Gross National Product (GNP) value of all final goods and services produced by domestically owned factors of production

n during a given period. NOTE: Value, Final goods and services, Domestically owned capital and Labor, Given Period-typically a year Gross Domestic Product (GDP) value of all final goods and services produced in the economy during a given period. NOTE: Value, Final goods and Services, Within the Economy, Given Period-typically a year Canadian work in HK earn $12k Sony TV produced in HK in 2012 for $10,000 HK person works at Japan Nominal GDP growth also includes price and . Canada GNP HK GNP Japan GNP HK GNP HK GNP Japan GNP To eliminate the inflation/deflation effect we focus on Canada GDP HK GDP Japan GDP HK GDP HK GDP Japan GDP Real GDP. Nominal GDP = current price x current quantity; Annual nominal GDP growth rate = (current previous) / previous x 100% Real GDP = price in base year x quantity in current year; Annual RGDP growth rate = (current previous) / previous x 100% Limitation of GDP/GNP: 1) does not include non-market services (barter/underground economy/spouses) 2) does not include bads, ex pollution, cleanup fee GDP increases (only +) Labor Force = Employed + Unemployed; Unemployment rate = number unemployed / labor force; Participation rate = labor force / total population of working age UE% cannot reflect the true as some people may switch out from UE to not in the labor forces. Balance of Payments: (1) Current account: (1) Net exports + (2) Net investment income from abroad + (3) unilateral transfer Net exports (NX) of goods and services from abroad: (a) Trade balance = Net export of goods, (b) Net exports of services; NX = a + b = exports imports Net investment income: returns from holding foreign assets returns paid to foreign owners of domestic assets Interest payments, Dividends and Royalties Does not include: The actual purchase of the assets Buy a house in Australia Ex. Net unilateral transfers: Foreign aid, Gifts of money by individuals, Charity (2) Capital and financial account: (Net purchase of existing real and financial assets) Assets: stocks, bonds, real estate; 2 parts: (A) Foreign direct investment (FDI) foreign business firm buys or builds capital goods (preference long term commitment). Ex. Toyota builds a factory in HK (B) Portfolio investment foreigner acquires domestic securities. Ex. Bank of Tokyo buys $100M HK Stocks FDI in China: (1) Preference for FDI vs. Portfolio investment (2) Inflow of FDI into China (3) Chinas FSI policy (a) Tax Holiday (b) Export clause (4) RoundTripping Capital account convertibility legally permitted to exchange domestic currency for any amount of foreign currency at the market exchange rate and vice versa. China: current account convertible and FDI, Reasons for capital account controls: (a) Fear of capital flight (b) hot money.
Qualified Foreign Institutional Investor (QFII): Foreign investors from all over the world. (To avoid foreign or local hot money). May invest in A shares, Treasury bonds and index futures. Qualified Domestic Institutional Investor (QDII): Allow outflow of money. Can invest in shares in countries with have MOU on supervision and co-operation with CBRC

Money Market: M1 = Currency + Checking account deposits + travelers checks + Checking account at savings M2 = M1 + Savings deposits + small denomination time deposits (less than $100,000) + non institutional money market funds + money market deposit accounts + overnight repurchase agreements + overnight Eurodollars (held by US depositors in the Carribean branches of US banks) M3 = M2 + Time deposits + institutional money market funds + term repurchase agreements L = M3 + short term T bills + commercial paper + US savings bonds + term Eurodollars held by nonbank US residents + bankers acceptances Monetary paradox : Underground Economy Cash is King Ms/ Md/P M R P (Y, / Taste) P
Money Demand: Wealth = financial wealth = W = Bonds and real cash balances = B + Md/P Md/P affect by: Income level (Y): The higher the income the more the need to spend, so higher demand for cash. Interest rate (R): The higher the interest rate the higher the cost of holding money instead of bonds and so the lower the demand. Taste preference of liquidity Increase in Y, shift the curve to right

