LGS 200 Lecture Notes - Lecture 19: Loanable Funds, Real Interest Rate, Foreign Exchange Market

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yellowcattle867

9 May 2017

School

University of Alabama

Department

Legal Studies

Course

LGS 200

Professor

Tripp

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Document Summary

The market for loanable funds: an identity from the preceding chapter: S = i + nco (saving) = (domestic income) + (net capital outflow: supply of loanable funds = saving, a dollar of saving can be used to finance. The purchase of a foreign asset: so, demand for loanable funds = i + nco, recall: S depends positively on the real interest rate, r. How nco depends on the real interest rate: the real interest rate, r, is the real return on domestic assets, a fall in r makes domestic assets less attractive relative to foreign assets. People in the us purchase more foreign assets. The loanable funds market diagram: r adjusts to balance supply and demand in the loanable funds market, both i and nco depend negatively on r, so the demand curve is downward- sloping. The market for foreign-currency exchange: another identity from the previous chapter: Nco = nx (net capital outflow) = (net exports)

Related Questions

2.) In a simple economy (assume there are no taxes; thus, Y is disposable income), the consumption is C=50+0.80 Y. The current level of real GDP is $3000.

At this level of real GDP, consumption will be $___, and savings will be $___. If GDP were to increase by $1000, consumption would increase by $___. (Round off response to nearest dollar.)

At a real GDP level of $3000, the average propensity to conumer is $___, and the average propensity to save is ___. (Round off response to nearest dollar.)

11.) In the short run, if the economy has a recessionary gap, an increased government deficit resulting from higher government spending or lower taxes is most likely to :

a) increase aggregate demand, which will move the economy toward full employment real GDP

b) have no effect on aggregate demand or real GDP after direct and indirect offsets are counted

c) increase aggregate demand, raising prices and creatring an inflationary gap

d) decrease aggregate demand, reducing prices and increasin the recessionary gap

14.) The Federal reserve purchases $9 million in uS Treasury bonds from a bond dealer, and the dealer's bank credits the dealer's account. The required reserve ratio is 17 percent , and the bank typically lends any excess reserves immediately. Assuming that no currency leakage occurs, calculate how much much will the bank be able to lend to its customers following the fed's purchase. $ __ million. (round off to 2 decimal points)

18.) According to the quantity theory of money, the prices, a -3% change in the money supply, holding other variables constant leads to a

a) -3% changee in real GDP

b) -3% change in the interest rate

c) -3% change in the price level

d) a greater than -3% in real GDP

24. Over the course of a year, a nation tracked its foreign transactions and arrived at the following amounts:

Merchandise exports 500

service exports 75

net unilateral transfers 10

domestic assets abraod (capital outflows) -200

foreign assets at home (Capital inflows) 300

changes in official reserves -35

merchandise imports 600

service imports 50

This nations' blance of trade is ______

Its current account balance is ______

The nation's capital account balance is _____

27. Major discoveries of the highest-quality dia-monds ever found occur in Russia andCentralAsia, causing a significant decline in purchases ofSouth African diamonds. Moreover, assume a floating exchange rate.

Describe how the market for the rand is impacted by this event. Will demand shift to the left? Will supply remain the same? Or will supply change?

1. Why Niall Ferguson thought that the expansionary fiscal policy (or government deficit) could produce crowding-out effect? You can explain by using the IS-LM model or you can use the logic of loanable funds theory.

Niall Ferguson believed that expansionary fiscal policy could produce a crowding-out effect. Ferguson believed that if the government tried to increase demand during the crisis it would cause the real interest rate to increase. He theorized that if the government tried to boost the economy through deficit spending it would cause the interest rate to rise, which in turn would crowd-out investors and consumers. The interest in the deficit would lead to an increase in the demand for loanable funds, which would lead to an increase in interest rates. Ferguson stated "The lesson of economic growth is very clear. Economic growth does not come from state-led infrastructure investment. It comes from technological innovation, and gains in productivity, and these things come from private sector, not from the state."

2. Why Paul Krugman thinks that Niall Ferguson was wrong and thought that government deficit could not produce a crowding-out effect? In other words, please explain Krugman's Liquidity trap .

Paul Krugman disagreed with Ferguson and believed that the government deficit could not produce a crowding out effect. Krugman's liquidity trap: Private demand is so low that even if the short-term interest rate is 0% spending is less that what is needed for full employment. Normal monetary policy of the central bank purchasing short-term debts with new money is ineffective. Krugman argues that a major issue during the crisis was people wanting to save money combined with the private sector being far less likely to invest. He referred to this a "savings glut". It was argued that the federal reserve was playing the part that the private banking system through buying private securities and the federal government was playing the roll that business wasn't by engaging in investment. Due to the liquidity trap excess demand for savings is not going to drive interest rates up. Krugman stated " Government borrowing gives some of those excess saving a place to go and in the process expands overall demand, and hence GDP. It does not crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap."

