1 Welcome to EC 382: International Economics By: Dr. Jacqueline Khorassani Week Ten

2 Week Ten: Class 1 Tuesday, November 6 Tuesday, November 6 14:10-15:00 AC :10-15:00 AC 202 Some of you noticed that I did not post the study guide until last night Some of you noticed that I did not post the study guide until last night –Glad somebody noticed!

3 Collect Assignment (OCA1) Needs to be typed Needs to be typed It has 20 points It has 20 points You work on this alone You work on this alone –No duplicates –Duplicates receive zero marks

4 Question 1 Visit the WTO’s web page at wto.org to answer the following questions: a)Is Iran a member of WTO? How about Iraq? b)Which country is the newest member of WTO? c)Is the following statement true or false? Explain. “WTO is for free trade at any cost.” d)Is the following statement true or false? Explain. “The voting power of a nation that is a member of WTO depends on its GDP.” e)What was the size of the WTO’s budget last year?

5 Question 2 Search the web (or elsewhere) for at least Two examples of countervailing and/or antidumping duties imposed by Ireland or Europe in the recent years. Name the products and their exporting countries and the nature of the imposed duties. Clearly list your sources.

6 Last class I gave you an ICA I gave you an ICA Let’s look at it again Let’s look at it again

7 ICA 5: Find (1) merchandise balance, (2) goods and services balance, (3) current account balance, (4) capital account balance and (5) statistical discrepancy in Ireland 1. Ireland exports €50 worth of shoes 2. A German tourist gets a hair cut in Galway (€30) 3. Ireland imports €100 worth of TVs 4. Irish government sends €10 worth of aid to Afghanistan 5. A Japanese buys €90 Irish government bond 6. An Irish tourist goes to movies in Germany (€15) 7. An Irish buys a €55 German bond.

8 Key to ICA5 1. Merchandise Account has two items in it 1.Ireland exports €50 worth of shoes 2.Ireland imports €100 worth of TVs ► Merchandise Balance = = -50

9 Key to ICA5 2. Goods and Services Account includes merchandise account plus 2 additional items 1.A German tourist gets a hair cut in Galway (€30) 2.An Irish tourist goes to movies in Germany (€15) ► Goods and Services Balance = – 15 = -35

10 Key to ICA5 3. Current Account includes goods and services plus gifts ► Irish government sends €10 worth of aid to Afghanistan ► Current Account Balance = = - 45

11 Key to ICA5 4. Capital Account includes 1.A Japanese buys €90 Irish government bond 2.An Irish buys a €55 German bond ► Capital Account Balance = =35

12 Key to ICA5 5. We know that Balance of Payments = 0 Current Account Balance + Capital Account Balance +Statistical Discrepancy = Statistical Discrepancy = 0 Statistical Discrepancy= 10 Statistical Discrepancy= 10

13 Exchange Rates and Their Determination: A Basic Model CHAPTER 13 Note: See the Study Guide for the topics you should know. If you have a question, ask me.

14 What is the exchange rate? Value of one currency in terms of another currency Value of one currency in terms of another currency Spot rate = rate for transaction on spot Spot rate = rate for transaction on spot Is the exchange rate flow or stock?

15 Has dollar appreciated or depreciated? Yesterday the spot rate was Yesterday the spot rate was €1 = $1.43 Today the spot rate is Today the spot rate is €1 = $1.53 Dollar has depreciated Dollar has depreciated

16 What is the rate of depreciation of dollar? %Δ = ( )* 100 /1.43 = -7% Dollar depreciated by 7%

17 Euros per Dollar: What is causing these fluctuations?

18 Average yearly exchange rate of euro $ in 1999 $ in 1999 $ in 2000 $ in 2000 $ in 2001 $ in 2001 $ in 2002 $ in 2002 $ in 2003 $ in 2003 $ in 2004 $ in 2004 $ in 2005 $ in 2005 $ in 2006 $ in 2006

19 Demand and Supply Forces Affect the Exchange Rate. Foreign Exchange Market Foreign Exchange Market 1.Demand Curve Shows the quantity demanded for a currency by residents of another country at different exchange rates. Shows the quantity demanded for a currency by residents of another country at different exchange rates. 2.Supply Curve Shows the amount of a currency supplied at a different exchange rates. Shows the amount of a currency supplied at a different exchange rates.

