Macroeconomic Theory I - ECON 222 Combined Lecture Notes

Comprehensive flashcards covering the Augmented Solow Model, growth accounting, asset market dynamics, business cycles, IS-LM-FE modeling, and open economy macroeconomics including exchange rate systems.

Augmented Solow Model

An expansion of the basic Solow model that incorporates exogenous ongoing productivity growth, human capital, endogenous growth via R&D, and environmental or infrastructure impacts.

Effective Workforce

Represented by $AN$, where $A$ is the productivity level and $N$ is the number of workers; it grows at the rate $(n + g)$, where $n$ is the population growth rate and $g$ is the productivity growth rate.

Steady State (Augmented Solow Model)

A long-run equilibrium where capital per effective worker ($k_e$) is constant ($\Delta k_e = 0$), defined by the equation $k^*_e = \left( \frac{s}{n + g + d} \right)^{\frac{1}{1-\alpha}}$.

Human Capital ($h$)

The skills and knowledge acquired by workers through education and training; when added to the production function ($Y = AF(K, hN)$), it acts similarly to a change in productivity growth.

Conditional Convergence

The hypothesis that countries with similar characteristics (such as savings rates $s$, population growth $n$, and productivity $A$) will converge to the same steady-state income level.

Golden Rule Capital Stock ($k_{GR}$)

The steady-state level of capital per worker that maximizes consumption per worker ($c^*$).

Break-even Investment

The amount of investment necessary to keep the capital-labour ratio constant, expressed as $(n + d)k$, where $n$ is population growth and $d$ is depreciation.

Growth Accounting Equation

The formula used to measure the sources of economic growth: $\frac{\Delta Y}{Y} = \frac{\Delta A}{A} + \alpha_K \frac{\Delta K}{K} + \alpha_N \frac{\Delta N}{N}$, where $\alpha_K \approx 0.3$ and $\alpha_N \approx 0.7$.

Total Factor Productivity (TFP)

Represented by $A$, it is the part of economic growth not accounted for by inputs like capital or labour, often calculated as a "residual" in growth accounting.

Real Money Demand

The amount of money people choose to hold in terms of the goods it can buy, expressed as $\frac{M^d}{P} = L(Y, i)$, where $Y$ is real income and $i$ is the nominal interest rate.

Income Elasticity of Money Demand ($\eta_Y$)

The percentage change in money demand resulting from a $1\%$ increase in real income; empirical evidence suggests it is positive but less than one (about $0.5$).

Velocity of Money ($V$)

A measurement of the rate at which money is exchanged in an economy, given by $V = \frac{P \times Y}{M}$.

Quantity Theory of Money

A theory asserting that real money demand is proportional to real income ($\frac{M^d}{P} = kY$), implying that velocity is constant.

Zero-coupon Bond

A bond that does not pay periodic interest but is purchased at a discount and pays a face value ($F$) at a certain date; its price is given by $V_0 = \frac{F}{(1 + i)^t}$.

Risk Premium

The amount by which the expected return on a risky asset exceeds the return on a comparable safe asset.

Expectations Hypothesis

The theory that the current long-term interest rate depends on current and expected future short-term interest rates, assuming financial arbitrage among risk-neutral lenders.

Yield Curve

A graph plotting interest rates at different maturity periods; an upward-sloping curve suggests future short-term rates are expected to rise.

Medium of Exchange

A function of money where it acts as a device for making transactions less costly.

M2

A monetary aggregate consisting of $M1$ (currency and chequing balances) plus personal saving deposits.

Open-market Operations

The central bank's practice of buying or selling government bonds with the public to influence the money supply; a purchase of bonds increases the money supply.

Business Cycle Persistence

The characteristic of the business cycle where once an expansion or contraction begins, it tends to last for a while.

Procyclical

An economic variable that moves in the same direction as real GDP.

Leading Variable

A variable whose turning points occur before the turning points of real GDP (e.g., average labour productivity or stock prices).

FE Line (Full Employment Line)

A vertical line representing the labour market equilibrium where output ($Y$) is at its full-employment level ($\bar{Y}$), regardless of the interest rate.

IS Curve

A curve showing the combinations of income ($Y$) and the real interest rate ($r$) that clear the goods market, where desired savings equals desired investment ($S^d = I^d$).

LM Curve

A curve representing the combinations of income ($Y$) and the real interest rate ($r$) that clear the asset market, where real money supply equals real money demand ($\frac{M}{P} = L(Y, r + \pi^e)$).

General Equilibrium (GE)

A situation where the labour, goods, and asset markets are all simultaneously in equilibrium, occurring where the IS curve, LM curve, and FE line intersect.

Money Neutrality

The principle that a change in the nominal money supply leads to a proportionate change in the price level but has no effect on real variables.

Aggregate Demand (AD) Curve

A downward-sloping curve showing the relationship between the aggregate quantity of goods demanded and the price level ($P$).

Stabilization Policy

The use of fiscal and monetary policy to offset economic shocks and keep the economy near its full-employment level.

Crowding-out Effect

The reduction in private investment that occurs when an increase in government purchases raises the real interest rate.

Open Economy Trilemma

A country's inability to simultaneously maintain free cross-border capital flows, a fixed exchange rate, and an independent monetary policy; it can only choose two.

Nominal Exchange Rate ($e_{nom}$)

The amount of foreign currency that can be purchased with one unit of the domestic currency.

Real Exchange Rate ($e$)

An index of the amount of foreign goods one can obtain for a given amount of domestic goods, defined as $e = e_{nom} \times \frac{P}{P_{For}}$.

Purchasing Power Parity (PPP)

The hypothesis that a basket of goods should have the same price in all countries when expressed in a common currency, implying an exchange rate where $e = 1$.

Speculative Run

A situation where investors, fearing a currency devaluation, rush to sell assets denominated in that currency, depleting the central bank's foreign reserves.

Mundell-Fleming Model

A model of a small open economy with flexible exchange rates that assumes perfect capital mobility, where the domestic interest rate equals the foreign interest rate ($r = r_{For}$).

Real Interest Rate Parity

An implication of international asset market equilibrium and Relative PPP which suggests that domestic and foreign real interest rates are equal ($r = r_{For}$).