Key Concepts in Monetary and Fiscal Policy

Monetary policy

Controlled by the FED.

Fiscal policy

Governmental policy.

Federal Reserve

The central banking system of the United States that manages monetary policy to control inflation, unemployment, and interest rates.

Open Market Operations (OMOs)

The buying and selling of government securities by the Federal Reserve to influence the money supply.

MPS (Marginal Propensity to Save)

The fraction of additional income that is saved.

MPC (Marginal Propensity to Consume)

The fraction of additional income that is spent.

Consumption function

A formula showing the relationship between total consumption and disposable income.

Cost push inflation

Inflation caused by an increase in the costs of production, leading to higher prices.

Demand pull inflation

Inflation caused by an increase in aggregate demand, pulling up prices.

Interest rate effect

The impact of a change in the price level on interest rates, which in turn affects investment and consumption.

AD/SRAS model

A model showing the relationship between aggregate demand (AD) and short-run aggregate supply (SRAS).

Rise in Interest Rates

Leads to less borrowing and spending.

Fall in Interest Rates

Leads to more borrowing and spending.

Potential output

The level of output an economy can produce at full employment without causing inflation.

Stagflation

A situation where the economy experiences stagnant growth and high inflation simultaneously.

Negative Shock

An unexpected event that decreases economic activity.

Positive Shock

An unexpected event that increases economic activity.

Recessionary Gap

When actual output is less than potential output.

Inflationary Gap

When actual output exceeds potential output.

LRAS curve

Vertical because, in the long run, output is determined by factors like technology and resources, not the price level.

Aggregate consumption function shift

When factors like expected future income, wealth, or taxes change.

Discretionary fiscal policy

Government policy actions, such as changing tax rates or spending levels, to influence the economy.

Planned investment spending

Business expenditures on capital goods, planned in advance.

Automatic stabilizers

Government programs that automatically adjust to stabilize the economy, like unemployment benefits.

Crowding out

When increased government spending leads to reduced private sector investment due to higher interest rates.

SRAS curve

Upward sloping because higher prices can lead to increased production in the short run.

Inventory investment

Changes in the stock of unsold goods.

Unemployment

Changes with economic conditions; it rises during recessions and falls during economic expansions.