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Economics 2 (Subject) / asda (Lesson)

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• Monetary policy all measures aimed at -optimizing the money suppy to the national economy -securing money stability internally and externally
• Pro / Contra - European Monetary Union Pro: Lower transaction costs and high transparency Both advantages increase with increasing independence of the countries Contra: Problems and costs of EMU arise from asymmetric shocks If economic developments differ betwen members, the cost of a one-size-fits-all monetary policy are very high
• 19 Members of the EMU 1999: Portugal, Spain, France, Germany, Netherlands, Luxemburg, Belgium, Austria, Ireland, Finland 2001: Greece 2007: Slovenia 2008: Cyprus & Malta 2009: Slovakia 2011: Estonia 2014: Latvia 2015: Lithuania
• Countries not in the EU but use the Euro due to a formal agreement with EU Andorra Monaco San Marino Vatican
• Countries that use Euro unilaterally / not members of EMU Montenegro Kosovo
• European Central Bank (ECB) European System of Central Banks (ESCB) Central bank for Europe's single currency, the Euro Main task = to ensure purchasing power of the euro and thus price stability in Euro area Important feature of ECB & ESCB is its independence ESCB = system made up of the ECB + national central banks of the 19  countries main goal is to main price stability
• Bank of England Central bank of UK founded in 1694 given independence to set interest rates  in 1997 Main task = deliver price stability Unlike ECB does not have freedom to define price stability. This is done by UK government
• Price stability crucial measure of succesful economic and monetary policy
• Inflation sustained increase of general price level over a long period Permanent  devaluation process in which consumers money loses value Caution: no inflation if just few prices changed
• Causes of inflation Increase of money supply -Money supply grows faster than economic output -Quantity theory of money = price level of goods is proportional to amount of money in circulation Demand pull inflation -increase of aggregate demand leads to increase in prices -aggregate demand grows faster than aggregate supply Cost push inflation -increase of input prices increases production cost and thus prices of goods
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• Disadvantages of inflation Shoe leather costs -resources wasted when inflation encourages people to reduce money holdings Menu costs -costs of adjusting prices Confusion and Inconvenience -when CB increases money supply and creates inflation, it erodes real value of the unit of account -inflation causes money to have different real value at different times -With rising prices, more difficult to compare real revenues, costs and profit over time
• Disadantages of deflation Deflation = where price level actually falls Deflation can be as damaging as inflation -little incentive to spend today if expectation is for cheaper prices tomorrow -might result in consumers not spending at level which incentivises firms to invest -little or no growth --> increased likelihood of unemployment
• Harmonised Index of Consumer Price (HICP) Benchmark for price stability HICP: -Increase of 2% over the previous year = price stability -measures the changing cost of a fixed basket of goods -Problem: no single basket of goods
• Exchange Rate Mechanism 2 Members of the ERM2 usually plan to adopt the euro as soon as all convergence criteria are met Goal is to avoid excessive exchange rate fluctuations between the currencies Exchange rate is only allowed to fluctuate in certain limits (+/- 15%) only member is the danish krone since 1999 (+/-2,25) denmark has an optout for the euro and has no plans of introducing it minimum membership of 2 years compulsory for introducing the euro
• Monetary strategy - two pillar policy Primary objective = price stability Governing council takes monetary policy decisions based on an assesment of the risks to price stability Two pillars: Economic and Monetary analysis Economic: short or medium term risks to price stability, e.g. wages, oil price development Monetary: medium and long term trends in inflation, view of close relation between money & prices Full set of information is gained cross checking between both pillars
• Instruments of monetary policy Minimum reserve open market operation standing facilities
• minimum reserve policy ECB requires credit institutions to hold compulsory deposits on accounts with national central banks These reserves are called minimum or required reserves Reserves are deposits, that banks have received but not loaned out In a fractional reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest. Reserve ratio = fraction of deposits that bank hold as reserves How much money is created: depends on reserve ration reserve ratio increases --> fewer funds for lending --> less money creation
• fixed rate tender Offer of the central bank with fixed interest rate If sum of individual bids of the banks <= volume of credit which is distributed by the central bank, then each bank receives a loan in the amount of the single bid at the fixed interest rates If sum of individual bids of the banks > volume of credit, then it is allocated by means of a ratio Allocation quota = credit volume / sum of individual bids
