Unit 5: Long-run Consequences of Stabilization Policy

loanable funds market

a hypothetical market that brings together those who want to lend money and those who want to borrow money

rate of return

a project is the profit earned on the project expressed as a percentage of its cost

crowding out

occurs when a government deficit drives up the interest rate and leads to reduced investment spending

Fisher effect

an increase in expected future inflation drives up the nominal interest rate by the same number of percentage points, leaving the expected real interest rate unchanged

cyclically adjusted budget balance

an estimate of what the budget balance would be if real GDP were exactly equal to potential output

government debt

the accumulation of past budget deficits, minus past budget surpluses

fiscal year

runs from October 1 to September 30 and is labeled according to the calendar year in which it ends

public debt

government debt held by individuals and institutions outside the government

debt-GDP ratio

the government’s debt as a percentage of GDP

implicit liabilities

are spending promises made by governments that are effectively a debt despite the fact that they are effectively a debt despite the fact that they are not included in the usual debt statistics

target federal funds rate

a desired level for the federal fund rate set by the Fed through open market operations by moving the interest rate which shift the money supply curve

expansionary monetary policy

monetary policy that increases aggregate demand

contractionary monetary policy

monetary policy that reduces aggregate demand

Taylor rule for monetary policy

a rule for setting the federal funds rate that takes into account both the inflation rate and the output gap

inflation targeting

occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target

monetary neutrality

changes in the money supply have no real effects on the economy according to the concept of it

classical model of the price level

the real quantity of money is always at its long-run equilibrium level

inflation tax

a reduction in the value of money held by the value of money held by the public caused by inflation

cost-push inflation

inflation that is caused by significant increase in the price of an input with economy-wide importance

demand-pull inflation

inflation that is caused by an increase in aggregate demand

short-run Phillips curve

represents the negative short-run relationship between the unemployment rate and the inflation rate

nonaccelerating inflation rate of unemployment (NAIRU)

the unemployment rate at which inflation does not change over time

long-run Phillips curve

show the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience

debt deflation

the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation

zero bound

it exists on the nominal rate: it cannot go below zero

liquidity trap

a situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound

keynesian economics

focuses on the ability of shifts in aggregate demand to influence aggregate output in the short run

macroeconomic policy activism

the use of monetary and fiscal policy to smooth out the business cycle

monetarism

asserts that GDP will grow steadily if the money supply grows steadily

discretionary monetary policy

the use of changes in the interest rate or the money supply by the central bank to stabilize the economy

monetary policy rule

a formula that determines the central bank’s actions

quantity theory of money

emphasizes the positive relationship between the price level and the money supply. It relies on the velocity equation (M x V = Px Y)

velocity of money

the ratio of nominal GDP to the money supply. It is a measure of the number of times the average dollar bill is spent per year

natural rate hypothesis

to avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate

political business cycle

results when politicians use macroeconomic policy to serve political ends

new classical macroeconomics

an approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output

rational expectations

the view that individuals and firms make decisions optimally, using all available information

new Keynesian economics

market imperfections can lead to price stickiness for the economy as a whole

real business cycle theory

claims that fluctuations in the rate of growth of total factor productivity cause the business cycle

rule of 70

tells us that the time it takes a variable that grows gradually over time to double is approximately 70 divided by that variable’s annual growth rate

labor productivity (productivity)

output per worker

physical capital

consists of human-made goods such as buildings and machines used to produce other goods and services

human capital

is the improvement in labor created by the education and knowledge of members of the workforce

technology

the technical means for the production of goods and services

aggregate production function

a hypothetical function that shows how productivity (output per worker) depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology

diminishing returns to physical capital

an aggregate production function exhibits it when holding the amount of human capital per worker and the state of technology fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity

growth accounting

economists use this to estimate the contribution of each major factor in the aggregate production function to economic growth

total factor productivity

the amount of out put that can be achieved with a given amount of factor inputs

convergence hypothesis

international differences in real GDP per capita tend to narrow over time

research and development (R&D)

spending to create and implement new technologies

infrastructure

roads, power lines, ports, information networks, and other underpinnings for economic activity

sustainable

whether It can continue in the face of the limited supply of natural resources and the impact of growth on the environment d

depreciation

occurs when the value of an asset is reduced by wear, age, or obsolescence