Macroeconomics 2 – Key Vocabulary (Open-Economy Macroeconomics & Growth)

These vocabulary flashcards cover major concepts, definitions, and relationships introduced throughout the Macroeconomics 2 lecture series, encompassing open-economy macroeconomics (trade, exchange rates, balance of payments, policy frameworks) and long-run growth theory (Solow model, technological progress, institutions, and related challenges).

Openness in Goods Markets

The ability of consumers to choose between domestic and foreign goods; facilitated by international trade in goods and services.

Openness in Financial Markets

The ability of investors to buy domestic and foreign financial assets, allowing international capital flows.

Openness in Factor Markets

Freedom for firms to locate production abroad and for workers to choose where to work, often involving multinational enterprises and FDI.

Tariff

A tax on imported goods designed to restrict trade or raise revenue.

Non-Tariff Barrier

A trade restriction such as quotas, border controls or differing product regulations that impedes imports without using tariffs.

Capital Controls

Regulations that limit the flow of financial capital across borders.

Current Account

The section of a country’s balance of payments that records trade in goods and services plus net income from foreign assets.

Trade Balance

Exports minus imports of goods and services; a component of the current account.

Net Foreign Income

Income received from overseas assets minus income paid to foreign owners of domestic assets.

Current Account Surplus

A positive current account balance indicating that a country saves more than it invests abroad.

Current Account Deficit

A negative current account balance showing that a country spends more abroad than it saves.

Financial Account

Part of the balance of payments that records capital transfers and net foreign asset transactions.

Balance of Payments

A systematic record of all economic transactions between residents of a country and the rest of the world.

Gross Domestic Product (GDP)

Total value added from goods and services produced within a country’s borders in a given period.

Gross National Product (GNP)

GDP plus net income from abroad; measures output produced by a nation’s factors of production.

Nominal Exchange Rate (Quantity Notation)

The price of one unit of domestic currency in terms of foreign currency (e.g., €1 = $1.09).

Nominal Exchange Rate (Price Notation)

The price of one unit of foreign currency in domestic currency (e.g., $1 = €0.92).

Nominal Appreciation

An increase in the value of a currency relative to another in nominal terms.

Nominal Depreciation

A fall in the value of a currency relative to another in nominal terms.

Real Exchange Rate

The relative price of foreign to domestic goods, defined as ε = E × P / P* where E is the nominal rate.

Real Appreciation

An increase in the real exchange rate, making domestic goods more expensive relative to foreign goods.

Real Depreciation

A fall in the real exchange rate, making domestic goods cheaper relative to foreign goods.

Multilateral Real Exchange Rate

A trade-weighted average of bilateral real exchange rates against multiple trading partners.

Purchasing Power Parity (PPP)

The condition that identical goods should cost the same across countries when prices are expressed in a common currency.

Absolute PPP

A strict version of PPP stating ε = 1; the law of one price holds exactly.

Relative PPP

The theory that changes in exchange rates equal inflation differentials: ∆E/E ≈ π* – π.

Big-Mac Index

A casual PPP measure comparing local prices of a McDonald’s Big Mac to gauge currency under- or over-valuation.

Quantity Effect (Trade)

Change in import or export volumes due to a price or exchange-rate change.

Value Effect (Trade)

Change in the domestic-currency value of imports caused by exchange-rate movements, holding quantities fixed.

Marshall-Lerner Condition

A real depreciation improves the trade balance if the absolute sum of export and import demand elasticities exceeds one.

Net Exports (NX)

Exports minus imports adjusted for the real exchange rate (X – IM/ε).

Goods Market Equilibrium (Open Economy)

Occurs when output equals domestic demand for domestic goods: Y = C+I+G+NX.

Trade Balance Output Level (YTB)

Level of domestic output at which net exports equal zero.

Uncovered Interest Parity (UIP)

Condition that (1+i) = (1+i*) E/Ee; yields expected returns equality between domestic and foreign bonds.

Expected Exchange Rate (Ee)

Market expectation of the future nominal exchange rate.

Interest Parity Approximation

it ≈ i*t – (Ee – E)/E; ties interest differentials to expected currency appreciation.

IS Curve (Open Economy)

Combination of output and interest rates where goods market is in equilibrium, including exchange-rate channel.

LM Curve

Relationship showing combinations of interest rates and output where money market is in equilibrium; in modern form, central-bank policy rate.

Mundell–Fleming Model

An extension of IS-LM to an open economy incorporating UIP and exchange rates.

Flexible Exchange Rate Regime

System where the currency price is determined by market forces and can fluctuate freely.

Fixed Exchange Rate Regime

System where a country pegs its currency at a set rate to another currency or basket.

Crawling Peg

A fixed exchange rate with a preset, small, continuous adjustment path.

Currency Board

A hard-peg regime in which domestic currency is fully backed by foreign reserves and exchanged on demand at a fixed rate.

Monetary Trilemma

The principle that an economy can achieve only two of three goals: exchange-rate stability, free capital mobility, and independent monetary policy.

Devaluation

A discrete downward adjustment of a pegged nominal exchange rate.

Capital Account (BOP)

Component recording capital transfers and non-produced, non-financial asset transactions.

