Chapter 1

"Nominal"?

Indicates current prices; typically misleading measures of economic well-being

"Real"?

Indicates values measured in terms of fixed prices; typically of more interest than nominal variables

Government action re: budget deficit or surplus?

The government must finance any deficit by borrowing, while a budget surplus leads to a lower government debt burden

e-Finance

A new means of delivering financial services electronically; dramatic improvements in information technology have led to new financial products and the ability to deliver financial services electronically

Recession

A period when aggregate output is declining

Important contemporary stock market fluctuations?

"Black Monday" - 1987 (DOW down 22%) After Black Monday, one of greatest rise in history until 2000 2000 (Drop over 30% by 2002) Rose again to all time high in 2007 "Great Recession" - Major drop 2008-2009, recovered again by 2011

Required Reserve Ratio

% that Fed requires bank to hold to back their demand deposits

Bond

A debt security that promises to make payments periodically for a specified period of time

Assets

A financial claim or piece of property that is a store of value

Financial Crises

A major disruption in financial markets that is characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms

Common Stock (Stock)

A security that is a claim on the earnings and assets of a company; represents a share of ownership in a corporation; one way for corporations to raise funds to finance their activities

Effects of the business cycle on us?

Affect all of us in immediate and important ways; ex: Output rising = easier to find a good job and vice versa

Money

Anything that the public accepts as payment for debts (goods or services); in the US = coins, paper money, demand deposits

Why are bond markets important?

Bond markets are important to economic activity because it enables corporations and governments to borrow to finance their activities and determines interest rates

Open Market Operations

Buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system

Fed's impact on interest rates and liquidity?

By manipulating open market operations, required reserve ratio, and the discount rate, the Fed can control money supply (interest rates/economic liquidity) which in tern affect other thins (like employment and economic activity)

Purpose of methods used to measure aggregate price level?

Can be used to convert a nominal measurement into a real measurement

Dark side of financial innovation?

Can lead to devastating financial crises; creative thinking on the part of financial institutions can lead to higher profits but can sometimes result in financial disasters

Stock Market

Claims on the earnings of corporations (shares of stock) are traded; most widely followed financial market in almost every country that has one; people can get rich or poor quickly

Complex structure of the Financial System?

Comprised of many different types of private sector financial institutions (banks, insurance companies, mutual funds, finance companies, and investment banks) all which are heavily regulated by the government; essentially lots of middle men in larger financial transactions

Fluctuations in stock market affect?

Considerable fluctuations affect the size of people's wealth and as a result may affect their willingness to spend

How do central banks affect the quantity of money and interest rates?

Creates/destroys money in the economy depending on their goals by manipulating open market operations, required reserve ratio, and the discount rate

Fluctuations and trends of interest rates?

Different interest rates tend to move together, economists frequently lump interest rates together even though there is some difference (ex: three-month Treasury bills fluctuate more than any other and is typically lower than average)

Who/what do financial markets affect?

Direct effects on personal wealth, behavior of businesses and consumers, and economic cycles

GDP excludes?

Excludes purchases of goods that have been produced in the past, intermediate goods (which are used up in producing final goods and services), and purchases of stocks and bonds

Real GDP

Expresses values in terms of prices for an arbitrary base year; GDP measured with constant prices

Banks

Financial institutions that accept money deposits and make loans (such as commercial banks, savings and loan associations, and credit unions)

Security

Financial instrument; a claim on the borrower's future income that is sold by the borrower to the lender

Banks and the average American?

Financial intermediaries an average person uses most frequently - Personal loans, mortgages, checking accounts, savings accounts

Why are financial markets are important?

Financial markets (such as stocks and bonds) are crucial to promoting great economic efficiency by channeling funds from people who do not have a productive use for them to those who do

Inflation and politics?

Generally regarded as an important problem to be solved and is often at the top of political and policymaking agendas

Inflation Rate

Growth rate of the aggregate price level (use the growth rate equation with GDP deflator values)

Interest rate impact on the economy?

Impact the overall health of the economy because they affect not only consumers' willingness to spend or save but also businesses' investment decisions (high rates postponing a corporation to expand stunts growth and job creation)

Who do interest rates affect?

