Understanding Business Cycles and Economic Policies

These flashcards encompass key terms and concepts from the lecture, focusing on business cycles, monetary policy, aggregate demand/supply, and inflation.

Business Cycle

Fluctuations in overall economic activity, including periods of expansion and contraction.

Expansion

The phase of the business cycle when the economy is growing, characterized by rising output, income, and employment.

Contraction

The phase when the economy is shrinking, often leading to a recession, characterized by falling output, income, and employment.

Recession

 A significant decline in economic activity that lasts more than a few months, typically measured by a sustained fall in real GDP, employment, real income, and wholesale-retail sales.

National Bureau of Economic Research (NBER)

The organization that officially determines the start and end dates of recessions in the U.S. by analyzing factors like real GDP, real income, employment, industrial production, and wholesale-retail sales.

Procyclical variables

Economic indicators that move in the same direction as the business cycle.

Countercyclical variables

Economic indicators that move in the opposite direction of the business cycle.

Acyclical variables

Economic indicators that do not show a clear pattern with the business cycle.

Leading indicators

Economic variables that change before the economy starts to follow a particular pattern.

Coincident indicators

Economic variables that change at the same time as the overall economy.

Lagging indicators

Economic variables that change after the economy has already begun to follow a particular pattern.

IS Curve

The curve that shows the relationship between the real interest rate and output/income.

Monetary Policy

The process by which a central bank manages the money supply to achieve specific goals.

Short Run

The period in which prices are sticky and real effects from monetary and fiscal policies are observed.

Long Run

The period in which prices are flexible and the economy returns to potential output.

Phillips Curve

An economic concept that describes an inverse relationship between inflation and unemployment.

Okun's Law

The relationship between unemployment and output; for every 1% increase in unemployment, a country's GDP will be an additional roughly 2% lower.

Aggregate Demand (AD)

The total demand for goods and services within the economy at a given overall price level in a given period.

Aggregate Supply (AS)

The total supply of goods and services that firms in an economy plan on selling during a specific time period.

Autonomous consumption (C̄)

Basic level of consumption that occurs regardless of income level.

Marginal propensity to consume (mpc)

The fraction of additional income that a household consumes rather than saves.

Government spending (G)

Total government expenditures on goods and services.

Net exports (NX)

The value of a country's total exports minus the value of its total imports.

Real interest rate (r)

The nominal interest rate adjusted for inflation.

Nominal interest rate (i)

The interest rate before taking inflation into account.

Fisher Equation

An equation that describes the relationship between nominal interest rates, real interest rates, and expected inflation.

Taylor Principle

The principle that the central bank should raise nominal rates more than one-for-one with rising inflation.

Financial frictions

Additional costs of borrowing beyond the basic interest rate that hinder lending.

Multiplier Effect

An effect in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.

Tax multiplier

The factor by which a change in tax policy affects the overall economy.

Potential output (Yₚ)

The level of economic output an economy can sustain over the long term without increasing inflation.

Self-Correcting Mechanism

The economic principle that the economy naturally returns to potential output over time without policy intervention.

Inflation targeting

A monetary policy strategy used by central banks to control inflation, typically by setting an explicit goal for the inflation rate.

Central Bank Independence

The principle that central banks should operate independently from political pressures in order to maintain stable prices and trust.

Shoe-leather costs

The costs incurred by people in terms of time and effort when they reduce their money holdings, due to inflation.

Menu costs

The costs associated with changing prices, including reprinting menus or changing prices on goods.

European Central Bank (ECB)

The central bank for the eurozone that manages monetary policy for the euro area.

Demand-Pull Inflation

Inflation that occurs when demand for goods and services exceeds supply.

Cost-Push Inflation

Inflation caused by an increase in prices of inputs, leading to a decrease in the supply of goods.

Stagflation

An economic condition characterized by slow economic growth and relatively high unemployment accompanied by inflation.

Divine Coincidence

The situation where policies aimed at stabilizing inflation also stabilize output.

Adaptive expectations

The idea that people form expectations about the future based on past experiences.

Rational expectations

The theory that individuals and firms make decisions based on their rational outlook, available information, and past experiences.

Time Inconsistency

A situation where optimal plans change over time due to changing incentives, often leading to poor economic outcomes.

Binding constraint

A situation where external factors limit the ability to achieve desired economic outcomes.

Zero Lower Bound (ZLB)

The situation in which interest rates are at or near zero, preventing central banks from lowering them further.