20 Consider demand for euro by Americans Why will Americans demand euro? Why will Americans demand euro? To import European goods and services To import European goods and services To buy European bonds/stocks To buy European bonds/stocks To sell the euros later or in a different location for profits To sell the euros later or in a different location for profits

21 The Demand for euro euros $/€ Demand for Euros $1 $2 $3 € 1 € 2 € 3

22 Shifts: What if US GDP goes up? Euros $/€ Demand for euros D1D1 D2D2 US income goes up  Demand  D1

23 International Economics Week Ten –Class 2 Week Ten –Class 2 –Wednesday, November 7 –11:10-12:00 –Tyndall

24 Shifts: What if US Prices go down? Euros $/€ Demand for euros D1D1 D2D2 Americans buy fewer European goods  Demand goes down  D 2

25 Shifts: What if interest rates in Europe go up? Euros $/€ Demand for euros D1D1 D2D2 US residents would want to buy more European bonds Demand  D1

26 Consider supply of Euro by Europeans Why will Europeans supply euro? Why will Europeans supply euro? To importers American goods and services To importers American goods and services To buy American bonds/stocks To buy American bonds/stocks To sell later or in the different location for profits To sell later or in the different location for profits

27 The Supply of Euros Supply of Euros euros $/€ $1 $2 $3 €1€1 €2€2 €3€3

28 Shifts: What if European’s income goes up? Supply of Euros Euros $/€ S1S1 S2S2 Europeans will want to buy more American goods  Supply of euro goes up to S 1

29 Shifts: What if Europeans expect euro to appreciate further in the near future? Supply of Euros Euros $/€ S1S1 S2S2 Europeans will supply less now  Supply of euro goes down to S 2

30 Equilibrium Exchange: Equilibrium Exchange: –The exchange rate where the quantity demanded of foreign exchange equals the quantity supplied. In our examples, the amount of euros U.S. residents want to buy equals the amount of euros Europeans want to sell. In our examples, the amount of euros U.S. residents want to buy equals the amount of euros Europeans want to sell. Equilibrium in the Foreign Exchange Market

31 Equilibrium Exchange Rate Supply of Euros $/Euro Euros Demand for Euros

32 What if Europe’s GDP goes up? Supply of Euros $/Euro Euros Demand for Euros Supply of euro goes up to S1 S1 Euro depreciates

33 What if US prices go up and EU prices don’t Supply of Euros Demand for Euros $/Euro Euros D1 S1 Demand goes up because Americans would want to buy more European goods Supply goes down because Europeans buy fewer American goods Euro appreciates

34 Are fluctuations in the value of a currency good or bad for the economy? No surplus/ shortage No surplus/ shortage –Good

35 But fluctuations in the value of a currency discourages international trade or investment. I order a US car today for $30,000 I order a US car today for $30,000 Delivery and payment in 6 months Delivery and payment in 6 months In 6 months, what if $ appreciates against euro? In 6 months, what if $ appreciates against euro? I have to spend more euros than expected. I have to spend more euros than expected. Uncertainty  discourages international trade Uncertainty  discourages international trade –Bias toward trade within a nation

36 But wait; there is a solution I can buy dollars in a forward market. I can buy dollars in a forward market. –Sign a contract today to buy $30,000 in six months for €0.8 per dollar. There is a fee involved There is a fee involved

37 International Economics Week Ten - Class 3 Week Ten - Class 3 –Wednesday, November 7 –15:10-16:00 –AC 201

38 Need reasonably accurate forecasts for country’s Need reasonably accurate forecasts for country’s –GDP –Inflation –Interest rate The supply/demand model is good for general comments about exchange over the medium to long run. The supply/demand model is good for general comments about exchange over the medium to long run. Fluctuating exchange rates have led to an industry of forecasters.

