Summary EIT – exam
1. International trade
Classical theories
- Unequal resource distribution
- Absolute and comparative cost advantages
New trade theories
- Increased returns of specialization due to economies of scale (lower unit cost of production)
- First mover advantage – economies of scales causing a barrier to entry for other companies
- Government intervention
If a country has absolute cost advantage in production, division of labor will lead to total output
increasing. The country specializes itself of the production of product A/B.
If a country is relatively better at producing a product, a comparative cost advantage arises. The
country’s commodities (product) of A and B are divided: the higher outcome means that country
should specialize in producing that significant commodity/product.
Why trade barriers? (slide 9)
 Protecting domestic infant industries from international competition
 Protecting domestic strategic goods
 Protecting domestic jobs
 Limit foreign influence in domestic economy
 Provide extra income for government
 Protecting customers
Types of barriers (slide 10)
 Tariffs
 Quota’s
 Licenses
 Embargo
 Export subsidies
 Voluntary export/important restraints
 Local content requirement
 Technical standards
 Capital controls
Import products
limiting amount
import only for allowed licensed parties
no import allowed
lower costs for domestic exporters
informal quota’s
components of imported goods/origin
excessive specifications import goods
restrictions on cross border transactions
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Effects of trade barriers (slide 11)
 Increased prices of foreign goods
 Increased domestic prices due to lower competition
 Smaller variety of goods available for consumers
 Increased number of jobs
 Loss of welfare
 Risk of trade wars
Graphics
- Welfare effects without international trade
-
A market with imports
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-
Gains and losses in a market with imports
-
Impact on tariffs
By tariffs, world price will shift upwards, consumers will consume less, domestic producers produce
more until their price reaches world price (Sw+t). / Less efficiency, higher prices.
3
-
A market with exports 1.0
A market with exports 2.0 (employment will go up)
-
-
Gains and losses in a market with exports
4
-
Impact of quota’s
Import tariffs promote domestic production, therefore introducing tariffs can increase import of a
country (eg raw materials) because import increases, the supply of a currency will increase. Because
of the tariffs, import prices rise, therefore production prices rise, therefore export products will
become more expensive, decreasing the demand for the currency, leading to a devaluation of the
currency.
International trade agreements
GATT
- General Agreement on Tariffs and Trade
- Goal: freer trade by lower tariffs on goods
WTO
-
World Trade Organisation, replaced GATT in 1997
Goal: freer trade (by lowering on goods and services via the negotiation of new trade
agreements, and setting disputes between WTO-members).
WTO – principles underlying all WTO-rules

Most favored nations principle
Equal treatment for all country trading partners
exemptions for: (1)free trade areas, (2)favorable conditions for developing countries and
(3)barriers against dumping practices.

National treatment
Treating foreigners (import) and locals (domestic production) equal as a good has entered
the market

Trade facilitation
Prohibition of applying bureaucratic delays and red tape in order to pose a burden for
moving goods across borders for traders.
Free trade agreement 1.0
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Free trade agreement 2.0
Free trade agreement 3.0
Present issue number 1
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China threatening to retaliate against US metals tariffs
- An act of revenge
- Trump imposed steep tariffs on aluminum and steel imports on national security grounds
- China said this was reckless.
- Anti-dumping investigation into US sorghum product
If a product is exported at a price lower than the normal value of the product
Consequences:
 Impact on American employers and consumers
 25% Mercedes tariff
 NAFTA relation
Present issue number 2
EU and BREXIT deals
Britain leaves the EU’s single market and the Customer Union and follows in a deeper and special
partnership with the EU, having a comprehensive free-trade deal.
Possibilities
 Full membership
 Membership of the European Economic Area only
 The Swiss Solution
 The Turkish Solution
 A comprehensive free trade deal: CETA
 No deal (only WTO rules)
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2. The foreign exchange market
FE= bank deposits denominated in different currencies
Trading FE= global OTC market operated by (mainly) banks
Exchange rates= price of a nation’s currency in terms of another currency
Real exchange rate= the rate at which the domestic goods can be exchanges for foreign goods (PPP
concept)
Theory of Purchasing Power Parity (PPP)
- Two currencies are in equilibrium, when a market basket of goods, considering exchanges
rate is priced the same in both countries
- Currency 1 to 2 (ER1) = P1/P2
- P1= average price baskets of goods in country 1 in currency 1
- P2= average price of baskets of goods in country 2 in currency 2
- Does not provide a clear explanation of actual exchange rates because of restrictions in free
trade.
- Transport costs between countries and different production costs and goods are never
identical.
Interest parity condition
- Domestic interest rate
foreign interest rate + expected appreciation of foreign currency
or
Foreign interest rate – expected depreciation of domestic currency
If a domestic interest rate is 2% and an appreciation is expected of 1%, investors will only accept a
foreign interest rate of 1% (difference 2% - 1%) so that return on assets in both countries are
identical.
xbblCurrency board= arrangement in which the domestic currency is backed 100% by a foreign
currency and a fixed exchange rate with that currency exist. Country has NO monetary policy: CB
issues money into the economy in exchange of the foreign currency.
Dollarization= arrangement in which the domestic currency is replaced by the US dollar.
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Exchange rate determination
Factors effecting the exchange rate
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Semi fixed exchange rates
Advantages and disadvantages of fixed systems
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Policy trilemma= limited options and resources available for countries to implement a monetary
policy. No free flow of capital is achieved, no fixed exchange rate and an independent monetary
policy.
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2. International Financial system
Monetary consequences FE intervention
- Sale of FE by the CB to banks leads to a decline of the monetary base (bank reserves + cash +
money in the hands of households and corporates) and thereby reducing bank liquidity and
as a consequence reducing the money supply and increasing interest rates.
- Sale FE – monetary base decreases – money supply increases – interest rates increase –
capital inflow increases – demand domestic currency increases – appreciation domestic
currency
- Sterilized intervention= the monetary effects of a FE intervention are counteracted by an
offsetting open market operation (sale of a FE= offsetting operation is purchasing the same
amount in bonds).
Balance of Payments
All transactions between a nation and other nations during one year
3 categories
1. Current account
income generating transaction
Net export of goods
Net receipts from abroad (service, investment, unilateral)
2. Capital account
capital transactions
Net receipts from capital transactions
(purchase securities, direct investments, loans)
3. Financial account
official reserve transactions
Net change in government CB international reserves FE
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BoP – diagram

