Inflation, Unemployment, & Stabilization Policies

Budget and Monetary Policy Basics

1. Budget Surplus

   • Occurs when government revenues exceed expenditures in a fiscal year.

2. Simple Budget Balance Calculation

   • Formula: Budget Balance = Revenues - Expenditures

3. Role of the Federal Reserve (Fed)

   • Central bank responsible for managing the U.S. money supply and maintaining financial stability.

4. Open Market Operations

   • Buying Treasury bonds/bills: Increases the money supply (expansionary).

   • Selling Treasury bonds/bills: Decreases the money supply (contractionary).

Monetary Policy and Economic Gaps

5. Expansionary vs. Contractionary Monetary Policy

   • Expansionary: Used during recessionary gaps to stimulate growth (lower interest rates, increase money supply).

   • Contractionary: Used during inflationary gaps to slow growth (raise interest rates, decrease money supply).

6. Inflationary Gap vs. Recessionary Gap

   • Inflationary Gap: Economy operates above full employment; leads to inflation.

   • Recessionary Gap: Economy operates below full employment; leads to unemployment.

7. Graphs: Be prepared to identify both gaps on Aggregate Demand (AD) and Aggregate Supply (AS) curves.

Economic Models and Theories

8. Monetary Neutrality

   • In the long run, changes in the money supply only affect prices, not real output.

9. Classical Economics (Adam Smith)

   • Economy is self-correcting with fully flexible prices and wages.

10. Keynesian Economics

    • Economy can stay below full employment; supports government intervention.

    • Quote: "In the long run, we’re all dead."

11. Short-Run Aggregate Supply (SRAS)

    • Upward sloping due to sticky wages and prices.

    • Shifts left when wages/prices adjust upward, reducing profit margins.

12. Inflation Expectations

    • Inflation expectations become "built-in" when businesses and workers anticipate ongoing inflation.

Inflation and Its Effects

13. Inflation Tax

    • The reduction in the purchasing power of money due to inflation.

    • Simple Calculation: InflationRate×RealMoneyHoldingsInflation Rate × Real Money HoldingsInflationRate×RealMoneyHoldings.

14. Effects of High/Low Inflation

    • High Inflation: Reduces purchasing power, harms savers.

    • Low Inflation: Stabilizes the economy but may signal weak demand.

15. Unanticipated Inflation

    • Benefits borrowers (repay loans with cheaper money).

    • Hurts lenders and savers.

Phillips Curve

16. Short-Run Phillips Curve

    • Shows inverse relationship between inflation and unemployment.

17. Long-Run Phillips Curve

    • Vertical at the Non-Accelerating Inflation Rate of Unemployment (NAIRU); inflation expectations adjust.

18. Shifts in the Phillips Curve

    • Positive Supply Shock: Shifts curve downward (reduces inflation).

    • Negative Supply Shock: Shifts curve upward (increases inflation).

Key Economic Concepts

19. Disinflation

    • Reduction in the inflation rate.

    • Can cause higher unemployment in the short term.

20. Monetarism

    • Advocates for steady, predictable increases in the money supply to support long-term economic growth.

21. Quantity Theory of Money

    • Formula: MV=PQMV = PQMV=PQ (Money Supply × Velocity = Price Level × Output).

22. Laffer Curve

    • Demonstrates how tax revenue changes with different tax rates; overtaxing or under-taxing reduces revenue.

Monetary Policy Tools

23. Discount Rate

    • The interest rate the Fed charges banks for borrowing.

24. Federal Funds Rate

    • The interest rate banks charge each other for overnight loans.

Historical Context

25. Pre-Great Depression

    • Classical economics dominated.

26. Keynesian Economics Emerges

    • FDR implemented policies influenced by Keynesian thought to address the Great Depression.

    • "The General Theory of Employment, Interest, and Money" is a key work.