1. Unit-5 Macro Review Phillips Curve, Balance of Payments & Foreign Exchange

2. Phillips Curve Natural rate of unemployment Long-run Phillips curve Unemployment Rate 0 Inflation Rate LONG RUN Phillips Curve B A 3.... and increases the inflation rate... Unemployment Rate (percent) 0 Inflation Rate (percent per year) SHORT RUN Phillips Curve Phillips curve B 4 6 A 7 2 In the short run, Inflation expectations does not = actual inflation

3. Balance of Payments Current Account –Import/Export payments on Goods & Services –Investment Income in/out of USA Capital Account –Foreign purchase of US assets –US purchase of foreign assets Equals (X-M) Trade Deficit when negative Trade Surplus when positive Official Reserves Fed holds quantities of foreign currency called reserves. These are used to eliminate any BOP deficit or surplus (sum of all 3 accounts must = zero)

4. Determinants of Exchange Rates 1. Changes in Consumer Tastes 2. Relative Income Changes 3. Relative Inflation 4. Relative Real Interest Rates 5. Speculation & Investment U.S. Income Rises Demand Imports Demand Foreign Currency

5. Euro Price of a dollar Qty of Dollars D1D1 S1S1 --------------.75 Euro Q1Q1 Graphing Exchange Rates Fed raises interest rates => D2D2 Europeans invest more in USA => Demand for dollars ↑ => Dollar appreciates Dollar Price of a Euro Qty of Euros D1D1 S1S1 -------------- 1.3 $ Q1Q1 S2S2

6. Suppose the Gov’t uses expansionary Fiscal Policy: Goal to get AD shift right US goods become more expensive US Dollar appreciates AD shifts left NET EXPORT EFFECT If Gov’t policy leads to crowding out, then interest rates rise in USA Conclusion Expansionary Fiscal policy is less effective when: a) crowding out occurs b) it leads to an appreciating dollar

7. Tariffs & Quotas Revenue Tariff - designed to raise revenue Protective Tariff – designed to protect domestic market Quotas- limit # of goods imported D S ------------- ------------ P US Market (Wheat) Price World Price: when below domestic price we import World Price: when above domestic price we export

8. Tariffs & Quotas: will always produce deadweight loss and lower consumer surplus lead to higher prices & protect inefficient producers D S domestic ------------- ------------ P World Qty (Wheat Price S World S Tariff