Increase in FE > compare with import of goods
Exchange rate regimes
Rules of Golden Standard
1. Fixed gold price
2. Currency convertible in gold
3. Fixed ratio of the value of gold reserves (monetary) and the value of money (banknotes and
coins) circulating (ratio of 1)
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Bretton Woods System
Rules
1. Gold price fixed in the US dollar
2. US dollar convertible in gold
3. Currencies of other participating countries pegged to the US dollar
4. Countries facing a structural balance of payment deficit (ER fall) may borrow the required FE
(to finance net import) from the IFM in order to keep the exchange rate of their currency
stable.
5. IMF-loans must be repaid in the medium term – debtor countries can reform their
economies in the meantime in order to reduce the country’s dependency on imports and
increase its competitiveness (rising exports).
6. IMF advises participating countries regarding their economic policy


Worldbank – International bank providing cheap loans for capital development to
developing countries
GATT = General Agreement on Tariffs and Trade
(fixed exchange rate system has been abandoned in 1973 due to structural BoP deficits of the US.
The European Monetary Union and beyond
 The European Monetary Union was intended as a step towards further deepening of the EU.
 The EMU introduced one common monetary policy, one currency and further economic
coordination via de Stability and Growth Pact: to pursue sound public finances and
coordination of fiscal policy rules (government deficits below 3% of GDP, government debt
below 60% of GDP, and low and stable inflation).
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Interdependency between the fiscal position of governments and the crisis situation in the banking
sector: the potential vicious circle between banks and the debt of their sovereign. (slide 41)
Banking Union helps with:
 Being stronger and more
immune to shocks due to a
system of supervision and
prudential requirements.
(sufficient capital reserves and
liquidity)
 Falling banks will be
resolved without taxpayer’s
money, limiting negative effects
on governments and so
government fiscal positions via a
common resolution framework
including a resolution fund: so
no bail out by governments and
so government fiscal position
will not be weakened further.
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4. Banking 1
Bank (credit institution) = grant credits for its own account and repayable funds from the public.
Functions
 Hold deposits and savings
 Make loans to households and corporates services
 Responsible for maintaining the payment system
Financing banks
 Hold model until maturity
 Originate to distribute model
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Financial institutes
 Insurance companies
 Investment funds (hedge, private equity, money market funds)
 Pension funds bank: technical provisions for future pensions



Hedge fund: a leveraged investment fund
Private equity fund: an investment fund specialized in investing in venture capital (equity in
the companies the investment fund invests in)
Money market fund: investment fund specialized in investing in money market instruments
Money
 Officially-issued legal tender of notes and coins. Circulate medium of exchange.
Functions
 Medium of exchange
 Store of value
 Unit of account
Flat money = officially issues paper currency (banknotes and coins)
Electronic money = debit cards (prepaid cards preloaded by banks) and credit cards
Monetary aggregates
M2 = M1 + close substitutes of M
M3 = M2 + close substitutes of M2
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



