1. International Finance Real World Economic Activity Data Collection Economic Theory Models Economic Analysis

2. International Finance The Quantity Theory Equation 1 Equation 2 Equation 3

3. International Finance Quantity Theory of Price Adjustment M P Q t* time M0 2 M0 P0 2P0 Q0 time

4. International Finance Extreme Macro Instability

5. International Finance The Purchasing Power Parity Equation 4 Equation 5

6. International Finance Purchasing Power Parity and Overshooting M P,E M0 2M0 P0,E0 E P 2P0, 2E0 time

7. International Finance Unpleasant Monetarist Arithmetic Equation 6

8. International Finance Unpleasant Monetarist Arithmetic: Sargent and Wallace: P* vs P** time Money, Bonds t* time P* P** Money Deficit Price Level

9. International Finance The Absorption Model of the Balance of Trade Equation 7 Equation 8

10. International Finance United States Current Account and Fiscal Balance, 1968-1992

11. International Finance Further Implications Equation 9 Equation 10 Equation 11 Equation 12

12. International Finance Balance of Payments BOP = Current Account + Capital Account Under fixed exchange rates only: Change in Foreign Exchange Reserves = BOP

13. International Finance Fiscal and External Balances, USA

14. International Finance Organization and Characteristics of FOREX Markets Spot and forward markets Many buyers and sellers, so no buyer or seller dominates Transactions are quick, buy/sell decisions have to be made very quickly Low transactions costs Open virtually 24/7.

15. International Finance Reasons to Use FOREX Markets Export and Import Transactions Triangular arbitrage in the Spot Market Hedging on foreign investment Forward speculation Interest arbitrage Engage in a speculative attack on a foreign currency (aka “hedge fund” management)

16. International Finance Demand and Supply of Foreign Exchange R($,DM) DM US Demand for DM German Supply of DM R*

17. International Finance Responses to Overvaluation: Devaluation and Fiscal Contraction R($,DM) DMDM US Demand for DM German Supply of DM R* New US Demand Trade Deficit R**

18. International Finance Conditions for a Devaluation to “Work”, or not! Marshall-Lerner conditions must hold: elasticity of foreign demand for export good and elasticity of domestic demand for import good must sum to value greater than unity. Example: imports are oil, exports are wheat. Devaluation may actually make BOT worse! People will still buy oil and just need so much wheat. Elasticity pessimism.

19. International Finance Further conditions why devalution may not work Issue of contractionary devaluation: imports may be inputs in production so devaluation may cause a fall in investment, employment, output Harberger-Laursen-Metzler effect: devaluation worsens income, so net saving falls quickly, so there is a savings- investment imbalance, and the trade balance falls.

20. International Finance Multiple Equilibria in ForEx Market Supply Demand A B C DM R

21. International Finance J-Curve Dynamics time Trade Balance 0 Devaluation

22. International Finance Triangular Arbitrage Equation 13 Equation 14 Equation 15

23. International Finance Covered Interest Parity K dollars K(1+r) K/R sterling (K/R)(1+r*) (K/R)(1+r*) FR buy spot sell forward US investment UK investment

24. International Finance Covered Interest Rate Parity Equation 16 Equation 17 Equation 18 Equation 19 Equation 20 Equation 21

25. International Finance Measuring Capital Mobility Equation 22 Equation 23 Equation 24 Equation 25

26. International Finance Real Exchange Rate Non-tradeables Tradeables Real Exchange Rate T* NT*

27. International Finance The Real Exchange Rate Equation 26 Equation 27 Equation 28

28. International Finance U.S. Real Exchange Rate Swings, 79- 81

29. International Finance Classification of Policy Regimes Monetary Policy Fiscal Policy Exchange Rate Regime FixedFlexibleInstrument WEAK STRONG WEAK

30. International Finance The Mundell-Fleming Model of Fixed Exchange Rates Equation 29

31. International Finance Mundell - Fleming Model General Equilibrium r Y E IS LM FF

32. International Finance Endogeneity of the Money Supply Equation 30

33. International Finance Mundell - Fleming Model Effects of Monetary Expansion r Y E LM LM’ FF IS E’

34. International Finance Mundell - Fleming Model Effects of Fiscal Expansion r Y E LM LM’ FF IS IS’E’

35. International Finance Mundell - Fleming Model Effects of Devaluation r Y E LM LM’ FF IS FF’

36. International Finance Swan Diagram: Internal/External Balance EE II r G-T A:external deficit, internal inflation. B:external surplus, internal inflation

