decrease in E



R = real exchange rate

R = tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign
country.




e.g. ↑ prices US → you can buy less with your Euros from US




IS curve

,Balance of Payments

Balance of payments: detailed record of international transactions (i.e. Mirror image of foreign exchange market!)

 Three main components
 All three involve buying and selling of currency

1. Current account (CA) = represents a country's cross-border transactions of goods and services, payments made to
foreign investors, and transfers such as foreign aid.
2. Capital account (CP) =keeps track of the net change in a nation's assets and liabilities during a year. Capital
account's balance will inform economists whether the country is a net importer or net exporter of capital. – records
private financial transactions.
3. Official Reserves Account (OR) = Central Bank actions on FE market. Part of the capital account, are the foreign
currency and securities held by the central bank of a country and used to balance the payments from year-to-year.
The reserves increase in case of a trade surplus and decrease when there is a trade deficit.

 (+) sign for all transactions that involve purchase of domestic currency
 (-) sign for all transactions that involve sale of domestic currency

Double bookkeeping: Demand and supply of domestic currency always in balance

= FE market always clears

BoP = CA + CP + OR = 0

BoP surplus = CA-CP = OR

• Degree to which Central Bank intervenes in Foreign Exchange (FE) market
• Indicates degree to which exchange rate reflects market forces
• Fully flexible exchange rate → OR = 0 (when central bank refrains/stops from foreign exchange market
involvement)
• CA + CP = 0
• CA = -CP
• Shows how surplus or deficit on CA is financed!



IS-LM Model

• How to incorporate FE market into IS-LM model?
• BoP reflects demand and supply for currency
• Flexible exchange rate → OR=0
• CA = -CP or CA + CP = 0
• So we need to find a way to get CA and CP into IS-LM
• Include a curve that captures equilibrium on FE market in Y-i space

,Current Account




Note: An Exchange Rate Depreciation or a rise in World Income moves the CA up,
shifting the CA=0 line to the right




Capital Account

• Capital flows across borders in search for highest return
• Return on capital = i




When E depreciates  Exports>Imports  budget surplus

When E appreciates  Exports<Imports  budget deficit

, Equilibrium on FE market




FE curve = all combinations of Y and i where FE market is in equilibrium

FE curve positive slope

Start in point A. Assume ↑ in Y → increase imports → Deficit on CA

Need for capital import → surplus on CP

How to get more capital import → ↑ i → point B



Simplifying assumption for FE curve

CP = k ( i - iworld )

BoP = CA + CP = 0
i = iworld

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