1. Lecture 24: Interest Rates, Exchange Rates & The Balance of Payments
Benjamin Graham
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

2. Housekeeping New syllabus is posted 3 Khan academy videos for Friday
Why start with supply and demand?
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

3. Reading Quiz (1)
How would you describe the interest rates the U.S. government was paying on its debt in 2012 (and currently):
a. Historically low
b. Historically high
c. Historically average
d.Extremely volatile -- i.e. historically high some months, historically low others
Lecture 13: Balance of Payments Benjamin Graham

4. Reading Quiz (2)
If a country is running a current account surplus, then...
a. The deposits in the current account exceed what is necessary to cover foreign exchange liabilities.
b. It is exporting more than it is importing
c. It is importing more than it is exporting
d. It has more savings in the current account than the past account.
Lecture 13: Balance of Payments Benjamin Graham

5. Reading Quiz (3)
The Trump administration wants to renogiated NAFTA in ways that reduce the US trade deficit with NAFTA countries. Which statement is true:
A. The US is currently running a trade deficit with both Mexico and Canada
B. The U.S. is currently running a trade deficit with Mexico and a trade surplus with Canada
C. The U.S. is actually already running a trade surplus within NAFTA, it is just China with whom we have a large trade deficit
D. NAFTA doesn’t actually affect the trade deficit, so this whole debate is a bit of a red herring
Lecture 13: Balance of Payments Benjamin Graham

6. Review Question: Who controls the money supply in the US?
A. The federal reserve (i.e. the central bank)
B. The executive branch
C. Congress
D. Both Congress and the Executive Branch
Lecture 13: Balance of Payments Benjamin Graham

7. Causes of Inflation and Deflation
If the supply of money increases slower than the supply of other goods/services, we get deflation
1896 Cross of Gold speech
If the money supply increases faster than the supply of goods & services, we get inflation
This is common with fiat currencies
One of the greatest speeches in american history, and its on... bimetalism
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

8. Dollar-Gold System (1946-1971)
After WWII, trade was growing quickly, supply of gold was not
We didn’t want deflation
Bretton Woods: Dollar became international reserve currency
Instead of being backed by gold directly, other currencies were back by dollars
By 1965, there were more dollars overseas than gold in U.S. reserves
In 1971, Nixon announced the U.S. would no longer redeem dollars for gold
Dollar becomes a fiat currency
No intrinsic value
Not exchangeable for anything else at a fixed rate
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

10. Inflation and Fiat Currencies
1:4 before WWI, 1-1 trillion in 1923.
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

11. Interest Rates and Inflation
Nominal interest rate:
How much do I have to pay you next year tomorrow to get money today?
Real interest rate = nominal interest rate - inflation
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

12. Clicker Question
If I have a mortgage at a 3.5% nominal interest rate, and inflation is 2%, what is my real interest rate?
A. 0%
B. 1.5%
C. 2%
D. 3.5%
E. 5.5%
What about if inflation went to 5%?
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

13. Interest Rates and the Money Supply
If interest rates are low, people borrow more
Money comes out of banks (MB) and becomes cash in people’s hands (M0)
Velocity of money increases
If interest rates are high, people save
Money goes out of people’s hands (M0) and into banks (MB)
Velocity of money slows
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

14. Inflation and the Economy (key points)
Low real interest rates stimulate the economy (i.e. cause growth).
Firms borrow money and buy factories, etc
Low interest rates cause inflation
They increase the money supply (via the velocity of money)
However, governments in debt may want inflation for its own sake
Federal Reserve is politically independent
Dual mandate: Keep inflation low and unemployment low
These two things are tradeoffs
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

15. Philipps Curve
One of the greatest speeches in american history, and its on... bimetalism
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

16. The big bad Fed
Politicians are too willing to trade inflation later for growth and low unemployment now
So we don’t want them in control
But the Fed is undemocratic and super powerful
So Ron Paul is freaked out about that
And they make a good scapegoat
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

17. The Volcker Disinflation
In 1979, inflation was at 9%
Volcker cranked up the interest rate, drove down inflation
But it hurt a lot
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

18. Exchange Rates The U.S. has a “floating” exchange rate
Some other countries peg to the U.S. Dollar
Upside: stability, which allows borrowing & investing
Downsides: 1. no flexibility to have inflation during recessions
2. Currency crises
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

19. Currency Unions Many countries use the Euro, some use the US Dollar
An unbreakable peg
Upsides: stability, ease of borrowing & trade
Downsides: No inflation during recession
Also M3, which includes some other large time deposits and long-term deposits
Lecture 12: Money, Exchange Rates, and Interest Rates Benjamin Graham

20. Current Account Balance
X-M
Exports - Imports
Y - (C + I + G)
Total income – (private consumption + investment + government spending)
A current account surplus is when exports are greater than imports
A current account deficit is the reverse
Note: The government’s surplus/deficit is T - G
(taxes - government spending)
This is different that the current account balance, but it affects the current account balance
Also M3, which includes some other large time deposits and long-term deposits
Lecture 13: Balance of Payments Benjamin Graham

21. Capital Account Balance
Current Account refers to goods and services (trade)
Capital account refers to capital
If you run a current account deficit you have to borrow to cover it
That borrowing is a capital account surplus (take in more capital than you send out)
And vice versa
Also M3, which includes some other large time deposits and long-term deposits
Lecture 13: Balance of Payments Benjamin Graham