The document outlines topics that will be covered in lectures 1-6 of ECO-506: Macroeconomic Theory II, including: 1) Balance of Payments, 2) IS-LM-FB Model, 3) Effectiveness of Fiscal and Monetary Policies, 4) Exchange Rate Concepts, 5) Perfect and Imperfect Capital Mobility, and 6) Problems of Stabilization in Global Framework. Specific concepts that will be discussed are the current account balance, capital account, options for a country with a negative current account balance, exchange rate regimes, and purchasing power parity.

1. ECO-506: Macroeconomic Theory II
Lectures 1-6
By : WAQAS AHMED
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2. Introduction
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3. Topics to be Covered
1. Balance of Payments
2. IS-LM-FB Model
3. Effectiveness of Fiscal and Monetary Policies
4. Exchange Rate Concepts
5. Perfect and Imperfect Capital Mobility
6. Problems of Stabilization in Global
Framework
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4. Balance of Payments
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5. What is BOP?
Which are two main accounts of BOP?
What is Current account Balance?
If a country has negative CAB then what options are
available for that country?
What is Capital Account?
How many parts of Capital Account exist?
Four Possible Situations of BOP.
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6. What is BOP?
• The balance of payments is a systematic record of
the transactions of the residents of a country with the
rest of the world during a particular period of time.
• There are two main accounts of BOP(see Summary of
BOP data of Pakistan):
1. Current Account 2. Capital Account
• The current Account records trade in goods,
services, income and current transfers.
• The Capital account records purchase and sales of
assets, such as stocks bonds and lands.
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7. If a country has negative CAB then what options
are available for that country?
• Country can sell her assets abroad
• Country can borrow from other countries or IMF
• Use foreign currency reserves
• Achieve balance in CAB
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8. What is Capital Account?
The Capital account records purchase and sales of
assets, such as stocks bonds and lands.
How many parts of Capital Account exist?
Transaction of the Private Sector
Transaction of the Government
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9. Four Possible Situations of BOP
1. Current Account Surplus
Equivalent Capital Account Deficit
No Problem
2. Current Account Deficit
Equivalent Capital Account Surplus
No Problem
3. Current Account Surplus
Capital Account Surplus
Rise in Reserves of Central Bank
4. Current Account Deficit
Capital Account Deficit
Fall in Reserves of Central Bank
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10. If a country has negative CAB then what options
are available for that country?
• Country can sell her assets abroad
• Country can borrow from other countries or IMF
• Use foreign currency reserves
• Achieve balance in CAB
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11. Exchange Rate Concepts
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12. What is Exchange Rate?
Fixed, Flexible and Managed Exchange Rate
Regimes?
Difference between:
Depreciation and Devaluation
Appreciation and Revaluation
What is Purchasing Power Parity(PPP)?
What is Real Exchange Rate?
Reversing of Real exchange Rate to PPP
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13. What is Exchange Rate?
Exchange Rate is the price of one currency in
terms of another.
Interbank closing rates for dollar on 02-03-2009
Buying Rs 79.88
Selling Rs 79.92
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14. Exchange Rate Regimes
• In a fixed exchange rate system foreign central banks
stand ready to buy and sell their currencies at a fixed
price in terms of dollar.
• In a flexible(floating) exchange rate system, the central
banks allow the exchange rate to adjust to equate the
supply and demand for foreign currency.
• When central banks intervene to buy and sell foreign
currencies in attempts to influence exchange rates the
system is known as managed floating or dirty floating.
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15. Depreciation and Devaluation
A devaluation takes place when the price of
foreign currencies under a fixed rate regime is
increased by official action. Whereas,
depreciation takes place when, under floating
exchange rate regime domestic currency
becomes less expensive in terms of foreign
currency.
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16. Appreciation and Revaluation
A revaluation takes place when the price of
foreign currencies under a fixed rate regime is
decreased by official action. Whereas,
appreciation takes place when, under floating
exchange rate regime domestic currency
becomes more expensive in terms of foreign
currency.
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17. What is Purchasing Power Parity(PPP)?
Two currencies are at Purchasing Power Parity(PPP)
when a unit of domestic currency can buy the same
baskets of goods at home or abroad.
What is Real Exchange Rate?
The real exchange rate is the ratio of foreign to
domestic prices, measured in the same currency.
R= e Pf /P
If RER=1 the currencies are at PPP.
Why Reversing of Real exchange Rate to PPP is Slow
Market baskets differ across countries
Barriers to movement of goods between countries
Non-traded goods are part of price indexes
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18. Goods Market Equilibrium
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19. Domestic Spending=DS=C+I+G
Spending on Domestic Goods=C+I+G+(X-Q)
NX=f(Y, Yf, R)
Marginal Propensity to Import
Repercussion Effects
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