Chapter 13 Stabilization Policy and the AS/AD Framework - Vocabulary Flashcards

Vocabulary flashcards covering stabilizing policy, the Taylor rule, AD/AS framework, inflation dynamics, and the oil-price shock events described in the notes.

Stabilizing policy

A set of government or central bank actions aimed at reducing economic fluctuations and keeping output, employment, inflation, and growth within stable ranges.

Taylor Rule / Monetary Policy Rule

A simplified rule: Rt − r̄ = m̄(π_t − π̄), showing how the central bank adjusts the policy rate in response to inflation deviations from the target.

Rt (nominal policy rate)

The central bank’s nominal policy interest rate at time t, used to influence borrowing costs, spending, and investment.

r̄ (equilibrium real interest rate)

The real interest rate that aligns with full employment and price stability in the long run.

π_t (actual inflation)

The observed rate of inflation at time t.

π̄ (target inflation)

The central bank’s desired inflation rate to maintain price stability.

m̄ (inflation responsiveness)

The coefficient indicating how much the policy rate responds to deviations of inflation from the target.

i_t (nominal interest rate)

The observed nominal rate; related to real rates and expected inflation via the Fisher relation.

π^e_t (expected inflation)

The inflation rate expected by agents at time t.

R_t (nominal policy rate in Taylor framework)

The nominal policy rate used in the equation Rt − r̄ = m̄(πt − π̄); related to it by it = Rt + π^e_t.

Fisher equation

it = Rt + π^e_t, linking the nominal rate, real rate, and expected inflation.

IS curve

The relation that connects real output to real interest rates; used to derive aggregate demand.

Ỹ_t (real output)

The economy’s real GDP at time t.

ā (autonomous aggregate demand)

Baseline level of aggregate demand when prices do not change its level; includes components like government spending and exports.

b̅m̅ (inflation sensitivity of AD)

Coefficient showing how inflation gap (π_t − π̄) affects aggregate demand.

π_t − π̄ (inflation gap)

The deviation of actual inflation from the target inflation.

AD equation

Ỹt = ā − b̅m̅(πt − π̄); shows how inflation affects aggregate demand.

Phillips curve

∆πt = v̄Ỹt + ō, linking changes in inflation to the output gap and a supply shock.

∆π_t (change in inflation)

The difference between inflation in period t and period t−1.

v̄ (Phillips coefficient)

Coefficient that measures how strongly inflation responds to the output gap.

ō (supply shock term)

Exogenous factor in the Phillips curve representing a supply shock's effect on inflation.

AS (Aggregate Supply)

Total quantity of goods and services firms are willing to supply at various price levels.

AD/AS framework

Macro model that analyzes equilibrium price level and real output from the intersection of AD and AS curves.

Oil price shock

A sudden rise in oil prices that can raise production costs, shift AS left, and raise inflation.

Event 1 – Initial Oil Price Shock

Oil prices surge; AS shifts left; stagflation can occur; π rises; ō positive for one period.

Event 2 – Consumer Reaction/Demand response

Contractionary policies reduce AD in response to the shock; inflation may subside while output falls.

Event 3 – Policy Response

Policy measures (expansionary or other) to stimulate activity; AD/AS adjustments over time.

Stagflation

Simultaneous high inflation and stagnating (low) output growth.

Adaptive expectations

Expectations formed from past experience rather than fully forward-looking forecasts; influence on supply-side behavior.

Potential output

The economy’s long-run sustainable level of real output.