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Quantity Theory of Money
used to explain the long run determinants of the price level and the inflation rate
the fed uses its tools to put money into the economy ( increase the money supply)
*causes inflation--> price level rises
* value of money falls
different factors affect nominal variables and real variables.
*changes in money supply ONLY affect nominal variables
Inflation- Induced Tax Distortion
income tax on nominal savings so after tax real interest rate falls
Arbitrary Redistribution of Wealth
lender of a loan can lose money when inflation rate causes value of the loan to decrease
Country interacts economically with other country
1. imports and exports of goods and services
2. buying and selling capital assests
Factors that affect Net Exports
1. Tastes of consumers for foreign and domestic goods
2. Prices in domestic and foreign countries
3. Exchange rates at which people use domestic currency to buy foreign currency
4. Income of consumers home and abroad
5. Cost of transporting goods between countries
6. Policies of the government toward international trade
Net Capital Outflow NCO
purchase of foreign assets by domestic residents - purchase of domestic assets by foreign residents
Factors that Affect NCO
1. Interest rate paid on domestic assets
2. Interest rate paid on foreign assets
3. Perceived economic and political risk of holding assets abroad
4. Government policies that affect foreign ownership of domestic assets
nominal exchange rate
the rate at which a person can trade the currency of one country for the currency of another country
increase in the value of a currency as measured by the amount of another currency it can buy
decrease in the value of a currency as measured by the amount of another currency it can buy
real exchange rate
the rate at which a person can trade the Goods and services of one country for the goods and services of another country
nominal exchange rate * US price/ foreign price
law of one price
a good must sell for the same price in all locations (internationally) If not same price, arbitrage
Purchasing power parity
a theory of exchange rates where by a unit of any given currency should be able to buy the same amount of good in all countries
- law of one price assumed
- arbitrage assumed
-exchange rates move
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