37. International Finance The Dornbusch Model of Flexible Exchange Rates Equation 31

38. International Finance Dornbusch Model: Basic Setup DD AA p e A

39. International Finance Dornbusch Model: Monetary Expansion with Overshooting DD AA p e AA’ A B C

40. International Finance Wicksell's Problem Sweden Denmark Norway wheat fish timber ultimate flows intermediate flows

41. International Finance Bilateral Exchange Arrangements-Unbalanced Flows A B C D

42. International Finance D’s Money as Medium of Exchange, Barter between A and B A B C D

43. International Finance A’s and B’s Money as Media of Exchange A B C D

44. International Finance Borrowing and Lending Strategies r1 r2 ri i1 i2 Borrowing Lending Positive maturity transformation Period 1 Period 2

45. International Finance The Phillips Fixed-Coefficient Model of the Banking System Equation 32 Equation 33

46. International Finance Internal Structure of Eurodollar Market Europe USA London Lenders Borrowers

47. International Finance Eurodollar Market and OPEC Recycling OPEC Deposits LDC Borrowers Europe USA London Lenders Borrowers

48. International Finance Manufacturing, Resources, and Service Sector Economy O O' M R D-m D-r D-s Manufacturing employment Resource employment Services ww

49. International Finance Manufacturing, Resources, and Service Sector Economy- Direct Deindustrialization Due to Boom in Resource Sector: M-M': Direct De-industrialization Effect O O' M R D-m D-r D-s M' w W’

50. International Finance Manufacturing, Resources, and Service Sector Economy- Indirect Deindustrialization Due to Boom in Ensuring Service-Sector Boom: M'-M'': Indirect De-industrialization Effect O O' M R D-m D-r D-s w w' M' w'' M''

51. International Finance

54. A B C Nominal Value of Debt Secondary Market Value

55. International Finance Seignorage and Dollarization: Multiple Equilibria Equation 34 Equation 35

56. International Finance Inflation Laffer Curve  (M/P)  Deficit B A

57. International Finance Inflationary Dynamis in a Dollarized Indexed Economy Manufacturing 50% wages 50% Import Component Oil Shock Price of Output COLA Indexed Gov't Debt Fiscal Deficit Monetary Growth Dollarization Devaluation

58. International Finance Structure of Financial Markets Banks Foreign Exchange CD's T'Bills Commercial Paper Time and Saving Deposits Long-term bonds spot forwardfuture call/put option warrants and convertible bonds Repurchase Agreements Swaps:debt for equity Dual currency bonds Heaven and hell bonds Parallel loans and currency swaps Optioned and non-optioned equity Mortgages Mortgage-backed securities Preferred stock Stripped and zero coupon bonds Prime and score securities Poisoned pills Acceptances Figure 1:Instruments of Markets Bonds Equity

59. International Finance Trading Structure in Financial Markets Exchange-traded Over-the- counter Structured/ embedded Futures Swaps Options Convertibles Warrants Figure 2

60. International Finance Nikkei-linked bond with puts Investor Issuer Arranging bank Investor put coupon,premium put premium put premium Figure 3

61. International Finance Equity derivative swap, two-sided Bank A Bank B depreciation appreciation premium (upfront or LIBOR flow) Figure 4

62. International Finance Customized derivative swap Investor Bank A T-notes at 5% 5% appreciation appreciation in Nikkei over 22,000 premium for call at 22,000 Figure 5

63. International Finance Equity Derivative Swap with Embedded Options Bank Y Bank X LIBOR Prem Index apprec. Knock-out on Nikkei Yen/$ Quanto Figure 6

64. International Finance Swap Credit Exposure: Regulatory Approach OEM Swap credit risk Mark to market CEM Swap credit risk Swap credit risk Swap credit risk Credit conversion Figure 7

65. International Finance Creation of a Differential Swap Company Y Bank A Bank B Bank C i-US i-DM less SPR i-US US fixed DM fixed i-DM i-DM and i-US: DM and US LIBOR Figure 8