Important on many levels (example - personal: mortgage rates; corporation: high rate postpone building a new plant)

Financial Intermediaries

Institutions that borrow funds from people who have saved and then make loans to others

Fluctuation in the exchange Market: weaker dollar?

Leads to more expensive foreign goods, makes vacationing abroad more expensive, and raises the cost of indulging your desire for imported delicacies, so Americans decrease purchases of foreign goods and services and increase consumption of domestic goods and services

Financial Markets

Markets in which funds are transferred from people who have a surplus of available funds to people who have a shortage of available funds

Fluctuation in the exchange Market: strong dollar?

Means US goods exported abroad will cost more in foreign countries, and hence foreigners will buy fewer of them; benefits American consumers by making foreign goods and services cheaper but hurts domestic businesses and jobs

Consumer Price Index (CPI)

Measured by pricing a "basket" of goods and services bought by a typical urban household; expressed as a price index with the base year equal to 100

Connections between money, interest-rate fluctuations, and Americans?

Money plays an important role in interest-rate fluctuations, which are of great concern to businesses and consumers; typically, as the money growth rate rises, the long-term bond rate rises as well, but not always

GDP Deflator

Nominal GDP divided by real GDP; measures aggregate price level

PDE Deflator

Nominal personal consumption expenditures (PCE) divided by real PCE; measures aggregate price level

Recent decline of banks?

Other financial institutions such as insurance companies, finance companies, pension funds, mutual funds, and investment banks have been growing at the expense of banks

History/trends of financial crises?

Part of capitalist economies for hundreds of years and are typically followed by the most severe business cycle downturns (ex: August 2007-2009)

Growth Rate

Percentage change in a variable = [(xt - xt-1)/(xt-1)] X 100 where t indicates today and t-1 a year earlier

Fiscal Policy

Policy that involves decisions about government spending and taxation; government spending and taxation by legislature/executives

Causes of inflation?

Price level and money supply generally rise together, indicating that a continuing increase in the money supply might be part of what causes increased price level, and therefore inflation; Countries with highest inflation rates are also the ones with the highest money growth rates

Stock market impact on business investment decisions?

Price of shares affects the amount of funds that can be raised by selling new stock to finance spending

Connections between rate of money growth and business cycle fluctuations?

Rate of money growth has declined before almost every recession, indicating that changes in money might be a driving force behind business cycle fluctuations (*not every decline in the rate of money growth is followed by a recession)

Aggregate Price Level (Price Level)

The average price of goods and services in the economy

Federal Reserve System (Fed)

The central bank of the US; regulates the US monetary and financial systems

Inflation

The condition of a continually rising price level

Interest Rate

The cost of borrowing or the price paid for the rental of funds (usually expressed as a %/year); many types

Budget Deficit

The excess of government expenditure over tax revenues

Budget Surplus

The excess of government expenditure over tax revenues

Central Bank

The government agency that oversees the banking system and is responsible for the amount of money and credit supplied in the economy; in the US, the Fed

Discount Rate

The interest rate that the Fed charges financial institutions when those institutions borrow money from the Federal Reserves

Monetary Policy

The management of the nation's money supply, credit availability, and the level of interest rates by the Fed

Foreign Exchange Market

The market in which exchange rates are determined

Unemployment Rate

The percentage of the labor force not working

Foreign Exchange Rate

The price of one currency stated in terms of another currency

Inflation Rate

The rate of change of the price level, usually measured as a percentage change per year

Monetary Theory

The theory that relates changes in the quantity of money to changes in economic activity

Aggregate Income

The total income of factors of production (land, labor, capital) in the economy during the course of the year; best thought of as being equal to aggregate output ($ spent = $ paid)

Aggregate Output

The total production of final goods and services in the economy

Nominal GDP

The total value of final goods and services calculated using current prices; if all prices doubled but actual production remained the same, nominal GDP would double even though people would not see the benefits of twice as many goods and services

Business Cycles

The upward and downward movement of aggregate output produced in the economy; money plays a role!

Gross Domestic Product (GDP)

The value of all final goods and services produced in the economy during the course of a year; most commonly reported measure of aggregate output

How do financial markets affect economic growth?

Well functioning markets can produce high economic growth, poor performing markets could keep a country desperately poor

Financial Innovation

When an economy introduces new types of financial products; important force for good by making the financial system more efficient