Macroeconomics: Inflationary Finance, the Phillips Curve, Banking, and Monetary Policy

Comprehensive vocabulary flashcards covering seigniorage, the Monetary Laffer Curve, the Phillips Curve and expectations, commercial banking mechanics, the bank expansion multiplier, Federal Reserve operations, and the loanable funds interaction with money and credit.

Seigniorage

The profit the government receives from creating fiat money ($M$) on which it pays zero interest, acting as an interest-free loan or gift from the public.

Real Seigniorage ($s$)

The real revenue a government extracts from printing money, defined by the relationship $s = \frac{\Delta M}{P} = \mu \cdot m$, where $\mu = \frac{\Delta M}{M}$ is the rate of money growth and $m = \frac{M}{P}$ is real money balances.

Monetary Laffer Curve

The relationship showing that real seigniorage ($s = \mu \cdot m$) initially rises with money growth ($\mu$), reaches a peak $s_{\max}$ at $\mu_{\max}$, and falls as higher expected inflation increases nominal interest rates and reduces real money demand ($m^D$).

Hyperinflation

A runaway economic condition defined as sustained inflation exceeding $50\%$ per month (approximately a 403-fold increase per year), typically occurring when a government attempts to extract a seigniorage target ($s^*$) exceeding $s_{\max}$.

Modern Monetary Theory (MMT)

An economic perspective associated with Stephanie Kelton and G.F. Knapp's Chartalism asserting that money derives value from being required to pay taxes, and that a sovereign currency-issuing government cannot involuntarily run out of money or default.

Inflation-Induced Taxation of Capital

The fiscal distortion where inflation increases nominal investment returns that are taxed as regular income, resulting in an after-tax real return of $r_{AT} = r(1-\tau) - \pi \tau$, where $\tau$ is the tax rate and $r$ is the real return.

Bracket Creep

The process by which inflation pushes taxpayers with unchanged real earnings into higher marginal income tax brackets in a graduated tax code, indexed federally to CPI-U since 1981 and Chained CPI-U since 2019.

Phillips Curve

The observed empirical negative correlation between the rate of inflation ($\pi$) and the unemployment rate ($U$), originally documented by A.W. Phillips in 1958.

Stagflation

The simultaneous presence of high unemployment ($U$) and high inflation ($\pi$), which emerged in the 1970s and refuted the early Keynesian belief in a permanent, stable Phillips Curve trade-off.

Natural Unemployment Rate Hypothesis

The theory formulated by Milton Friedman and Edmund Phelps (1968) stating that when inflation is fully anticipated ($\pi = \pi^e$), unemployment converges to its natural rate ($U_N$), making the Long-Run Phillips Curve (LRPC) vertical at $U_N$.

Acceleration Hypothesis

The proposition that maintaining an unemployment target permanently below the natural rate ($U^* < U_N$) requires continuous, ever-accelerating inflation, because expected inflation ($\pi^e$) repeatedly adjusts to actual inflation.

Cold Turkey Disinflation

An aggressive monetary policy that abruptly reduces inflation to zero immediately, causing a sharp, severe short-run spike in unemployment ($U \gg U_N$) until inflation expectations rapidly adjust downward.

Gradualism Disinflation

A policy approach that reduces inflation in small, controlled increments to keep unemployment below a tolerable maximum ($U \le U_{\max}$), taking longer to restore price stability than Cold Turkey.

NAIRU

The Non-Accelerating Inflation Rate of Unemployment; a Keynesian concept conceptually similar to the natural rate of unemployment ($U_N$), built on the assumption that low unemployment actively drives inflation.

Adaptive Learning (AL)

An expectations model where economic agents formulate expectations about future variables (such as inflation) using historical observations and regression learning, placing declining weight on older data.

Equilibrium or 'Rational' Expectations (EE / 'RE')

The macroeconomic framework assuming the public's expectations equal the optimal mathematical forecast given the true economic structure, policy intentions, and all available public and private data.

Demand Deposits

Fully checkable commercial bank deposits that legally paid zero interest until 2011 and were subject to statutory reserve requirements up to $10\%$ before being reduced to $0\%$ in April 2020.

Certificates of Deposit (CDs)

Bank time deposits with fixed positive maturities that pay interest; large negotiable CDs ($\ge \$100{,}000$) are marketable and excluded from monetary aggregates, while small CDs ($< \$100{,}000$) have early withdrawal penalties and enter M2.

NOW Accounts

Negotiable Order of Withdrawal accounts authorized nationwide in 1980 by the DIDMC Act, allowing non-business depositors to write checks against interest-bearing savings deposits.