Additional deposits = amount of cash + reserves
Short in reserves but solvent > borrow additional funds from the CB
Bank can make loans if it receives additional deposits
10 extra overnight deposits > required ratio 10 > create an amount of money up to 100
Liquidity management
Bank holds excess reserves, positive difference between actual and required reserves if > the costs
of additional borrowing of the CB, the repo rate (CB to commercial banks if funds fall) or lending rate
exceeds costs of holding the excess reserves.
Asset management
1. Select borrowers with low risk of default who pay interest rates
2. Select securities with high returns and low risk
3. Minimize risk by diversifying assets
4. Manage liquidity to meet deposit outflows, estimate the sum of L-assets and cash inflow,
and sum the overnight deposits + cash outflow > exceed latter.
Liability management
 The bank must ensure stable financing of the assets – long term assets should be financed
by long term liabilities (Northern Rock!)
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Banking structure
Crisis management Eurozone
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Bank
Liquid assets
short-term liabilities
Non-liquid assets
Long term liabilities
Own funds (share capital and free reserves)
Liquidity = can a bank deal with its short-term commitments? Enough cash flow available.
Solvency = can a bank pay back all of its commitments (liabilities), buffers to deal with losses.
(SLIDE 51)
What can you do when you are running the risk of going bankrupt of all the losses you are making?
1. Loan from the ECB (or the FED if you are in the US) will improve the banks liquidity. This will
help when you are not liquid. It will have no consequences for the bank solvency as it won’t
increase own funds.
2. To increase own funds, you have to increase share capital by issuing shares (stock)  own fund
buffers will increase. On the left side of the T-Account, liquid assets will increase.
 Issuing shares (in the bank: being co-owner of the bank) increases own funds +
bank reserves. However, if you are not solvent, no one wants to buy stock.
3. Sell non-liquid (risky) assets for cash
4. Liquidity improving: by substitute liquid of short-term liabilities by long term liabilities. You can
only change short term loans to long term loans when they are maturing. (Wanneer ze ouder
worden en je nog een keer opnieuw moet lenen en dat je dan 5 jaar leent ipv 30 dagen, want je
kan niet de lening die je hebt veranderen naar een long-term lening).
Resolutions:
1. Removal of managers
2. Sale of business
3. Bridge institution  temporary vehicle which you use in order to sell a bank. Bridge
institution can take over the bank to sell it afterwards.
4. Good bank – bad bank: you can sell the unhealthy assets to another separate bank (you
make that bank) and let that one go bankrupt. (let bad bank go bankrupt and sell the good
bank)
5. Bail-in: the holders of capital will pay for it. (The creditors and shareholders will pay for the
bank’s rescue) (most important one).
Forget about page 50.
Why bailout should be avoided (using Ireland as an example):
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Lower bank lending (lower risk profile)
Italian banks holding
government bonds
Less spending  lower
economic growth lower
taxes  government debt
goes up
Italian government promises
retirement age at 62 years and
minimum wage for everybody
(also the unemployed) 
government debt increasing
Bank losses due
to lower bond
prices
Re-financing
cost-interest rate
goes up
Bail out  government debt is going up even more and interest rates are going up even more. With
a bail-out a bank is saved by the government by using tax payers’ money. Therefore, we arrange the
possibility of bail-in.
In Italy politicians will choose for a bail out.
Bail in in Italy is practically suicide.
Own government bonds government bonds go up
Lower ban k lending - lower risk profile  lower eco growth = lower taxes = government debt will go
up.
What goes wrong in emerging markets, it is almost one of the two and it is sometimes even two of
the two:
1. Mismanagement of financial liberalization / globalization
2. Severe fiscal imbalances (not able to find new ways of getting new money, expenses of the
government are to0 high).
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Richest country in the world looking at roil reserves but miss-management of the country let to total
break-down of the oil industry. That country has especially the second one.
Interest rate
loans go up
Local assets
prices go down
Import prices go up
Emerging markets:
Government debt
goes up.
Banks  miss
management
$
US:
I goes up
Capital flight
Buy $ sell local
currency 
exchange rate
goes down
SLIDE 62
1. Setting the official interest rate: EU is repo rate (amount of money available for banks at the
repo rate is limited), US is federal fund target rate, UK = bank rate
a. Lending facilities ECB: repo-facility  amount you can borrow is limited; marginal
lending (rate) facility; ad hoc facilities (in 2011 the situation in Europe was close to a
financial meltdown and then the ECB made ad hoc loans, it is created when
necessary). The steps are in the order for when you need more, so first repo-facility
then marginal lending then ad hoc.
i. Ad hoc facilities  2011/2012 3 year loan at 1% max 11,00 bn
ii. Lending facilities ECB  US: Fed fund target rate, discount facility:
unlimited.
ECB decides how much banks can lend from the CB.
Lending facility  when a bank wants to lend more than the ECB “allows”.
ECB:
1. Repo facility: limited
2. Marginal lending rate facility
3. Ad hoc facilities
US
 Federal fund target rate
 Discount facility: limited
US bank reserves should be 1% of deposit  when banks have more  they can lend to other banks
with deficits.
IMPORTANT
Federal Fund target rate beginning December changes Thursday.
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Federal fund target rate will increase  bank lending will become more expensive  less lending 
less spending to slow down the economy.
As US now coping with inflation overheated economy
EXAM question: How can you lower the bank reserves related to the deposits outstanding.
slide 63 (Over foto eronder)
- Increase minimum reserve requirement  excess reserves decrease
- They (interest rates) will go up as soon as Sell cheap bonds to Banks
- FED  how can the interest rate increase to 1.5?
o Setting federal fund rate higher
o You can use tools in slide 62.
- Why would you do it?
Less banking reserves available, supply will go to the left
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In this picture I am arguing if you lower bank reserves if you will lower supply.
Balance sheet comm US ban
Bank reserves
Loans
Securities
2
78
30
Deposits
Brrowings from FED
Own funds
110
100
5
5
110
FED wants to lower bank reserves:
- Increase minimum reserve requirements/ratio  excess reserve decrease
- Open market operations  sell cheap bonds to banks. However, interst rates will go up.
Securities will go up bank reserves go down outstanding loans go down deposit goes down.
ECB deposit rate is now -0.40% to stimulate commercial banks to do something else with their
reserves, e.g. buying bonds.
When increasing this rate  banks will keep it on a loan at the CB, so they will not use it for other
spending alternative alternative.
Deposit rate goes up  Bank reserves go up because they earn more money  or loans or securities
will be affected
 Securities go down  higher interest rates are going down  lower consumer borrowing
 lower bank lending = higher interest rate  result in less lending from bank to public
WATCH WHAT THE FED IS DOWING IN THE FIRST WEEK OF DECEMBER. IF THE FED IS DOING
SOMETHING HE WILL ASK SOMETHING ABOUT IT.
Over-night: you cannot borrow for a couple of years (only days weeks or months)
SLIDE 64: (links onder) need to be able to understand when a bank is borrowing money.
SLIDE 65
-
If the deposit rate increases it is less expensive to hold money on the CB, it will stimulate
bank to hold more money with the central bank and don’t use it for lending purposes.
If banks are selling securities it will increase interest rates.
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5. Banking 2
Capital adequacy management
 A bank should maintain adequate capital buffers to absorb losses under stress circumstances
 Hold capital up to 8% of the sum of risk weighted assets and off-balance sheet exposures
 Low capital buffers > capital crunch can cause a credit crunch and an economic crisis.
Global financial risk
Financial crisis in advanced economies


