FDI 6

18 flashcards · Other · by Daniel F.

1. Impact of varying exchange rates low value of the currency (depreciation) vs high value of the currency (appreciation)

   low value of the currency (depreciation) benefits exporting firms and import-competing businesses but increases import prices, causing domestic inflation. value of the currency (appreciation) hurts exporting firms and import-competing businesses but lowers import prices, reducing domestic inflation.

2. Floating (flexible) exchange rates Complete flexibility vs Dirty/managed float

   exchange rates move freely according to market forces Complete flexibility = clean float rare Dirty/managed float = flexible exchange rate with some interventions of the government to influence the market rate.

3. Fixed exchange rates

   government specified par-value (target exchange rate) band around par value that the exchange rate moves freely within country can fix: gold, another currency, basket of currencies if the market price is above or below the band the government does an official intervention degree of flexibility depends on band size and frequency of adjustments fix "forever" (permanent peg) rare Fix for a long time but allow for occasional adjustments (adjustable peg). Adjust band frequently in line with economic…

4. exchange rate policies: official interventions

   Buy/sell foreign currency against domestic currency to influence e To prevent depreciation: buy domestic, sell foreign. To prevent appreciation: sell domestic, buy foreign. Can be welfare improving if the disequilibrium is temporary. If disequilibrium is not temporary: Run out of currency reserves or accumulate excess foreign assets that are likely to lose value (more on this next week).

5. prevent depreciation with official intervention

6. prevent appreciation with official intervention

7. welfare improvement from official intervention

   predictable and temporary imbalances are great to use official intervention on

8. Exchange rate policies: Impose restrictions on quantity of foreign exchange

   All foreign exchange is done via a public authority. Foreign currency must be sold at a specific rate. Government allocates rights to buy foreign currency. Often results in an illegal parallel market. Works just like a quota on imports reduces welfare.

9. Exchange rate policies: Use monetary policy to influence domestic interest rates and short-term capital flows

   Higher interest rates will attract investors, increase the demand for and appreciate the domestic currency Adjust other macroeconomic conditions to influence supply and demand in foreign exchange market. Alter the par-value or switch to flexible exchange rates.

10. Marginal product of capital (MPK)

    how much additional output can be produced with an additional unit of physical capital, ceteris paribus assumption: MPK is declining in the stock of capital productivity of capital is less productive in capital-rich countries than in capital-poor countries

11. How MPK and interest rate r are related

    return to buying and installing additional physical capital (computer, machine, tool) (= return on investment) firms borrow money to pay for the capital with interest rate r In equilibrium, the interest rate paid by firms to the suppliers of loanable funds will equal the return on investment r = MPK

12. capital mobility vs no capital mobility

    no capital mobility MPK = r is different in both countries capital mobility Capital will flow to where it generates the highest returns process continues until MKP = r are the same in both countires abcgh = capital income paid by A to J reason for welfare gain - reason for this gain is that freedom allows individual wealthholders the chance to seek the highest return anywhere in the world.

13. Capital mobility: Distributional effects

    Japan (more capital) Lenders (savers) gain from the higher interest rate. Borrowers lose. The smaller capital stock reduces the productivity and earnings of land and labor. America (less capital) Borrowers gains from the lower interest rate. Lenders lose. The larger capital stock increases the productivity and earnings of land and labor. In both countries there is a net gain. Global output is maximized.

14. Taxes on international lending

    Tax imposed by the Japanese government on foreign assets held by Japanese residents. Tax imposed by America's government on Japanese investors. output in J increased by g output in A falls by gbd tax revenue: ec welfare improve for tax imposing country reduce for taxed country reduce for the world because the tax reduces global efficiency in the allocation of capital

15. Does the flow of capital hold up in reality

    yes before WWI: North-South no after WWII: North-North Nowadays: North-North Marginal returns to capital may be non-decreasing in reality poor countries may have bad institutions Capital markets are not fully integrated (capital controls: money is not allowed to flow freely)

16. Country-specific risk vs Industry-specific risk.

    Country-specific risk - Countries can be hit by adverse shocks which affect all firms/industries within a country at the same time (e.g. overall economic downturn) Industry-specific risk - Industries (in different countries) can be hit by a common shock (e.g. car industry)

17. Risk diversification

    International capital mobility allows for risk diversification across countries Invest in different countries diversify the country- specific risks Invest in different industries diversify the industry-specific risks)

18. Risk diversification: Example