Money Market Deposit Accounts (MMDAs)

Federally insured bank and thrift liabilities created by the Garn–St Germain Act of 1982 that paid market interest with a statutory limit of 6 checks or transfers per month until the restriction was eliminated in April 2020.

Sweep Accounts

Banking arrangements introduced in 1995 that programmatically transfer funds between checkable accounts and MMDAs to minimize reserve requirement burdens while preserving unlimited customer checking access.

Money Market Mutual Funds (MMMFs)

Non-bank open-ended mutual funds regulated by the SEC, introduced in 1971 to circumvent Regulation Q deposit caps by investing in short-term money market paper such as T-bills, commercial paper, and negotiable CDs.

Federal Funds Rate

The interest rate that depository institutions charge one another to borrow or lend reserve balances held on deposit at the Federal Reserve overnight.

Bank Leverage Ratio

The ratio of a commercial bank's total assets to its net worth equity ($A / NW$), defining the multiple of assets controlled per dollar of shareholder capital.

Prime Rate of Interest

An administered benchmark lending rate published by major commercial banks, historically charged to prime corporate borrowers and closely aligned with the 3-month Treasury bill rate plus approximately $3\%$.

Monetary Base ($B$)

The high-powered foundation of the money supply, defined as currency in circulation outside banks ($C$) plus total bank reserves held as vault cash or Federal Reserve deposits ($R$): $B = C + R$.

Bank Expansion Multiplier ($k$)

The factor relating the monetary base ($B$) to the money supply ($M$), defined as $k = \frac{M}{B} = \frac{c+1}{c+f}$, where $c = C/D$ is the currency ratio and $f = R/D$ is the reserve ratio.

Currency/Deposit Ratio ($c$)

The ratio of currency in circulation to liquid bank deposits ($C/D$), determined by factors such as payment convenience, deposit interest rates, banking privacy, the underground economy, and international currency substitution.

Interest on Reserves (IOR)

The policy rate introduced in October 2008 by the Federal Reserve to pay interest on required (IORR) and excess (IOER) bank reserves, which removed the incentive for banks to lend out surplus reserves and severed the traditional link between $B$ and $M$.

Board of Governors of the Federal Reserve System

The 7-member governing body of the Federal Reserve System based in Washington, D.C., whose members are appointed by the President and confirmed by the Senate to staggered 14-year terms.

Federal Open Market Committee (FOMC)

The 12-member Federal Reserve body consisting of the 7 Governors, the President of the Federal Reserve Bank of New York, and 4 rotating regional Fed Presidents that directs open market operations.

Traditional Base Equation

The pre-2008 Federal Reserve balance-sheet identity describing base creation: $B = S + L + I + C_T - D_O - NW$, where $S$ is Treasury securities, $L$ is net loans, $I$ is international reserves, $C_T$ is Treasury currency, $D_O$ is other deposits, and $NW$ is capital net worth.

Dynamic vs. Defensive Open Market Operations

Dynamic operations are intentional Fed asset transactions aimed at altering the monetary base ($\Delta B$), whereas defensive operations offset unwanted autonomous variations in items like float, loans, or Treasury balances to stabilize $B$.

Repurchase Agreement (Repo)

A collateralized lending transaction where the Federal Reserve buys Treasury securities from a primary dealer under an agreement that the dealer will repurchase them the following day at a set price plus interest.

Overnight Reverse Repurchase Agreement (Reverse Repo)

A transaction in which the Federal Reserve borrows funds overnight from eligible counterparties (such as Money Market Mutual Funds) by selling securities, effectively establishing a floor under short-term interest rates.

Quantitative Easing (QE)

Unconventional open market operations initiated post-2008 involving large-scale purchases of long-term Treasury securities and mortgage-backed securities (MBS) financed by issuing interest-bearing excess bank reserves.

Natural Rate of Interest ($r_N$)

The equilibrium real interest rate determined purely in the loanable funds market where non-monetary credit supply ($S_{NM}$) equates to non-monetary credit demand ($D_{NM}$), independent of monetary creation.

Liquidity Effect

The temporary reduction in real interest rates below the natural rate ($r < r_N$) caused by an increase in the money supply ($M/P > m^D$), which provides the incentive needed for the public to borrow and spend excess money balances.

Volcker Credit Crunch (1979–1984)

A sharp monetary contraction implemented by Fed Chair Paul Volcker to halt the Great Inflation, which drove real interest rates to historical peaks, propelled 30-year mortgages above $18\%$, and generated the double-dip recessions of 1980–1982.