Foreclosures increase supply of homes and lowers therefore house prices, creating negative
equity.
Foreclosures reduce cash flowing into banks and the value of mortgage-backed securities
held by banks. When losses are incurred additional funds are required. If banks are not
capitalized sufficiently to lend, economic activity slows down and unemployment increases,
this increases foreclosures (balancing a loan from a borrower).
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Government intervention
 Financial bailouts of failing banks
 Improve banking supervision (EU banking Union in addition to the EMU) and increasing
bank’s capital buffers
 Fiscal stimulus spending in the US (in Europe opposite due to the Sovereign debt crisis
 Loose monetary policy resulting in cheap money for banks
 Economic reform measures in order to make economies more competitive
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6. Financial crisis in emerging markets
Developing an EM crisis
1. Mismanagement of financial liberalization or globalization
Elimination of restrictions on cross border activities of domestic banks in
combination with a weak financial infrastructure and weal prudential supervision
can cause to much borrowing in FC, and allocating money insufficient. Asset bubbles
and low ROI in domestic economy.
2. Severe fiscal imbalance
Cause EM government to borrow much FC and allocate money inefficient in the
domestic economy, debt running out of control.
 Currency crisis
 Economic crisis

Foreign investors sell their investments, asset bubbles burst and private wealth falls,
money is pulled out of the country into other countries, domestic currency
depreciates and increase of interest rate and inflation. Economy contracts.
Prevention
 Tighten prudential regulation and supervision of banks
 Fiscal consolidation and sustainable debt to GDP ratio’s
 Fiscal policy focused on supporting reforms aimed at expanding and diversifying the
economy’s supply potential
 Limit currency mismatches: prevent carry trade (buying high yielding currency and
funding it with a low yielding currency, buy low – sell high)
 Managing financial liberalization
Central bank’s monetary policy instruments
 Setting official interest rate
 Discount lending
 Interest rate on reserves
 Reserve requirements
 Open market operations
 Ad hoc lending operations
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