Money Supply: Controlled by Central Bank (US: Federal Reserve System Fed) Monetary policy (1) Open market operations increase money supply, Fed buys bonds US government bonds; decrease money supply, Fed sells bonds (2) Discount rate lend money to member banks with discount rate (interest rate). An expansionary monetary policy would mean lowering the discount rate (3) Reserve requirements controls the amount that banks have to hold as reserves (not used too often), i.e. 10%, if bank has $1000, it can only lend out 900 max money supply, Fed the reserve requirement || money supply, Fed the reserve requirement Federal fund rate (FFR) = inter bank lending rate; every bank has an account in Fed, banks borrow money from another bank through Fed account Increase in money supply expansionary monetary policy, reduce the cost of holding money (lower interest rate Sell Bonds) Decrease in money supply contractionary monetary policy, increase the cost of holding money (increase interest rate Buy Bonds) IS-LM Model: Closed Economy Y1 B A L Y2 Ms/P Md/P M/P (Y2, RM (Y1, Curve Taste)
Money market (Assets markets) Assume 2 assets: Bonds and money LM Curve: L = money demand, M = money supply Ms/P increases -> shift LM curve to right -> R decreases Money market equilibrium implies bond market equilibrium Monetary Policy: Central Bank involve ( Ms/P Sell Bonds R Investment GDP )

Yf LM IS Y R

Recessionary gap (output gap)

Equilibrium in the Goods market: IS Curve: Investment = Saving Denote Supply = GDP = Y Aggregate Demand = C + I + G Equilibrium: Supply = Demand GDP = Y = Consumption + Investment + Government Spending Tax > G : budget surplus Tax = G : Balance Budget Tax < G : Budget deficit (G needs to borrow issue bonds) Expansionary Fiscal Policy: G spending More jobs GDP Tax deficit Issue Bonds R IS curve to right Raise GDP (multiplier effect: GDP will raise by a multiple of the initial increase in G) Issue Bonds R Borrow Investment GDP Buy Bonds R Borrow Investment GDP

Full Employment GDP: Yf: the amount that could be produced were the entire labor force employed. Eliminating a Recession:
Fiscal Policy: (1) Government could increase the budget deficit (2) IS Cuve shift to the right (3) GDP rises Monetary Policy: (1) Expansionary monetary policy (2) LM curve shift out and to the right (3) R falls and GDP rises

Exchange rate determination: Long Run Assumptions: Perfect capital markets No barriers to trade No transportation costs Perfect information No uncertainty No taxes Big Mac Index (Problem): not tradeable goods: cannot be arbitraged. (1) Cost different (ex. Wages, rent, beef) (2) Demand Purchasing power parity (PPP): Select a basket of goods Apply law of one price to this basket Derive the long run exchange rate Problem with PPP: Baskets are not identical Goods are not identical Many Services are not tradeable Preferences for Domestic goods vs Foreign or vice versa Actual exchange rate (spot rate) Absolute PPP is not a good predictor of exchange rates. Relative PPP is an accurate measure: (1) Relative inflation levels (2) Relative productivity Relative PPP: (I) Inflation: USA: 1 shirt $10; China 1 shirt = 50RMB => PPP rate: $1 = 5RMB. Suppose USA: 1 shirt $20; China 1 shirt 50RMB => PPP rate: $1 = 2.5RMB => inflation rate in USA = 100%; inflation rate in China = 0% => $ depreciates by 100%. Percent change in exchange rates = US inflation rate China inflation rate (II) Productivity: US shirt $10; China shirt price 50RMB => PPP rate: $1 = 5RMB. US productivity rises by 100% => US 1 shirt $5; China shirt price = 50RMB => PPP rate: $1 = 10RMB =>US$ appreciates by 100%. Percent change in exchange rates = percent change in home productivity percent change in foreign productivity Exchange rate determination: Short Run Exchange rate: $=100Yen => $=110Yen = The $ has appreciated vis-a-vis the Yen; the Yen has depreciated vis-a-vis the $. Flexible rate: rate is set by the market where supply = demand. Fixed rate: rate set by the government and central bank. Interest Rate Parity (IRP) Assumptions: Perfect capital market Perfect information No transaction costs Spot contract: binding commitment for exchange of funds on the spot. Forward contract: agreement made today for obligatory exchange of funds in the future, 1,2,3,6,12 months Uncovered IRP: ih = if + percent change in exchange rates => if + (expected spot spot)/spot; ih = nominal interest rate at home; if = nominal foreign interest rate; spot = spot exchange rate Covered IRP: ih = if + percent change in exchange rates => if + (forward spot)/spot Carry trade: borrow money from low interest rate country and buy currency with high interest rate. % forward premium = % interest differential => (Ft,1 e)/e = (i$ - iDM) / (1 + iDM) Example: 1) Buy USD and sell Yen, 2) weakens Yen, 3) Buy US Gov with USD, 4) Spread + Yen weakening, 5) Japanese exports rise