Dollar Appreciation & Purchasing Power Parity

Dollar appreciation 

• each dollar gets you more of the other currency 

• more of the foreign currency is needed to buy each dollar 

• U.S. exports get more expensive for foreigners 

• U.S. imports gets cheaper for us 

• exports decrease 

• import increase

• GDP decrease 

• demand for the U.S. Dollar will increase 

• supply of the U.S. Dollar will decrease

Dollar depreciation 

• each dollar gets you less of the other currency 

• exports increase

• imports decrease 

• gdp increase 

• U.S. exports gets cheaper for foreigners to buy

• U.S. imports gets more expensive for the U.S. 

• demand for the U.S. Dollar will decrease

• supply for the U.S. Dollar will increase

Supply of the U.S. Dollar comes from:

• U.S. citizens 

• banks

• industries wanting to make foreign purchases

• investment 

• assets 

• and by making transfer payments to foreigners 

Demand of the U.S. Dollars comes from:

• foreigners

• banks

• industries wanting to purchase our goods

• investments

• assets

• make transfer payments to us 

purchasing power Parity

•When the currency rates are set by national markets, currency will be changed by the purchasing power parity

• markets will adjust quickly with floating rates, our pressure for change will change in currency change 

Why do we have exchange currency?

1. Sell exports and buy imports 

2. Invest in another's country's stocks and bonds

3. Build factories or stores in other countries 

4. Speculate on currency values 

5. To hold currencies in bank account for future exports, imports, and business loans 

6. To control excess imbalances

        -the fed controls the imbalances via the balance of payments 

Foreign Exchange

Foreign exchange (FOREX)

• the buying and selling of currency 

• the exchange rate (e) is determined in the foreign currency market 

       - ex. The current exchange rate is approximately 77 Japanese yens to 1$

• simply put the exchange rate is the price of a currency 

• do not try to calculate the exact exchange rate 

Tip

• always change the D line on one currency graph, the S line on the other currency's graph

• move the lines of the two currency graphs on the same direction (left or right) and you will have the correct answer

• if D on one graph, S in the other will also increase 

• If D moves to the left, S will move to the left on the other 

Changes in Exchange Rates

• exchange rate (e) are a function of the supply and demand for currency 

       - an increase in the supply of a currency will make it cheaper to bye one unit of that currency 

       - a decrease in supply of a currency will make it more expensive to but one unit of that currency 

       - an increase in demand for a currency will make it more expensive to buy one unit of that currency 

        - 

Appreciation 

• appreciation of a currency occurs when the exchange rate of that currency increases (e^)

       - hypothetical: 100 yens used to buy 1$

Depreciation

• depreciation of a currency occurs when the exchange rate of that currency decreases (e down)

Exchange rate determinants

• consumer tastes

       - the increase in demand of the ten leads to the appreciation of the yen 

        - the increase in the supply of dollars 

• relative income. 

       - imports tend to be normal goods

       - this increases the demand for the dollar, causing the dollar to appreciate and the peso to depreciate 

• relative price level

• speculation

The Balance of Payments

• measure of money inflows and outflows between the United States and the rest of the world (ROW)

     - inflow = credit

     - outflow = debit

• balance of payments is divided to 3 parts 

       - current account

       - capital/financial account 

       - official reserves account 

Double entry bookkeeping 

• every transaction in the balance of payments is recorded twice in accordance with standard account practice

      - Ex. U.S. Manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland

             . A credit of $50 mil. To the current account 

             . A debit of $50 mil to the capital/financial account l

      - notice that the two transactions offset

Current account 

• balance of trade or net exports 

       - exports of goods/services - import of goods/services

       - exports create a credit to the balance of payments 

       - imports create a debut to the balance of payments 

• net foreign income 

       - income earned by U.S. Owned foreign assets - income paid to foreign held US assets

      - ex. Interest payments on US owned Brazilian bonds - interest payments in German owned US treasury bonds

• net transfers ( lend to be unilateral)

      - foreign aid -> a debut to the current account 

Capital/financial account 

• the balance of capital ownership

• includes the purchase of both real and financial assets 

• direct investments in the United States is a credit to the capital account 

      - ex. The Toyota factory in San Antonio

• direct investment by U.S. Firms/individuals in a foreign country are debits to the capital account 

• purchase of foreign financial assets represents a debit to the capital account 

      - ex. Warren buffet buys stock in petrochina

• purchase of domestic financial assets by foreigners represents a credit to the capital account 

Relationship between current and capital account 

• remember double entry bookkeeping?