Borrowings from CB increases the bank’s liquidity – bank reserves 1
Allowing to lend more to households and corporates 2
Results in an increase in the amount of deposits of households and corporates 2
Spending of consumers and corporates will increase!!!
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OMO
 An activity by the CB to give or take liquidity in its currency to or from a bank or a
group banks by buying or selling private sector securities or public sector securities
in the open market or via repo or secured lending transaction with a Commercial B >
CB gives money as a deposit for a defined period and as an eligible asset as
collateral.
Used for implementing monetary policy by means of supplying commercial banks
with liquidity or taking surplus liquidity from commercial banks to manipulate
interest rates. The supply of money and aggregate demand and thereby inflation,
especially to control recessions.
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‘’Monetary policy instruments and the transmission mechanisms.’’
TRANSMISSION MECHANISM 1
1. INTEREST RATE CHANNEL
ECB repo rate increase – bank borrows decrease (because more expensive) – affects bank lending
decreases (bank lending costs decrease because bank liquidity is expensive) – total demand goods
and services decrease (spending less) – affects GDP – affects inflation (people spend less so causes
inflation to fall)
2. EXCHANGE RATE CHANNEL
ECB repo rate increases – foreign capital moves to euro zone (higher interest rates cause attraction)
– demand euro goes up – exchange rate increases – euro zone export and import affected (net
export) – export falls (more expensive and higher export prices in FE, people spend less) – import
increase (import prices in euro cheaper) – net export decreases – total demand affected and falls –
GDP and inflation decrease
3. PRIVATE WEALTH CHANNEL
ECB repo rate increases – bond and shares prices decrease – net present value company goes down
as financing costs of company go up – profit goes down – share price goes down (=net present value)
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TRANSMISSION MECHANISM 2
1. INTEREST RATE CHANNEL
Open market selling of bonds to banks – less money available – lower bank lending or/and higher
interest rates – total demand falls – GDP falls – inflation falls
2. EXCHANGE RATE CHANNEL
Open market selling of bonds to banks – short of cash - higher interest rates make exchange rates go
up as attracts foreign capital – more demand currency so appreciation – export falls – import goes
up – net export falls – GDP and inflation decreases
3. PRIVATE WEALTH CHANNEL
Open market selling of bonds to banks – bond and shares prices decrease – net present value
company goes down as financing costs of company go up – profit goes down – share price goes
down (=net present value)
TRANSMISSION MECHANISM 3
Min reserve ratio= bank reserves / deposits x 100%
> 1% required ratio
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1. INTEREST RATE CHANNEL
Min reserve requirements higher – banks have less money available as reserves are higher and short
of cash – higher than 2% - lower bank lending as more expensive, interest rates higher – demand
lower – GDP and inflation decrease
2. EXCHANGE RATE CHANNEL
Min reserve requirements higher – SAME
3. PRIVATE WEALTH CHANNEL
Min reserve requirements higher – bond and shares prices decrease – net present value company
goes down as financing costs of company go up – profit goes down – share price goes down (=net
present value)
TRANSMISSION MECHANISM 4
Deposit rate -40, banks forced to keep as low as possible to use money for other purposes
1. INTEREST RATE CHANNEL
Deposit rate increase – SAME
Deposit rate decrease – banks are forced to move money from bank reserves
2. EXCHANGE RATE CHANNEL
Deposit rate increase – SAME
3. PRIVATE WEALTH CHANNEL
Deposit rate increase – SAME
___________________________________________________________________________
When does it not work?
2008 financial crisis: banks making losses
Credit crunch in banking sector = lower risk exposure
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
Bank borrowing and bank lending to corporates IS NOT POSSIBLE/BENEFICIAL
1. INTEREST RATE CHANNEL
ECB repo rate decrease 0% - bank borrowing – lending to governments – government conduct cheap
borrowing – spending of people dried up as they not borrowed but the government borrowed – no
effect on total demand – no effect on GDP and inflation
EXAMPLE
 Government debt ratio out of control
 Italy: borrow cheap spend cheap, should have improved the economy
2. EXCHANGE RATE CHANNEL
Decrease repo rate – exchange rate falls – goods are less expensive – export increases – import
decreases
3. PRIVATE WEALTH CHANNEL
Decrease repo rate – market interest rates fall – private wealth increases – uncertain about jobs pp
___________________________________________________________________________
 ECB repo rate increased but banks don’t need money than it is useless to increase repo rate
as this does not affect the banks > no monetary policy.
 Banks not shore of cash or don’t need cash? Use instruments number 2 or 3
 Increase deposit rate if you want to lower GDP or inflation.
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7. The conduct of monetary policy: strategy and tactics
Price stability (ECB) = because inflation or deflation create economic uncertainty and lowers
economic growth
High employment and economic growth = stable eco growth – high and stable employment
Dual mandate (FED) = high employment and economic growth – stable inflation
Interest rate stability = fluctuating interest rate create economic uncertainty (inflation), are
the result of fluctuating inflation. Stable prices strategy the same.
Exchange rate stability = stable exchange rates (via monetary policies where higher IR are
implemented during currency weaknesses). Stables trade relations with partners.
ECB halves its purchasing pricing of securities, and the rate at which it prints new CB money to inject
in the economy.
Why?
- Compromises, leaving the ECB room for manoeuvre rather than signaling a firm to end
purchases in the future.
- 2% ceiling ECB not reached, no inflationary pressure.
- Normalize
- Long-term interests need to be targeted (pin down the whole structure of interest rates)
- Quantitative easing = targeting a quantity long-term security to purchase in order to ease
long-term borrowing conditions by driving down yields on the purchased assets, and driving
investors into other securities.
- Direct rate targeting = specifies desired yields on the relevant assets and buys or sells
securities to achieve it.
ECB influencing the rate
 Signaling or market operations
1. Standing steady to buy and sell as required means they didn’t have to in the first place
2. Direct long-term investment interest rate targeting is useful when policy has to be
tightened as well as loosened.