Statistical Discrepancy (BOP)

Residual difference between the recorded current and financial account balances due to measurement errors.

Saving–Investment Identity (Open Economy)

Current account = Private saving + Public saving – Investment.

Nominal Interest Rate (i)

The stated return on a financial asset in currency units.

Real Interest Rate (r)

Nominal rate adjusted for expected inflation: r ≈ i – πe.

Liquidity Trap

Situation where monetary policy is ineffective because interest rates are near zero and cannot stimulate demand.

Fiscal Multiplier (Open Economy)

Change in output resulting from a change in government spending, smaller than in a closed economy due to import leakage.

Exchange-Rate Pass-Through

Extent to which changes in the nominal exchange rate affect domestic prices of imports or exports.

Real Devaluation Policy Mix

Combination of currency depreciation and fiscal contraction to reduce a trade deficit without expanding output.

Steady State (Solow Model)

Long-run equilibrium where capital per effective worker and output per effective worker are constant.

Depreciation Rate (δ)

The fraction of the capital stock that wears out each period.

Saving Rate (s)

Proportion of income saved rather than consumed in the Solow model.

Golden-Rule Level of Capital

Capital per worker that maximizes steady-state consumption where MPK = δ.

Capital Deepening

Increase in capital per worker, raising productivity until diminishing returns set in.

Technological Progress (gA)

Sustained improvement in productivity allowing output to grow without additional inputs.

Effective Labor (AN)

Labor input adjusted by the state of technology; captures labor-augmenting technological progress.

Balanced Growth Path

State where capital, output and effective labor all grow at the same constant rate (gA + gN).

Convergence Hypothesis

Prediction that poorer economies grow faster than rich ones and catch up in income per capita, conditional on fundamentals.

Total Factor Productivity (TFP)

Residual measure of output growth not explained by capital or labor growth; proxy for technological progress.

Cobb–Douglas Production Function

Y = K^α N^{1–α}; exhibits constant returns to scale and diminishing marginal products.

Human Capital

Stock of skills and knowledge embodied in workers that enhances productivity.

Research & Development (R&D)

Expenditures aimed at creating new knowledge, products, or processes that raise productivity.

Process Innovation

Technological improvement that alters the way goods are produced, boosting efficiency.

Product Innovation

Creation of new or improved goods and services expanding consumer choice.

Appropriability

Ability of innovators to capture the economic benefits of their inventions, often via patents or secrecy.

Patent

Legal right granting temporary monopoly to inventors in exchange for public disclosure of innovations.

Institutional Quality

Degree to which legal and political systems protect property rights and enforce contracts, influencing growth.

Easterlin Paradox

Observation that long-term increases in average income do not always lead to higher average happiness in wealthy nations.

Life Satisfaction

Self-reported measure of overall well-being, sometimes diverging from income growth.

Automation

Use of machinery and algorithms to perform tasks previously carried out by humans.

Robotics

Branch of technology dealing with design and use of robots; significant factor in labor displacement.

Offshoring

Relocation of production tasks to foreign countries, often to exploit cost advantages.

Productivity Effect (Trade/Automation)

Gains in efficiency that raise output and may create new jobs despite automation.

Replacement Effect

Loss of jobs when machines or cheaper foreign labor substitute for domestic workers.

Wage Inequality

Dispersion of wages across workers, often measured by ratios (e.g., top 10%/bottom 10%) or Gini coefficient.

Gini Coefficient

Statistical measure of income or wealth inequality ranging from 0 (perfect equality) to 1 (perfect inequality).

Task Displacement

Removal of routine tasks from human workers due to automation or offshoring.

Global Value Chain

The full range of activities that firms and workers perform to bring a product from conception to end use across countries.

Liquidity Preference

Desire to hold cash or easily liquid assets rather than illiquid investments; underlies the LM relation.

Central Parity

Target exchange rate around which a currency is allowed to fluctuate within fixed bands.

Speculative Attack

Large sale of domestic currency driven by expectations of devaluation, challenging a fixed exchange rate.

Sudden Stop

Abrupt reversal of capital inflows, often triggering currency and financial crises.

Optimum Currency Area (OCA)

A region where adopting a common currency yields net economic benefits due to high integration and symmetry of shocks.

Currency Devaluation vs. Depreciation

Devaluation is an official lowering of a fixed rate; depreciation is a market-driven fall under flexible rates.

Quantity of Money (M)

Total nominal stock of money in an economy determined by the central bank and banking system.

Liquidity Trap

Scenario in which nominal interest rates are near zero, making monetary policy ineffective in stimulating demand.

Capital Mobility

Degree to which financial capital can move freely across borders without restrictions.

Real Policy Rate

Inflation-adjusted short-term interest rate set by the central bank; influences investment and consumption.

Exchange-Rate Crisis

A situation where a fixed exchange rate collapses or experiences a forced devaluation.

Foreign Direct Investment (FDI)

Long-term investment by a firm in productive assets located in another country.

Import Ratio

Imports divided by GDP; indicates openness in goods markets.

Export Ratio

Exports divided by GDP; measure of an economy’s trade exposure.

Interactive Learning Tasks

Course feature encouraging students to apply concepts during lectures for points in a group competition.