• the current account and capital account should zero each other out 

• that is... If the current account has a negative balance (deficit), then the capital account should then have a positive account (surplus)

Official reserves 

• the foreign currency holding of the United States federal reserve system

• when there is a balance of payments surplus. Des accumulates foreign currency and debits the balance of payments 

• when there is a balance of payments deficit the fed depletes its reserves of foreign currency and credits the balances of payments 

• the official reserves should zero out the balance of payments 

Active v passive official reserves 

• the United States is passive in its use of official reserves. It does not seek to manipulate the dollars exchange rate 

• the people's republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States 

•Goods and service exports - goods and services imports

• unofficial way of trade: good exports + goods imports 

• informal: Goods imports + service imports 

• Current account = balance of trade + net investments + net transfers 

• capital account = foreign purchases of U.S. Assets + US purchases of assets abroad 

• official reserves = Capitol account balance + current account balance

Unit 5 and 6 - Philips curve & supply side economics

Phillips curve

•Represents the relationship of unemployment and inflation

• LRPC: 

      - occurs on the natural rate of unemployment

      - represented by a vertical line 

      - not trade between unemployment and inflation in the long run. Means economy produces at the full employment level

     - long run Phillips curve will only shift if the LRAS shifts

     - the major LRPC assumption is that more worker benefits create higher natural rates and fewer benefits lower natural rates.

•SRPC:

     - a trade of with inflation and unemployment in the short run

               . inverse relationship

     - has relevance with okun's law

     - since wages are sticky, inflation changes move the points on the SRPC

    - if inflation persist and the expected rate of inflation rises, then the entire SRPC moved upward which causes the situation called stagflation 

    - if inflation expectation drop due to new technology or economic growth then the SRPC moves downward

Aggregate supply shocks

   - causes both the rate of inflation and rate of unemployment to increase

   - is a rapid and significant increase in resource cost 

Misery index

• a combination of inflation and unemployment in any given year

• single digit misery is good 

Long run Phillips curve (LRPC)

• because the long run Philips curve exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un will also cause LRPC to shift

• increases in Un, will shift LRPC ->

• decrease in Un will shift LRPC <-

Supplied side economics 

• it is the belief that the AS curve will determine will determine the levels of inflation, unemployment, and economic growth. 

• to increase the economy, shift AS curve to the right ->

• supply side economists focus on the marginal tax rate

      - marginal tax rate: the amount paid on the last dollar earned or on each additional dollar earned

• they believe lower taxes are incentive for a business to invest in the economy

• also believe lower taxes are an incentive for workers to work hard there by becoming more productive

• lower taxes are incentives for people to increase savings and therefore create lower interest rates, which causes an increase in business investment

1. Supply side economist support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provides disincentives to work, invest, innovate, and undertake entrepreneur ventures. 

• also called Reaganomics 

     - lowered the marginal tax rates to get the US out of recession. -> deficit 

Laffer Curve

• it is used to support the supply side argument

• as race rates increase from 0 tax revenues increase from 0 to maximum number than decline

Criticism 

1. Research suggest that the impact of tax rates on incentives on work save and are small

2. Tax cuts also increase demand, which can fuel inflation. Thus creating a situations where demand exceeds supply

3. Where the economy is actually located on the curve, is difficult to determine 

Types of money

• commodity money

• representative money

•fiat money

   - not backed by legal money

   - backed by govt word

Functions of money

•medium of exchange 

    - through money you exchange

•Store of value

• unit of account

     -P = worth (quality)

Time to short, for wages to adjust to the price level

• rational: workers may not be aware of changes in their real wages due to inflation and have adjusted labor supply decisions in wage demands accordingly. 

Nominal wages 

• is the amount of money received per hour, per day, or per year

sticky wages

• nominal wage level that is set according to an initial price level and does not vary 

•Keynesian range

     - price level: fixed

     - wage level: fixed

     - unemployment is flexible

     - implications: output depends upon change in employment 

• intermediate 

     - price level: flexible

     - wage level: fixed

     - unemployment level: flexible

     - implications: output depends upon changes in price level and employment 

• classical range

     - price level: flexible

     - wage level: fixed

     - unemployment level: fixed 

     - implications: output depends upon change in price level

LRAS

Time long enough for wages to adjust to the price level

Assumptions

1. Price 

2. Changes in wage and price level offset each other