3. In the discussion, other discussants such as George Soros and Robin Wells pointed out some interesting issues. Please provide at least one thing that you agree and one thing that you disagree. Discuss in details why you think so.

I agree with Soros view that the publics view of the financial markets has been forever changed. " Financial markets namely that they tend toward equilibrium, and that equilibrium is disturbed by extraneous forces, outside shocks. But the finical system collapsed of its own weight." I feel like this is a situation in which it takes a very long time to build trust, but that trust can be lost instantly. The crash has challenged the felling of security that people once felt in the banking system. The idea of the market regulating itself is fading, it wasn't until the government stepped that people felt reassured in the banking system. I believe this will lead to a period of government regulation that wouldn't have arose without this change in view. I disagree with robin Wells' view that the US needs to shift towards protectionism. I believe that free trade is good for everyone as long as there is a comparative advantage. If the US moves toward protections as a result of the deficit it will slow economic growth and place us at a disadvantage compared to countries with free trade. Not to mention consumers in the US will be placed with the burden of higher prices on goods.

Please make comments to the discussion I provided above(at least 300 words). And you can start with "I agree with you on some points... But I disagree with you on some points".

Economic Questions, if you have time, explain why that's the answer:

7A. Assume the U.S. dollar and the Canadian dollar are traded in flexible currency markets. Which of the following would cause the U.S. dollar to depreciate relative to the Canadian dollar?

A. Higher price level in Canada relative to the United States.

B. Higher interest rates in the United States relative to Canada.

C. Lower interest rates in the United States relative to Canada.

D. Decreasing GDP in the United States than in Canada.

E. Increasing GDP in Canada relative to the United States.

7B. If an exchange rate is said to be floating, that means it is

A, set by the World Bank.

B. set by the government.

C. set by the market forces of supply and demand.

D. set by the International Monetary Fund.

E. set by individual banks.

7C. When the international value of the U.S. dollar increases,

A. Americans pay more for foreign goods.

B. the U.S. trade deficit decreases.

C. U.S. imports decrease.

D. Americans would demand less foreign currency.

E. U.S. exports decrease.

7D. Suppose interest rates fall in the United States, but they donât fall in other nations. What is the impact on the flow of financial capital, the value of the U.S. dollar, and U.S. net exports (based on the changing value of the dollar)?

Capital Flow / Value of the U.S. dollar / Net Exports

A. Inflow / Appreciate / Increase

B. Inflow / Appreciate / Decrease

C. Outflow / Depreciate / Decrease

D. Outflow / Depreciate / Increase

E. Outflow / Appreciate / Decrease

7E. Which of the following would cause the U.S. dollar (USD) to appreciate as compared to the euro?

A. Interest rates in the United States decrease.

B. American consumers prefer to buy European goods.

C. European consumers boycott American goods.

D. GDP in the European Union decreases.

E. GDP in the European Union increases.

8A.

Which of the following would cause the U.S. dollar (USD) to depreciate as compared to the euro?

A. Interest rates in the United States decrease.

B. Interest rates in the European Union decrease.

C. Price levels in the European Union increase.

D. Price levels in the United States decrease.

E. GDP in the European Union increases.

8B. The U.S. dollar is currently trading for 7 pesos per dollar. If the exchange rate adjusts to 10 pesos per dollar then

A. the U.S. dollar has depreciated.

B. the U.S. dollar has appreciated.

C. the Mexican peso has appreciated.

D. both the Mexican peso and the U.S. dollar have appreciated.

E. both the Mexican peso and the U.S. dollar have depreciated.

8C. Suppose the United States and Brazil sign a free trade agreement. If real interest rates increase in the United States but not in Brazil, which of the following will be true of Brazilian capital flow, exports, and the value of the Brazilian real?

Capital Flow / Exports / Value of Brazilian Real

A.Inflow / Increase / Depreciate.

B. Inflow / Decrease / Appreciate.

C. Outflow / Increase / Appreciate.

D. Outflow / Decrease / Appreciate.

E. Outflow / Increase / Depreciate.

8D. Suppose Europeans began purchasing real assets in the United States. How would this impact the foreign exchange market for the euro and the U.S. dollar price of the euro?

Supply of euro / U.S. dollar Price of euro

A. Increase / Increase

B. Increase / Decrease

C. Decrease / Increase

D. Decrease / Decrease

E. Decrease/ Not Change

9. Suppose U.S. consumers decide they like foreign goods better than they like domestic goods. As a result of this change, which of the following is true?

I. The demand for the U.S. dollar will increase.
II. The demand for the U.S. dollar will decrease.
III. U.S. exports will increase as a result of the changing value of the U.S. dollar.
IV. U.S. exports will decrease as a result of the changing value of the U.S. dollar.

A. I only.

B. I and III only.

C. I and IV only.

D. II and IV only.

E. II and III only.

LGS 200 Lecture Notes - Lecture 19: Loanable Funds, Real Interest Rate, Foreign Exchange Market

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