Macro chapter 18 and 19

Okun's rule of thumb

1 percentage point rise in the unemployment rate will tend to be associated with a 2 percent fall in output from its trend and vice versa.

supply shock

Any change in production costs that leads suppliers to change the prices they charge at any given level of output

financial shocks

Any changes in borrowing conditions that change the real interest rate at which people can borrow

Actual output

May fail to meet this potential as aggregate expenditure ebbs and flows

optimistic IS curve

Describes spending plans in good times when people are optimistic about their economic future

MP curve

Describes the real interest rate set by monetary policy and financial markets

Total Inflation

Expected inflation + Demand-pull inflation + Cost-push inflation

excess demand

When the quantity demanded at the prevailing price exceeds the quantity supplied

multiplier

a measure of how much GDP changes as a result of both the direct and indirect effects flowing from each extra dollar of spending

spending shock

change in aggregate expenditure at a given real interest rate and level of income

Lower interest rates boost

consumption. investment. government purchases net exports. This in turn boosts aggregate expenditure. An increase in aggregate expenditure increases GDP because businesses adjust output to meet demand so in equilibrium GDP = Aggregate expenditure This increases output gap

Equilibrium GDP

describes the level of GDP at the point of macroeconomic equilibrium Equilibrium: Y = AE

Potential GDP

economy's highest sustainable level of production and is determined by available inputs.

Philips curve

illustrates the link between the output gap and unexpected inflation

The risk-free rate

rises in response to monetary policy

wage-price spiral

the process by which rising wages cause higher prices, and higher prices cause higher wages

classical dichotomy

the theoretical separation of nominal and real variables

Aggregate expenditure

the total amount of goods and services that people want to buy across the whole economy AE = C + I + G + NX C: Consumption expenditure (private) I: Planned investment (no inventories) G: Government expenditure (inv. & cons.) NX: Net exports (Export -Imports)

three inflationary forces

1. inflation expectations. 2. demand-pull inflation. 3. supply shocks and cost push inflation. - These forces can be used to understand what drives inflation and how it responds to economic conditions.

The Phillips curve shifts in response to unexpected changes in

1. input prices. 2. productivity. 3. exchange rates.

Recessionary equilibrium

GDP is less than potential GDP

Fiscal policy

Government policy that attempts to manage the economy by controlling taxing and spending.

Demand-pull inflation

Inflation resulting from excess demand

IS curve

The IS curve shows that lower interest rates lead to higher real GDP and a more positive output gap

Output gap

The difference between actual and potential output, measured as a percentage of potential output

Unexpected inflation

The difference between inflation and inflation expectations

risk premium

The excess return required from an investment in a risky asset over that required from a risk-free investment. Rises if lending becomes riskier Real interest rate = Risk-free interest rate + Risk premium

real interest rate

The interest rate corrected for the effects of inflation. The real interest rate is the opportunity cost of spending money this year.

risk-free interest rate

The interest rate on a loan that involves no risk

potential output

The level of GDP at which all resources are fully employed. It is determined by the available supply of labor, human and physical capital, and technological progress

monetary policy

The process of setting interest rates in an effort to influence economic conditions

Inflation expectations

The rate at which average prices are anticipated to rise next year

IS curve axises

The real interest rate is on the vertical axis The output gap, which goes on the horizontal axis, measures output relative to potential GDP The IS curve is downward-sloping, because lower real interest rates boost aggregate expenditure, which leads to a higher level of GDP and, hence, a more positive output gap

Bust equilibrium

Where output declines to be less than potential output. Because this economic slump is an equilibrium, it will persist if nothing changes

Boom equilibrium

Where output is at potential, validating people's optimism

labor market Phillips curve

links unexpected inflation to the unemployment rate (rather than the output gap.)

Three methods for measuring inflation expectations

surveys of consumers. surveys and forecasts of economists. financial markets

Macroeconomic equilibrium

when the quantity of output that buyers collectively want to purchase is equal to the quantity of output that suppliers collectively produce. Y = C + I + G + NX

Cost-push inflation

when unexpected boosts to production costs push sellers to raise their prices. This leads to more inflation at any given level of the output gap and for any given level of inflation expectations