Unit 6 Review: Policy Impacts, Capital Flows, and Net Exports

Foreign Exchange Market (Forex)

A market where currencies are traded based on supply and demand.

T.R.I.P.S.

Mnemonic for the four primary 'shifters' of currency demand and supply: Relative Real Interest Rates, Relative Inflation Rates, Relative Income Levels, Productivity/Tastes.

Relative Real Interest Rates ($r$)

The return on financial assets that influences currency demand and supply.

Relative Inflation Rates ($PL$)

The purchasing power of a currency compared to other currencies.

Relative Income Levels ($Y$)

The economic capability of a country to buy imports, influencing currency exchange.

Capital Inflow

When foreign investors purchase domestic financial assets due to higher domestic interest rates.

Capital Outflow

When domestic investors move their money abroad seeking better returns due to lower domestic interest rates.

Currency Appreciation

The increase in the value of a currency relative to others.

Currency Depreciation

The decrease in the value of a currency relative to others.

Expansionary Fiscal Policy

Government action that increases spending or decreases taxes to stimulate the economy.

Contractionary Fiscal Policy

Government action that decreases spending or increases taxes to cool down the economy.

Expansionary Monetary Policy

Central bank action that increases the money supply and lowers interest rates to stimulate the economy.

Contractionary Monetary Policy

Central bank action that decreases the money supply and raises interest rates to control inflation.

Net Exports ($NX$)

The difference between a country's exports and imports.

Stronger Dollar

A situation where the value of the currency appreciates, making imports cheaper and exports more expensive.

Weaker Dollar

A situation where the value of the currency depreciates, making imports more expensive and exports cheaper.

Aggregate Demand (AD)

The total demand for goods and services within a particular market.

Higher Domestic Interest Rates

Results in increased demand for a country's currency and can lead to currency appreciation.

Lower Domestic Interest Rates

Results in decreased demand for a country's currency and can lead to currency depreciation.

Inflation's Effect on Currency

High inflation generally leads to currency depreciation due to reduced purchasing power.

Crowding Out Effect

When government deficit spending raises interest rates, negatively impacting private investment and net exports.

Search for Yield

The tendency of financial capital to seek the highest possible return on investment.

Impact of Higher Interest Rates on Capital Flows

Higher interest rates attract foreign capital, leading to currency appreciation.

Impact of Lower Interest Rates on Capital Flows

Lower interest rates lead to capital outflow, resulting in currency depreciation.

Real Rate of Return

The increase in an investment's value after accounting for inflation.

Purchasing Power Parity

The theory that currencies should have the same purchasing power in different countries.

Automatic Stabilizers in Currency

Mechanisms, such as currency depreciation, that help stabilize the economy without direct intervention.