Rate-targeting would involve a targeting rise in the common interest rate: ECB would
package the bonds it holds and sell bundles that exactly correspond to the constructed
rate. That would achieve the desired monetary policy and common safe asset without
taxes and exposes etc.
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Turkey current account surplus Article
- Sharp rise in exports and fall in imports rebalancing crisis-hit economy
- Largest monthly current account surpluses
- Currency crisis have led to a rapid rebalancing of the economy
- Foreign investors have been scared off by the rise of interest rates (deemed to be necessary
during an overheating economy)
- Lira plummeted
- Swift correction Turkey’s current account balance
- Consumers and businesses are cutting back on imports due to rising prices
- Trade deficit improving in the months where there is a lot of tourism
- Exchange rate depreciation makes country’s exports cheaper on world markets
- Exchange rates increase profits of exporters
- Export countries Germany US should support a recovery
- Fewer working days in august so September export surged
https://studiedelen.mijnhva.nl/studiedelen/fbe-4000EIT_17/18191/Documents/Turkey%20heads%20for%20record%20current%20account%20surplus.pdf
US – China Article
- Trade confrontation
- Refusal to buy its debt by Beijing.
- Tit-for-tat trade sanctions
- One makes aggressive move, so the other responds and does the same.
- Trump says China has been cheating on trade
- Reaction to tariffs of US
- Trump imposes 10% extra tariffs on extra Chinese exports.
- To 25% as a consequence of tit-for-tat.
- Risk a trade war
- US thinks China is vulnerable for US pressure and tariff war
- China soon runs out on products to impose tariffs on
Obstacles for operating American businesses in China
Eased enforcement of trade sanction on North Korea (scrap nuclear weapons)
Manipulate the currency to drift down in value, which offsets the price effect of 10% tariffs.
China big role of American government debt buyer. They make it harder to fund the US
federal deficit.
https://studiedelen.mijnhva.nl/studiedelen/fbe-4000EIT_17/18191/Documents/The%20US,%20China%20and%20the%20logic%20of%20trade%20confrontation.pdf
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Turkey’s currency crisis Article
- Slash public spending rapidly when inflation surged
- Rebuild market confidence by cutting public spending in a sweeping austerity program.
- Sharply raise interest rates in the face of a mounting currency crisis.
- Spending and growth targets were a welcome sign to take measures to tame the inflation
and depreciate the Lira.
- Banks face mounting bad loans, as the borrowers in dollars struggle to meet the debt
payments rising.
- New economic program based on more realistic GDP and inflation.
- Lower but more sustainable growth.
https://studiedelen.mijnhva.nl/studiedelen/fbe-4000EIT_17/18191/Documents/Turkey%20unveils%20plan%20to%20fight%20currency%20crisis.pdf
Exam practice
1. What can be done in order to stabilize a weak currency (€), by:
a. Fiscal measures (fiscal policy means that you use your budget policy in order to
influence the economy)
i. Higher taxes  people will have less money to spend (spending goes down)
 if you spend less, you spend less on goods (some are produced in the
country itself, some are produced in another country)  import goes down
 supply € goes down  € appreciates.
ii. Or: higher taxes  lower spending  lower inflation  relative price
decline exports  more export  more demand for € € appreciates.
iii. Or: Lower government spending  lower spending (total)  …. (steps 1 or
2)  € appreciates.
b. Monetary measure (ECB)
i. Increase official rate (repo rate)  higher bank lending rates  lower
spending  etc.  € appreciates.
ii. Or: to attract foreign capital  increased demand for €  € appreciates.
iii. Or: ECB sells bonds to banks  lower bank liquidity  bank lending rates go
up  etc.
c. Trade policy-related measures
i. Tariffs: Impose a tariff  people will import less (import goes down) 
supply of € goes down  € appreciates (exchange rate goes up).
ii. Or (bonus point): if import is price-inelastic an increase in import prices (by
imposing a tariff) will increase the value of imports and the supply for € goes
up  € depreciates. If export will be lower  this will lower the exchange
rate. (If this happens, we could argue that an import tariff is not effective)
THE FOLLOWING QUESTIONS ARE RELATED TO EACHOTHER
2. If government debt increases fast and unexpected, what will be the consequences for
government borrowing rates?
a. The government borrowing cost is going up (if borrow more, pay more).
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3. What are the consequences for government prices?
a. If interest rates go up  Bond prices go down (if interest rates go down  bond
prices go up)  example: if I buy a bond, interest rate goes up  no one is
interested in my bond  if I lower my celling price  then it becomes interesting
because the rate of return increase.
4. What are the consequences for the financial position of banks holding such government
bonds?
a. Banks will have a weaker financial position, because they make a loss on their bond
holdings.
Assets
BANK
Liabilities
________________________________________________________
Bank holdings (goes down)
Liabilities
Own fund (goes down)
5. What will be the effect on bank lending?
a. Bank lending goes down, because they have fewer capital buffers so less money
available. Bank lending rate goes up  bank lending goes down.
6. What will be the effect of this on the government debt?
a. If bank lending is falling  people spend less (because of lower bank lending)  tax
income will be less  the economy will grow slower  government debt will
increase.
b. If the government is increasing its debt by higher interest rate this will have
consequences for the banking system. It will lower bank lending  this means lower
spending  lower tax income  the effect will be that government debt will
increase. Solve it by lower the government deficit. Lower deficit and lower spending
can trigger an economic recession.
7. So, what should the government do if situation nr. 2 is reality.
a. The government should stabilize the government deficit (by increasing taxes or
lower government spending). Otherwise the circle will go on where the government
will increase influence the banker sector.
THEORY
If the repo rate of the ECB is lowered  bank lending rates will go down  more consumer
spending  more economic growth + inflation.
We want more inflation to happen when there is a risk of deflation.
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REALITY
If the repo rate of the ECB is lowered  when there is a bank crisis, lending will not fall (cheap
government borrowing, risk free). The only thing you can do is an incentive for higher debt.  more
consumer spending  more economic growth (but it is not a healthy economic growth because the
government is spending, not the people.

