Intermediate Macroeconomics Topic Summarisations

IS-LM

A stylized, closed-economy model used to analyze the effects of fiscal policy, monetary policy, and shocks on output, consumption, and investment. It assumes fixed prices and focuses on the inverse relationship between expenditure and the interest rate.

IS

The component of the IS-LM model that represents the relationship between expenditure and the interest rate. It is based on analyzing the demand for goods but does not consider the supply of goods.

LM

The monetary policy component of the IS-LM model. It represents the relationship between output and the interest rate, based on the demand for money and the supply of money by the Central Bank.

Monetary Policy Rule LM

A variety of the LM curve in the IS-LM model that is based on money demand and supply. It assumes a fixed interest rate and a monetary policy rule where the Central Bank increases the interest rate as output increases.

Fixed Interest Rate

In the IS-LM model, the assumption that the Central Bank fixes the interest rate instead of the money supply. It adjusts the money supply to match the demand for money at the chosen interest rate.

Monetary Policy Rule

A description of how the Central Bank sets the interest rate to achieve its policy targets. The most prominent rule is the Taylor Rule, which adjusts the interest rate based on inflation and output deviations from target levels.

Equilibrium Output

The level of output in the economy that is sustainable and corresponds to the average level of output. It is determined by the supply side of the economy and is external to the IS-LM model.

Central Bank

The institution responsible for conducting monetary policy and controlling the money supply in an economy. It issues currency, holds reserves owned by commercial banks, and sets the interest rate.

Commercial Banks

Financial institutions that hold reserves at the Central Bank, hold deposits owned by the private sector, issue loans, and act as intermediaries between savers and borrowers. They play a central role in the banking and monetary systems.

Money Supply

The total amount of money in circulation in an economy. It includes currency, bank reserves, and bank deposits. Narrow money refers to currency and reserves, while broad money includes currency and deposits.

Interest on Reserves

The interest rate paid on reserves held by commercial banks, which is lower than the interest rate on loans and other assets.

Rate of Return

The percentage of profit or loss on an investment, which is affected by the difference between the interest rate on reserves and the interest rate on loans and other assets.

Commercial Banks

Financial institutions that issue loans and hold deposits from the private sector.

Bank Lending Channel

The mechanism through which commercial banks increase their rate of return by issuing more loans, which increases the share of loans on their balance sheets and reduces the share of reserves and other assets.

QE (Quantitative Easing)

A monetary policy tool used by central banks to stimulate the economy by purchasing assets from the private sector, using commercial banks as intermediaries.

OMO (Open Market Operations)

A monetary policy tool used by central banks to control the money supply by buying and selling government securities in the open market.

Money Supply

The total amount of money in circulation in an economy, which increases when reserves and deposits held by commercial banks increase.

LM Curve

A graphical representation of the relationship between the interest rate and national income, which shifts out when the money supply increases.

Portfolio Substitution Effect

The impact of QE on the asset portfolio of non-bank financial institutions, such as pension funds, leading them to purchase alternative types of assets with higher returns.

Money Creation

The process by which commercial banks increase the money supply by issuing loans to the private sector, resulting in an increase in deposits held by the private sector at commercial banks.

Money Multiplier

The ratio of the change in the money supply to the change in reserves, which is not constant and affects the ability of the central bank to control the money supply.

Tiered Reserves

An alternative policy to paying interest on all bank reserves, where the central bank pays interest only on required reserves, incentivizing commercial banks to increase lending.

Monetary Policy

The actions taken by the central bank to control the money supply and interest rates in order to achieve macroeconomic objectives.

Government Borrowing

The process by which the government raises funds through issuing debt securities, such as bonds, to finance its expenditures.

Government Budget Constraint

The relationship between government expenditure, tax revenue, debt, and interest payments, which must be balanced to ensure fiscal sustainability.

Debt Sustainability

The ability of the government to manage its debt in a way that is sustainable in the long term, considering factors such as economic growth and interest rates.

Money Financing

The use of the central bank to increase the monetary base to finance government spending, which can have implications for inflation and macroeconomic policy outcomes.

Pros of Money Financing

The potential benefits of using money financing as an alternative source of funding, such as increased investment in long-term projects and reduced inequality.

Cons of Money Financing

The potential drawbacks of relying too heavily on money financing, including increased inflation and the risk of financing unproductive projects.

QE and Debt

The relationship between quantitative easing and government debt, where the purchase of bonds by the central bank does not cancel or eliminate the debt.

Bank of England

The central bank of the United Kingdom that receives interest payments on bonds and pays funds back to the government.

Open Economy

An economy that engages in international trade and has free movement of capital.

Exchange Rates

The rate at which one currency can be exchanged for another.

Capital Mobility

The measure of how responsive investment flows are to interest rate differentials.

UIP (Uncovered Interest Parity)

An assumption that there are no costs to swapping one currency for another in the future, which affects the expected returns from foreign investments.

Nominal Exchange Rate

The rate at which one currency can be exchanged for another, denoted as E.

Real Exchange Rate

The relative prices of goods and services in terms of domestic and foreign currencies.

Depreciation

A decrease in the value of a currency relative to another currency.

Current Account

The difference between a country's exports and imports.

Balance of Payments

The sum of the current account and the capital account, which should always be zero in equilibrium.

Mundell-Fleming Model

An extension of the IS-LM model to the open economy that analyzes the relationship between interest rates, output, and exchange rates.

Fiscal Policy

The use of government spending and taxation to influence the economy.

Monetary Policy

The use of central bank actions to control the money supply and interest rates.