• Example: Fixed rate tender Credit volume: 15b Total of individual bids: 20b Bank A bids for 4b How much money is alloted to Bank A Allocation quota = 15b / 20b = 0,75 Allocation amount = 4b * 0,75 = 3b CB allots 3b to Bank A
• Variable rate tender Offer of the central bank with a variable interest rate It can happen that not all banks that bid receive money If demand > supply of the central bank, allocation is carried out according to quotas If sum of individual bids of the banks > available central bank money, then the bank with the highest interest bid receives individual bid, then the second bank, etc. The bank with the lowest bid rate will be allocated the remaining central bank money. If at least two banks have the same bid rate and if the remaining central bank money is smaller than the sum of the individual bids, the money is distributed by the allotment ratio Allotment ration or Allocation quota = remaining credit volume / sum of individual bids (same bid rate)
• Example Variable rate tender Bank A bids for 3b and bank B for 4b at an interest rate of 1.01% Bank C bids for 1b at a rate of 1% credit volume is 10b (8b have already been lent to other banks, 2b have not yet been allocated) Allotment ratio = remaining credit volume / sum of individual bids (same bid rate) = 2b / (3b + 4b) = 2b / 7b = 0,286 Allocation amount (Bank A) = 3b * 0,286 = 0,86b Allocation amount (Bank B) = 4b * 0,286 = 1,14b Allocation amount (Bank C) = 0
• Arguments for lowering interest rates ECB reduces key interest rate --> Banks reduce market interest rate, € loses value --> Housholds, companies, etc. save less and borrow more -->Consumption, investments and export rise Y(+) = C(+) + I(+) + G + (Ex(+)- IM)
• Arguments against lowering interest rates ECB reduces key interest rate --> Banks don't or hardly reduce market interest rate --> Banks use money for speculations and for increasing profits --> Danger of bubbles --> No/hardly any effect on credit crunch, GDP, households, companies, etc. Y = C+I+G+(Ex-IM)       --> No change
• open market operations (classic) 2 options purchase of assets by central bank sale of assets held by central bank Most often the central bank trades in government bonds. It would also be conceivable to trade in other assets, such as gold.
• Purchase of asset by CB When the CB buys assets (bonds), money flows from CB to economy Circulating amount of money increases
• Sale of assets held by central bank When CB sells assets (bonds), money flows from economy to CB Circulating amount of money decreases
• What is a bond? Primary / secondary market connection bond price & yield An official paper given by the government or a company to show that you have lent them money that they will pay back to you at a particular interest rate Primary market = includes initial issues of securities (shares, bonds) Secondary market = market for securities trading on the stock/bond market bond price up --> yield (rate of return) down bond price down --> yield (rate of return) up
• Standing facilities Marginal lending facility = in order to obtain overnight liquidity from the bank, against the presentation of sufficient assets Deposit facility = overnight deposits with the central bank
• Domestic value of money External value of money Domestic Purchasing power of currency domestically change of internal value over time inflation/deflation External value of domestic currency in relation to one or multiple foreign currencies
• Purchasing Power Parities PPP’s in a currency area show regional differences in the value of the respective currency PPP between two currency areas: price relations that indicate how many units of foreign currency are required to purchase the same amount of a good or service or a bundle of goods and services, which are available domestically for a unit of domestic currency Example: PPP of 2 of the Netherlands compared to the USA means that you can buy the same amount of goods and services in the USA for 2 dollars as in the Netherlands for 1 Euro
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• Purchasing power standard In order to allow comparisons for more than two states, PPP are expressed on the basis of an artificial currency : unit of domestic currency per unit PPS In Europe, the euro is usually the art or reference currency internationally this is the standard dollar If e.g. the GDP has been adjusted by PPP, this can be indicated as GDP (in PPS)
• Exchange rate Exchange ratio between two currencies exchange rate and its development have to be monitored in business relationships with companies outside their own currency area
• Exchange rate fluctuation Fluctuating exchange rates strongly influence international trade strong fluctuation --> income and costs of a cross.border trading business are not calculable for transactions with partners outside currency area, there is thus an exchange rate risk It can therefore make a difference in which currency and at which time the contract was done In international transactions with partners outside Europe, billing is often done in dollar