39 Money, Interest Rates, and the Exchange Rate CHAPTER 14

40 Anything that can be used for final discharge a debt. Anything that can be used for final discharge a debt. –Credit card is not money –Balance in checking account is money –Coins and currency are money What is money?

41 What can money be used for? 1) Medium of Exchange What is the main problem with barter economy? What is the main problem with barter economy? –It requires double coincidence of wants. 2) Unit of Account Measure and compare values Measure and compare values Makes economic transactions easier to compare Makes economic transactions easier to compare

42 3)Store of Value Save now spend later Save now spend later Smoothes inconsistencies between money earned and money spent Smoothes inconsistencies between money earned and money spent Note: Individuals in high inflation countries my keep other currencies or goods as a store of value. Note: Individuals in high inflation countries my keep other currencies or goods as a store of value. What can money be used for?

43 Coins and paper currency act as primary mediums of exchange – money. Coins and paper currency act as primary mediums of exchange – money. Demand deposits held at banks and depository institutions provide the same function as currency – money. Demand deposits held at banks and depository institutions provide the same function as currency – money. What is the Supply of Money? What is the Supply of Money?

44 M1: M1: Is total quantity of currency plus demand deposits (narrow money, internationally). Is total quantity of currency plus demand deposits (narrow money, internationally). There are broader measures of money such as M2, M3,…etc. They include other (less liquid) assets. There are broader measures of money such as M2, M3,…etc. They include other (less liquid) assets. M1<M2<M3 M1<M2<M3 The Supply of Money

45 What is Monetary Base (B)? Cash held by the public (C) and the total quantity of bank reserves (R) on deposit at central bank Cash held by the public (C) and the total quantity of bank reserves (R) on deposit at central bank

46 The percentage of deposits (r) banks are legally required to keep on deposit with the central bank The percentage of deposits (r) banks are legally required to keep on deposit with the central bank What is Reserve Requirement ?

47 What is Money Multiplier (MM)? The reciprocal of the reserve requirement The reciprocal of the reserve requirement MM = 1/r Money supply (M1) is equal to the monetary base multiplied by the money multiplier. Money supply (M1) is equal to the monetary base multiplied by the money multiplier. MS = M1 = 1/r * B MS = M1 = 1/r * B

48 Example Example €80 = Cash in hands of the public €80 = Cash in hands of the public €230 = Bank Reserve €230 = Bank Reserve Required reserve = 0.1 Required reserve = 0.1 What is MS? What is MS? MS = 1/0.1 * (310) MS = 1/0.1 * (310) MS = 3100 MS = 3100

49 Monetary policy   Refers to central bank changing money supply by changing the monetary base and/or the money multiplier. MS = M1 = 1/r * B MS = M1 = 1/r * B   MS ↑ if   B↑ or if   r↓

50 1. Change the interest rate banks pay on borrowed money from the central bank Discount Rate (US), Marginal Lending rate (Europe): Discount Rate (US), Marginal Lending rate (Europe): Lower interest rate  increase in borrowed reserves  B ↑  MS↑ Lower interest rate  increase in borrowed reserves  B ↑  MS↑ How can the central bank change B or r?

51 2. Changing reserve requirement (r): Lower reserve requirement means banks could make more loans. Lower reserve requirement means banks could make more loans. –If r ↓  MM↑  MS↑ Rarely used b/c effect too powerful Rarely used b/c effect too powerful How can the central bank change B or r?

52 3. Open Market Operations, refinancing : Buying and selling bonds by central bank Buying and selling bonds by central bank If the central bank buys bonds, money is given to bond seller (public or bank) and more money is in the economy  B ↑  MS↑ If the central bank buys bonds, money is given to bond seller (public or bank) and more money is in the economy  B ↑  MS↑ How can the central bank change B or r?

53 Money Supply Curve Interest Rate (i) Money (M1) MS 2 MS 1 Money Supply (MS) Controlled by the central bank Expansionary monetary policy Contractionary monetary policy