Macroeconomic Equilibrium

A state where variables are constant, expected to remain constant, and expectations are correct.

Flexible Exchange Rates

Exchange rates that are determined by market forces and can fluctuate freely.

LM Curve

A relationship between domestic output and the interest rate.

IS Curve

A relationship between output, interest rates, and the exchange rate.

Equilibrium Exchange Rate

The exchange rate that ensures the IS curve passes through the intersection of the LM and FE curves.

Fiscal Expansion

An increase in government expenditure that leads to an exchange rate appreciation.

Monetary Expansion

An increase in the money supply that leads to an increase in output and a depreciation of the exchange rate.

Depreciation

A decrease in the value of a country's currency relative to other currencies.

Monetary policy

The actions taken by a central bank to manage the money supply and interest rates to achieve macroeconomic goals.

Output

The total amount of goods and services produced in an economy.

Perfect capital mobility

The ability of capital to move freely across borders without any restrictions.

Flexible exchange rates

Exchange rates that are determined by market forces and can fluctuate freely.

Domestic interest rate

The interest rate set within a country, which is influenced by the world interest rate.

LM curve

The curve that represents the relationship between the interest rate and output in the Mundell-Fleming model.

Real exchange rate

The relative price of goods and services between two countries, adjusted for inflation.

World interest rate

The interest rate determined in the global financial market, which influences domestic interest rates.

FE curve

The curve that represents the relationship between the exchange rate and output in the Mundell-Fleming model.

IS curve

The curve that represents the relationship between output and the interest rate in the Mundell-Fleming model.

Investment

The expenditure on capital goods, such as machinery and equipment, that is expected to generate future income.

UK economy

The economy of the United Kingdom.

Fed

The Federal Reserve, the central bank of the United States.

Policy rate

The interest rate set by a central bank as part of its monetary policy.

Mundell-Fleming model

A macroeconomic model that analyzes the effects of monetary and fiscal policies on output, interest rates, and exchange rates.

Foreign economy

The economy of a country other than the domestic economy.

World income

The total income generated by all countries in the world.

Equilibrium

A state of balance or stability in which opposing forces or influences are equal.

Aggregate demand

The total demand for goods and services in an economy at a given price level and period of time.

Labour market

The market in which employers and employees interact to determine wages and employment levels.

Competitive labour market

A labour market in which there are many buyers (employers) and sellers (workers) and no single entity has control over wages.

Non-competitive labour market

A labour market in which there are few buyers (employers) and many sellers (workers), giving employers more control over wages.

Labour demand

The quantity of labour that employers are willing and able to hire at a given wage rate.

Labour supply

The quantity of labour that workers are willing and able to offer at a given wage rate.

Production function

The relationship between inputs (such as labour) and outputs (such as goods and services) in the production process.

Marginal product of labour

The additional output produced by employing one additional unit of labour.

Firm profit

The difference between total revenue and total costs for a firm.

Real wage

The wage rate adjusted for changes in the price level.

Optimality condition

The condition in which a firm maximizes its profit by equating the marginal product of labour to the real wage.

Labour supply curve

The relationship between the wage rate and the quantity of labour supplied by workers.

Utility function

A mathematical function that represents an individual's preferences or satisfaction from consuming goods and services.

Budget constraint

The limit on the consumption choices of an individual or household imposed by their income and the prices of goods and services.

Equilibrium wage

The wage rate at which the quantity of labour demanded equals the quantity of labour supplied.

Excess supply of labour

A situation in which the quantity of labour supplied exceeds the quantity of labour demanded at a given wage rate.

Excess demand of labour

A situation in which the quantity of labour demanded exceeds the quantity of labour supplied at a given wage rate.

Involuntary unemployment

Unemployment that occurs when individuals are willing and able to work at the prevailing wage rate but cannot find employment.

Trade union

An organization that represents the interests of workers in negotiations with employers.

Payroll tax

A tax imposed on employers based on the wages they pay to their employees.

Monopoly union model

A model that assumes a single trade union has monopoly power in the labour market and sets the wage rate.

AS curve

The aggregate supply curve, which represents the relationship between the price level and the quantity of output supplied in an economy.

New Keynesian DSGE models

Dynamic stochastic general equilibrium models that incorporate sticky prices and other features of the New Keynesian school of thought.

Sticky prices

Prices that do not adjust immediately to changes in supply and demand conditions.

Lambda

The parameter that represents the stickiness of prices in the New Keynesian model. A value of 1 indicates flexible prices, while a value less than 1 indicates sticky prices.

Preferred price

The price that a firm would choose in a given period if it had perfect information about future prices. In the New Keynesian model, firms use expected values to determine their preferred prices.

IS-LM model

A macroeconomic model that assumes fixed prices and analyzes the relationship between interest rates (IS curve) and output (LM curve).

Aggregate Supply (AS)

The total supply of goods and services in an economy at a given price level. In the New Keynesian model, the AS curve is upward sloping when the economy is out of equilibrium and vertical when it is in equilibrium.

Productivity shocks

Shocks that affect the level of productivity in the economy. A positive productivity shock increases productivity, reduces marginal cost, and decreases inflation.

Business cycle

The fluctuations in economic activity characterized by expansions (increased output) and contractions (decreased output). Inflation and the output gap are determined by the intersection of aggregate demand and supply relationships.

Anchored expectations

Expectations of inflation that always equal the inflation target. In the New Keynesian model, anchored expectations imply that the economy returns to equilibrium immediately after a shock ends.