Nominal return on cash

The interest or return on liquid assets held, typically set at zero.

Commodity Money

Money that has intrinsic value, such as gold or silver.

Fiat Money

Currency that has value because a government maintains it and people have faith in its value.

Interest on Reserves

The interest rate paid by the central bank to commercial banks on their reserves.

Real money balances (M/P)

The amount of money available for spending, measured in terms of purchasing power.

Short-Run Aggregate Supply (SRAS)

The aggregate supply curve in the short term, which may be upward sloping.

Long-Run Aggregate Supply (LRAS)

The aggregate supply curve in the long run, which is vertical at the potential output.

Upward Sloping AS curve

An aggregate supply curve that rises as the price level increases.

Downward Sloping AD curve

Aggregate demand curve that falls as the price level rises.

Open Market Operations

The buying and selling of government securities by the central bank to control the money supply.

Financial markets

Markets where financial securities such as stocks and bonds are bought and sold.

Regulatory Policies

Government strategies aimed at managing the economic environment, including pricing, competition, and market behavior.

Currency Union

A group of countries that share a common currency, such as the Eurozone.

Fiscal Policy

Government policy regarding taxation and spending to influence the economy.

Automatic Stabilizers

Economic policies and programs that automatically help stabilize the economy, like unemployment insurance.

Political Pressure

Influence from government officials or groups that can affect the decisions of the central bank.

Expectations adjustment

The process by which people's expectations about inflation and the economy change based on new information.

Market confidence

The overall trust businesses and consumers have in the economy and its direction.

Economic volatility

Rapid and unpredictable changes in the economy, affecting growth, prices, and employment.

Milton Friedman

A famous economist known for his work on inflation and monetary policy.

Monetary easing

A policy aimed at lowering interest rates to stimulate economic growth.

Monetary tightening

A policy aimed at raising interest rates to combat inflation.

Hysteresis

The long-term effects of temporary events on the economy, particularly unemployment.

Inflationary Spiral

A situation where rising prices cause expectations of future inflation, leading to even higher prices.

Supply Shock

An unexpected event that affects supply, causing changes in the price or availability of goods.

Economic Growth

The increase in the production of goods and services in an economy over time.

Consumer confidence

The degree of optimism consumers have about the overall state of the economy and their personal financial situation.

Investment decisions

Choices made by businesses about how much to invest in capital goods, based on expected returns.

Economic policy

Government actions taken to manage and influence the economy.

Borrowing costs

The expenses incurred when obtaining funds from lenders, influenced by interest rates.

Price level

The average of current prices across the entire spectrum of goods and services produced in the economy.

Labor force participation rate

The percentage of the working-age population that is part of the labor force.

Output gap

The difference between actual output and potential output in an economy.

Natural rate of unemployment (U̇)

The lowest level of unemployment that an economy can sustain over the long term without creating inflation.

Investment multiplier

The ratio of the change in income to the change in investment.

Maximum sustainable employment

The highest level of employment that can be maintained without causing inflation.

Physical capital

Tangible assets such as buildings, machinery, and equipment that a company uses in production.

Long-term unemployment

Joblessness lasting for extended periods of time, often leading to skill degradation.

Boom and bust cycles

Economic cycles characterized by periods of rapid growth followed by significant declines.

Sector-specific shocks

Economic shocks that impact specific areas or sectors of the economy differently.

Relative prices

The price of one good or service compared to another, influencing consumer behavior.

Public spending

Government expenditure on services, infrastructure, and goods that provide value to society.

Debt-to-GDP ratio

The ratio of a country's public debt to its gross domestic product, used to assess economic health.

Recessionary pressure

Economic conditions that indicate a decline in output and employment.

Price stickiness

The resistance of prices to change, even when demand or supply shifts.

Risk premiums

Additional returns expected by investors for taking on additional risk.

Household savings rate

The percentage of disposable income that households save rather than spend.

Government deficits

The amount by which a government's expenditures exceed its revenues in a given period.

Long-run economic balances

The equilibrium achieved over time when supply and demand stabilize.

Sectoral shifts

Changes in the economy where resources move from one sector to another, affecting employment.

Earnings growth

An increase in the earning potential of businesses and individuals over time.

Fiscal stimulus

Government policy intended to encourage economic growth through increased spending or tax reductions.

Liquidity trap

A situation where monetary policy becomes ineffective because people hoard cash despite low-interest rates.

Exogenous shocks

Unexpected events that affect an economy from the outside, such as natural disasters or political upheaval.