If there is a bank crisis going on should try to not make the red (picture) happen.

More consumer spending also means more import.
SAUDI ARABIA
- Policy fixed exchange rate relative to US $.
1. Consequences for fiscal policy and monetary policy> I
a. If US interest rates go up  capita will flee to Saudi Arabia towards the US  if
capital is fleeing Saudi Arabia  it has to be converted in dollars (sell the Saudi
Arabian currency, then I can put it on a bank account in the US)  exchange rate is
depreciating (Saudi currency depreciates, because you are selling it).
i. If you sell your Saudi currency, where will it go? It means that in the market
supply and demand will meet each other. I have to find somebody that
wants to buy euros. They maybe will want it if they think that the Euro will
become strong.
ii. If the Saudi currency is moving to the US, the price of that currency is going
to drop.
b. If you are a Saudi investor and you put your money on an account in Saudi Arabia
and you can choose to invest
2. If you want a stable exchange rate  Saudi Arabia should be forced to increase taxes (fiscal
policy), or you use your monetary policy: increase interest rates.
If you are fixing your currency to another currency, you will lose monetary independence. You will
lose your autonomy.
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EXAM TOPICS
1. International trade – cost advantages, types and effects of imposing trade barriers, WTO and
International trade agreement
Comparative cost advantage= when a country can produce a service or good at a lower operation
cost.
Absolute cost advantage= even though a country has an absolute cost advantage over all products,
every country has a comparative one on a product or service.
Trade barriers
 Tariffs
 Quota’s
 Licenses
 Embargo
 Export subsidies
 Voluntary export/important restraints
 Local content requirement
 Technical standards
 Capital controls
Effects

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

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
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
WTO

Import products
limiting amount
import only for allowed licensed parties
no import allowed
lower costs for domestic exporters
informal quota’s
components of imported goods/origin
excessive specifications import goods
restrictions on cross border transactions
Increased prices of foreign goods
Increased domestic prices due to lower competition
Smaller variety of goods available for consumers
Increased number of jobs
Loss of welfare
Risk of trade wars
Domestic production increases
Deficit current account = net import of capital
Restriction on import > lower capital import, country is worse off
World Trade Organisation, replaced GATT in 1997
Goal: freer trade (by lowering on goods and services via the negotiation of new trade
agreements, and setting disputes between WTO-members).
WTO – principles underlying all WTO-rules
Most favored nations principle
Equal treatment for all country trading partners
exemptions for: (1) free trade areas, (2) favorable conditions for developing countries and
(3) barriers against dumping practices.
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

