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71 Cards in this Set

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A Bank is insolvent When:

It has negative equity

How do a decrease in interest rates effect the exports and hence the cab of a country

Interest rates decreasing decrease desire of overseas investors, hence the exchange rate relative to other currencies drop, increasing exports and decreasing imports. Cab = Primary + NX Nx^ so increase CAB.

What does fractional banking refer to.

Banks hold small fraction of deposits as liquid assets.

What is a bail in

Where bank's depositors are made to convert their loans into equity(shares etc..)

What do bank reserves include:

Cash that bank keeps in the vault.

What is bartering:

The exchange of a good for another good, many issues with this. etc. double coincidence of wants.

What is potential GDP

Its long run trend gdp value

What does a positive output gap infer about the current state of the economy

The inflation rate is likely to go up as workers will bargain for higher wages.

In the long run what does a decrease in money supply do?

Decrease in nominal GDP

What does a higher growth rate of money supply lead to?

It leads to higher inflation, prices will be adjusted as more money will be worth less.

How is the nominal interest rate of a country calculated.

Nominal interest=Real Interest + Inflation

What will an open market sale by RBA reduce that the RBA has holdings of

Securities such as commonwealth government bonds.

What happens when the reserve bank raises the cash rate.

Increase the interest rates so consumption will decrease.

When is expansionary monetary policy less effective?

When the bank is not willing to make more loans.

Does monetary policy effect ad and as

No it only has the ability to affect AD, demand sided policy with a time lag.

What is the RBA's inflation target.

2-3% per annum, over a business cycle.

What are asset prices affected by.

Interest Rates,


Expected income stream of the assets


Perceived riskiness of the income stream of the assets


Perceived prospect of capital gain



What has QE led to in US.

The us money supply to rise

If the government wants to use reserve requirement to ease inflation it will:

Increase the reserve to deposit ratio.

What is a credit crunch

Many banks are reluctant to make new loans

What does the term crowding out refer to:

When government increases spending.


Y=C+I+G+NX must still hold true so G Increases which means C+I+NX will decrease.

What is the difference between headline and cor inflation.

CPI Inflation is headline inflation.


More concerned with core or underlying inflation, which is inflation after stripping out temporary price fluctuations.

What are OMO

Open market operations, which is the RBA purchasing or selling financial instruments.

What is an exchange settlement account.

Banks have deposit with the RBA called ESA, allows dealings between RBA and governments on behalf of banks.


ESA make up part of a banks reserves, the rest is what they keep in the vault.

What is the cash rate

Interest rate within the IMM.

What kind of interest rate can the RBA control with OMO's

Only the very short run nominal interest rates.

How do interest rates effect consumption?

Income Effect: Net borrowers have higher lifetime income when interest rates higher, so consume more, whereas net savers are the opposite.




Substitution effect, Consumption may be shifted forward as more people will save with higher interest.

How do interest rates effect investment?

Higher rates mean higher costs of borrowing, lower investment


Lower share prices, reducing capital firms can raise


High borrowing costs also deter people from investing in houses

How do Interest rates effect net exports.

Higher interest rates will cause more people who want to invest in AUS, so the demand for AUD will go up and the AUD will appreciate against other countries, decreasing exports and increasing imports

What effect does an increase in real interest rate have on AD

Ad will decrease, Monetary Policy can only effect AD side.

How long is the Time lag for monetary policy

It is about 6 months before any efffects are seen

What determines the effectiveness of monetary policy

Firms and consumers respond to interest rate changes


Net exports respond to changes in exchange rate

For EMP to work what do banks have to do

They have to be willing to expand credit.




Banks may not be willing to lend.

What are the three components of the balance of payments?

Current Account Balance


Financial Account Balance


Capital Account Balance

What does the current Account Include

Net Exports + Net Primary Income + Net Secondary Income

How are net exports defined in the Current Account

Net Exports = Value of goods Aus exports - Value of goods imported

How is Net Primary Income Defined

Income received by Aus residents from investments in other countries - Income paid to people who have investments in Australia who are foreigners

What is the rule of thumb way to determine if something is positive or negative in the BOP

If it is money coming into Australia then it is typically positive, if it is money flowing out it is negative

How is net secondary income defined

Transfers received by AUS residents from other countries minus transfers made

What does the Financial Account Balance Include?