• Currency hedging Transactions designed to protect a transaction against financial risks On the financial markets, several financial products are used to compensate for exchange rate risks Common forms of foreign exchange hedging: -Forward exchange contracts -Forward exchange options
• Forward exchange contracts Advantages/Disadvantages Companies use these to protect against exchange rate fluctuations Imports and exports can be hedged against exchange risks Export: Company receives foreign currency - Forward transaction: exchange of foreign currency into domestic at fixed exchange rate Import: Company has to pay an amount in foreign currency - Forward transaction: exchange of domestic currency into foreign at fixed exchange rate Advantage: no exchange rate risks Disadvantage: no exchange rate opportunities, cost of foreign exchange contract
• Forward exchange options A contractually agreed right to buy (put) or sell (call) a specific item (share, currency, etc.) at a specific time or within a specific period of time Advantage: no exchange rate risks, still exchange rate opportunities Disadvantage: costs of forward exchange options
• Domestic partners as an alternative to hedging currency risks Direct / indirect exporting especially for SME's  Direct The domestic exporter delivers directly without a domestic intermediary to the foreign buyer. Buyer can be a consumer, retailer, wholesaler, foreign trade company, foreign branch or agent abroad. Indirect The export takes place via a domestic intermediary. The domestic intermediary sells to a final customer, a wholesaler or foreign trade company abroad
• Barter trade participants directly exchange goods or services for other goods or services without a medium of exchange such as money barter system was the order of the day before the invention of money
• International Licenses Licensor grants license to use intangible property cross border technology and know how transfer subject of license is intangible assets in the form of industrial property rights (patents)
• International Franchising Contractual form of cooperation between independent companies Franchisor grants franchisee, against payment of a fee, the right to use his corporate and sales concept e.g. McDonald's
• Piggyback exporting Company uses international sales channel of other company
• Joint Ventures Advantage / Disadvantages Joint venture with cooperation partners from different country Advantages: -Lower capital requirements and risks -Overcoming trade barriers -Use of local market knowledge of partner company Disadvantages: -Selection of suitable partner -allocation of competences -limited freedom of choice
• Direct investment Cross-border investment objective = influence business policy of foreign company
• Why do we trade? Scarcity of resources and goods (oil, coal, palm oil) Let other do activities and do activities for others  trade, division of labour and specialization lead to a higher level of benefit
• Three sector model Primary activities: farming and creation of resources & raw materials Secondary activities: production of goods, further processing of resources Tertiary activities: Service sector, giving away direct services Quaternary activities: services related to knowledge sector (IT, communication tech)
• Import restrictions Tarrif barriers to trade - Duties Non tariff barriers to trade -import bans -import quotas -self-restraints -administrative trade barriers
• Export promotion Subsidies Dumping State export credit insurance
• Custom duties Import duty is a tax on goods produced abroad and sold domestically customs increase the price of imported goods by the tariff An import duty reduces the import volume and brings the market closer to the equilibrium without foreign trade Total surplus and welfare are decreasing
• Determinants of international competitiveness Porters diamond model Factor conditions: Qualitative equipment of a country with production factors Demand conditions: All factors including demand (size of home market, etc.) Related and supporting industries: supply and trade, indirectly related industries Firm strategy, structure & rivalry: business response to first three Government: influencing core factors positively or negatively (legislation, subsidies, etc.) Chance: essential role (accidental discoveries, technological breakthroughs)
• Forms of economic integration Preferential trading areas -differentiation of trading conditions with individual partners -where goods can be imported at favourable tariffs (CETA, EUROMED) Free trade area -reduction of trade restrictions -all tarifs and quotas are abolished, no cusom duties (EFTA, NAFTA, JEFTA) Customs union -uniform rules with regards to third countries -common trade policy (EUCU between EU, Andorra, monaco, san marino, turkey) Common market -free movement of capital & labour (internal market of EU, EEA norway iceland liechtenstein) Economic Union -harmonization of import areas of economic policy Economic and monetary Union Introduction of single currency

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