GATT
-
National treatment
Treating foreigners (import) and locals (domestic production) equal as a good has entered
the market
Trade facilitation
Prohibition of applying bureaucratic delays and red tape in order to pose a burden for
moving goods across borders for traders.
General Agreement on Tariffs and Trade
Goal: freer trade by lower tariffs on goods
2. Foreign exchange market: determinants exchange rate; different regimes; pros and cons.
Understanding of policy trilemma.
Exchange rate
Supply curve
- import Eurozone, capital export Euro
- Demand for exchange
- Sell euro = shift supply curve to the right
Demand curve
- Export Eurozone, capital import Euro
- Selling FE currency
Demand export from Eurozone > demand euro INCREASE (import capital INCREASE) > euro
appreciates > demand shifts to the right > demand + supply INCREASE
Fixed
Exchange rate is set by government or CB
PRO
Provides currency stability for investors
Country business attractive
Avoids inflation
CON
Expensive to maintain (foreign reserves needed)
CB must convert FE to grow value, if not enough reserves, interest rates go up and recession
Floating
Determined by the market and supply & demand, self-correcting
PRO
Much more jobs created when the market reflects on the ER automatically. Demand for currency
low, leads to low prices so higher demand and supply products
World movement and actions do not have an impact on the currency
CON
High volatility
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Makes current existing problems worse, conditions may get worse
Managed floating
Influenced exchange rates by CB or monetary policies
PRO
Adjustments needed to achieve equilibrium and good impact on economy
Monetary policy is stronger
CON
Different governments set their exchange rates at inconsistent levels
Fiscal policy weaker
PPP
Policy Trilemma
Limited options and resources available for countries to implement a monetary policy. No free flow
of capital is achieved, no fixed exchange rate and an independent monetary policy.
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3. The European Union
Preferential trading area
- Country or group of countries receiving preferential treatment from another country or
trading block
- Tariffs and other import restrictions are abolished completely.
- FREE TRADE AREA
Economic and Monetary Union (EMU)
- Implement effective monetary policy for euro with objective of price stability
- Coordinating economic and fiscal policies in EU countries
- Ensuring single market runs smoothly
- Supervising and monitoring financial institutions
4. The functioning of banks and other financial institutions: how banks can create money;
management of bank’s liquidity, assets, liability & solvency?
Bank is a credit institution
 Hold people’s deposits and savings
 Make loans to households and corporate services
 Responsible for maintaining payment system
‘’Insurance companies, investment funds and pension funds banks’’
Money used as:
 Medium of exchange
 Store of value
 Unit of account
Flat money (coins and paper)
Electronic money (debit cards, credit cards, prepaid cards, smart cards)
M2= M1 + substitutes M
M3= M2 + close substitutes M2
Required reserve ratio =
Cash + bank reserves / overnight deposits x 100%
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LCR =
High quality liquid assets / net outgoing cashflow in 30 days > 100%
NSFR =
Available amount of stable financing / required amount of stable funding > 100%
Leverage ratio =
Ratio of total share capital + reserves to total assets > 3%
Liquidity management
- Hold excess reserves if costs of additional borrowing exceed the costs of holding excess
reserves.
Asset management
- Select borrowers with low risk of default
- Select securities with high returns and low risks
- Minimize risk by diversifying assets
- Estimate the sum of liquid assets and overnight deposits.
Liability management
- Ensure stable financing of its assets (long – term assets, long – term liabilities)
Capital adequacy management
- A bank should obtain capital buffers to absorb losses
5. Causes and consequences of the 2008/2009 financial crisis for banks and other financial
institutions in advanced economies and in emerging economies.
1. ADVANCED ECONOMIES
Causes and consequences
 Irresponsible mortgage lending:
risky loans past to investors as collateral
 Loose monetary policy:
results in low interest rates and high bank lending
 Weak financial regulation:
risk management was low
 Bursting of the housing bubble:
value of property decreased, MBS (mortgage backed
securities) prices decreased, creditworthiness questioned, withhold short-term credits so
higher interest rate
 CREDIT CRUNCH
investment capital not securable, prices of debt
Solutions
 Improving supervision
 Loose monetary policy (cheap money for banks)
 Reform measures
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2. EMERGING ECONOMIES
Causes and consequences
 Mismanagement financial liberalization/globalization (borrow to much because of free trade
and activities), money is allocated inefficient.
 Severe fiscal imbalances (borrow too much, money allocated inefficient domestically)
 Currency crisis occurs > FE SELL INVESTMENTS, ASSET BUBBLE & PRIVATE WEALTH BURSTS
 Economic crisis arises > DEPRECIATION OF CURRENCY BECAUSE OF SELLING DOMESTIC
CURRENCY AND INVEST IN OTHER COUNTRIES, INCREASE INTEREST RATES SO INFLATION
Solutions
 Tighten supervision of banks
 Limit currency mismatches (prevent excessive carry trade, buy low sell high)
 Managing financial liberalization
6. Tools and functioning of monetary policy – be able to explain the working of the different
policy instruments: setting the official rate, conducting open market operations, changing
the minimum reserve requirement, changing the deposit rate.
‘’A monetary policy is the implementation of actions taken by the CB or currency board or other
regulatory authority to impact the economic activity in a country and keep the currency stable. It is
for controlling inflation, consumption, growth and liquidity.’’
Monetary policy instruments
- Setting official interest rate
Refinancing the repo-rate. Maximum amount is set by the ECB.
This is implemented when the inflation is getting higher than the target. When setting an official
interest rate, borrowing and lending may be more expensive, so less people buy and inflation is
pushed down.
- Discount lending
Marginal lending rate. This offers unlimited overnight credit to banks. A higher discount rate makes
borrowing and lending more expensive, this means taking money out of the economy, and prices
start to decrease. Inflation is decreasing, but employment as well. When prices are lower, export on
the other hand is more interesting, so more demand for the currency so an appreciation of the
currency arises.
- Interest rate on reserves
Deposit rate (interest on reserves). A negative deposit rate (currently) leads to banks paying for the
balance with the ECB. Interest rates on savings account decreased, so consumption increases, prices
rise, employment rises. Domestic production is increased, and export is not so interesting anymore.
Less demand for the currency, so a depreciation.
- Reserve requirements
Minimum reserve ratio. If the required reserve ratio is increased, banks are forces to lower loans
outstanding, so amount overnight deposits will fall and increase the amount of reserves by selling
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securities. Interest rates increase again, and total spending falls. Consumer buying falls, prices fall,
employment falls. Inflation decreases. Export more interesting because of the lower prices. Demand
for currency increases, appreciation.
A decrease of the ratio causes opposite effect. Banks have more liquidity, and are not forces to
lower loans. The amount overnight deposits may increase, and decrease the amount by selling
securities. Interest rates decrease, total spending rises. Consumers buy more, prices go up.
Employment increases. Inflation happens. Export less interesting because of high prices. Domestic
production increases. Less demand for the currency, depreciation.
Ad hoc lending operations
Actions taken for a reason or in a special situation. An urgent matter.
- Open Market Operations
OMO is an activity by the bank to give or take liquidity in its currency to or from a bank or group of
banks. They do this by buying or selling securities in the open market, OR via repo or secured lending
transaction with commercial banks. The CB gives the money as a deposit for a defined period and
takes an eligible asset as collateral.
The CB uses this as a monetary policy tool, by supplying commercial banks to manipulate interest
rates, supply of money and aggregate demand and thereby inflation to control recessions.
Buying and selling of government securities > affect money supply in the economy.
7. Understanding working of the monetary transmission mechanism, and why it doesn’t
sometime work.
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