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Lecture 3

POLSCI 2J03 Lecture Notes - Lecture 3: Foreign Direct Investment, Economic Stagnation, Money Market Fund

Political Science
Course Code
Richard Mc Master

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Foreign exchange rate (FX)
o Relative value of currency
Purchasing price parity (PPP)
o Relative cost of goods and services
o Currency is more valuable relative to other currencies
o Currency less valuable relative to other currencies
Inflation occurs with depreciation, a loss of PPP, and a loss of GX value
What are the reasons for Inflation?
Too much capitol
Too much industry (controversial)
o Goes back to Freidman and the monetary supply
o Looks at capitol flows in global economy, it’s the manipulation of
other countries currencies
o Investors try to cause a currency to depreciate, once value is really
low, then they start buy all this currency back and profiting lots of
o Perception of depreciation (sell)
o Depreciation then occurs (buy)
Increased prices
Loss of savings
o Because of higher cost of living
Foreign investment drops
Decrease in exports
o Less capitol available because its to expensive
Inflation Rate
Seen as a percentage change in the consumer price index (CPI) of specific
categories including:
o Food/processed food/beverages/housing/clothes
Expressed as a typical cost to the consumer
What was Indonesia’s inflation rate between 2000-2007
o CPI for 2000 = 100
o CPI for 2007 = 188
o (188-100/100) x 100 = 88%
o Usually % over 12 month or 1 month period
Prone to volatility (swings), but has potential to be managed

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o In Indonesias case, theres 30 years of relative stability, but in 1960’s
you have a hike of almost 1000% (result of genocide, revolution
against dictator etc)
Interest Rates
o 5 of the principle paid by the borrower
o Set by national governments of national bank
o Increase with inflation therefore they make money more expensive,
restrict the capital mobility assuming that it’s the widespread
availability thats causing the inflation, but if we draw money into
banks then we will see a relative appreciation of currency, increase in
PPP, and the decrease of prices of commodities.
o Raises value of currency
o Diminishing investment within economies because of interest rates
o Greater attraction to your currency
o Economic stagnation (lack of business hiring people/no investment
into companies)
Mundell Fleming Model
A state cannot do all three of theses things, they can just pick 2 of these and
try to promote _____ :
o Independence of national monetary policy
Ability of a state to printing money/setting interest rate
o Stabilize exchange rates
By Pegging (the value of my currency, will not change between
2 and 3 quarters of a percentage of this currency)
o Permit unrestricted inward and outward capitol flows
Global finance
Balance of Payments:
The nations economic relationship with the rest of the world
Measured by Current and capital account balances (ability to invest capitol
into other countries)
Current account leads to two things, outputs (exports) and absorption (imports).
Outputs leads to Surplus (outputs are high; you will have a positive balance of
payments, exporting more than you import; you have greater ability to invest it
elsewhere) and creditor (extend credit throughout the world. Absorption leads to
Deficit (not have a surplus of capitol; more country money has to go to getting
imports from other countries) and Debtor (you do not have capitol in your account
to extend credit, you become a debtor and need someone else to pay for your credit)
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