Foreign Purchases of physical and financial assets in AUS, minus Aus purchases of physical and foreign assets in foreign countries

What does the Financial Account Balance Equal

Measure of net Inbound Foreign Investment


It is Equal to Inbound Foreign Investment(Investment in Aus by foreign) - Outbound Foreign Investment(Investment in foreign by AUS)

What can foreign Investment Include

FDI: Foreign Direct Investment


Foreign Portfolio Investment


Reserve Asset

What is the balance of Payment Identity

BOP=CAB+FAB+KAB==0

What is the situation with Australias Current Account Balance Deficit.

Australia, lots of resources but small population and a low saving rate, hence domestic savings aren't enough to maintain high level of domestic investment required for economic growth. Relies on foreign capital to fill the saving gap.

IS Ca Deficit a problem

Have to be financed either by selling assets to foreign investors or by borrowing from overseas.

What are the disadvantages of foreign borrowing

Increase interest payment in the future, adds to future CA deficits




Need to make debt and interest payment even in economic downturn




Debt size could increase if debt is denominated in foreign currencies and the domestic currency depreciates




High debt to GDP might lead to lower credit rating

What are the disadvantages of Selling Assets

Dividends on those foreign investments will add to the future current account deficits (Negative net primary income entry)

What is a Nominal exhange rate

The value of one country's currency in terms of another country's currency

What does Pounds/Dollar mean

It is how many pounds someone could purchase with one dollar

What is the foreign Exchange market

A place where currencies are traded for other currencies

What are some sources of demand for AUD in the foreign exchange market?

Foreign Firms and consumers who want to buy AUS products




Foreign firms and consumers who want to invest in AUS




Currency traders who believe AUD about to appreciate



What are some sources of supply for AUD in the foreign exchange market?

Australia firms and consumers who want to buy foreign products


Australian firms and consumers who want to invest overseas


Currency traders who believe aud about to depreciate

What are some of the detrminants of the exchange rate between two countries in the short run

Relative foreign demand for the two countries exports


Relative foreign demand for the two countries assets


Currency traders expectations of future value

What happens if the home country appreciates against other currencies

Exports become more expensive to foreign buyers




Imports become cheaper to AUS buyers




Net exports fall reducing the rate of increase of AE and GDP

What is the bilateral nominal exchange rate

The exchange rate considered only between two countries

Why does the bilateral exchange rate not reflect countries trade competitiveness accurately.

Nominal exchange rates against other trading partners

What is the nominal Trade Weighted Index

Measures value of currency against a basket of the currencies of the country's main trading partners

How is real exchange Rate Calculated

Nominal Exchange Rate *(Domestic Price Level/Foreign Price Level)




Nominal Exchange Rate = Units of foreign Currency/1 Unit of Home Currency

What are the three different types of exchange rate systems

Floating Exchange Rate


Managed Floating exchange rate


Fixed exchange Rate

What is a floating exchange rate

Exchange rates determined by the demand and supply of currencies in the FX market.

What is a managed floating exchange rate

Same as floating but with occasional CB and government intervention

What is a fixed or pegged exchange rate system

A country unilaterally keeps the value of its currency fixed against another(called anchor currency).

Does it impact on the value of a currency if it is fixed or floating currency

No, it will still be determined in the FX market.

What is the difference between depreciation and devaluation

Depreciation: Value of floating currency falls relative to another currency




Devaluation: Value of a fixed/pegged currency is lowered relative to another currency

What are the benefits of a fixed/pegged system

Facilitate international investment and trade, especially with anchor country




Fix foreign debt levels and repayments




Reduce fluctuations in import prices




Prohibit central bank from printing money excessively

Costs of fixed/Pegged Exchange Rates

Lose monetary policy independency


Open to speculative currency attack when it is overvalued

Is a common currency good

Makes buying and selling goods between member countries easier and cheaper




However lose independent monetary policy




And country in recession will not experience currency depreciation, which could revive net exports.

What is the big mac index

The US$ price of the big mac in different countries

What is the law of one price

The idea that a product should be sold at the same price everywhere when expressed in same currency, otherwise traders will profit

What is the theory of PPP

The long run exchange rates move to equalize the purchasing power of different currencies.

How is the nominal exchange rate for two currencies found when PPP

Long RUn Nominal Exchange Rate = (Foreign Price Level/Domestic Price Level)




Nominal Exchange rate = Units of foreign Currency/1 Unit of Home Currency