hi , the last two EOC questions numer 19 and 20 are about the traditonal flow approach and the asset market approach. Furthermore they mention loanable funds - i dont really understand that. can anybody help? do we have to know this approaches?? schweser doesnt really mention them… thank you!!
let’s putit this way : in the case of a credible , sustainable and large reduction in the budget deficit, reduced inflationary expectations are likely because the central bank is less likely to monetize the debt by indcreasing the money supply. what does monetize the debt mean and can somebody help on the question above?
Loanable funds: capital available in the economy to be given for credit. In this case, since govt plans to reduce its deficit, it will not need capital anymore to finance that deficit. Thus demand for loanable funds in the economy will reduce. Monetizing the debt: means paying for debt NOT from govt revenues or from borrowing additional funds, BUT by printing more money. Monetizing of debt causes increased money supply in the economy and thus increased inflation. Regarding traditional model vs asset market approach: Traditional model (PPP, IRP etc) generally explain exchange rates in long term. (that is what would be the long term effect of some economic fundamentals changing now). Whereas Asset market approach explains exchange rate in immediate short run for those same economic changes. Hope it helps.
just to add on asset market approach assumes PPP holds in the long run so long run expected exchange rates can be determined from PPP relationship. E(s)=s*1+id/1+if then from long run expected exchange rates determine short term exchange rates using uncovered interest rate parity i.e s=E(s)* 1+id/1+if basically once the central bank interviens in the money supply you work out the expected long run effect and using PPP and bring doen to current level using uncovered interest rate parity
thank you very much!!