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Macroeconomics Key Concepts and Policies

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  • Functions of Money

    Medium of exchange, unit of account, and store of value are the three main functions of money.

  • Fiat Money

    Money made valid by government law and tax-payability, without intrinsic value.

  • M1 Money Supply

    Includes circulating cash and demand deposits (checking accounts); most liquid money.

  • Fractional-Reserve Banking

    Banks hold only a fraction of deposits as reserves and create new deposits through loans.

  • Money Creation Through Loans

    Banks create deposits when making loans; loans are assets, deposits are liabilities for banks.

  • Federal Reserve's Role

    Central bank of banks; sets reserve requirements, policy interest rate, and provides reserves.

  • Reserve Ratio

    Minimum percentage of deposits banks must hold as reserves by law.

  • Open Market Operations

    Fed buys/sells Treasury securities to influence money supply and short-term interest rates.

  • Discount Window

    Fed facility providing emergency reserves to banks at a higher rate to discourage routine use.

  • Dual Mandate of the Fed

    Control money supply to stabilize prices and reduce unemployment.

  • Aggregate Supply Curve Shape

    Flat segment: output responds strongly to demand; vertical segment: output fixed, price changes only.

  • Fiscal Policy Multipliers

    Government spending has a larger multiplier than tax cuts; distribution affects multiplier size.

  • Zero Lower Bound on Interest Rates

    When rates approach zero, monetary policy loses effectiveness; fiscal policy becomes primary tool.

  • Phillips Curve

    Inverse relationship between unemployment and inflation in the short run.

  • Catch-up Growth

    Faster growth in lagging economies by importing existing technologies from frontier economies.

  • Production Possibility Frontier (PPF)

    Shows trade-off between inputs and outputs; moving frontier requires new technology or better inputs.

  • Diminishing Returns in Labor

    Adding workers without more capital leads to lower marginal productivity per worker.

  • Measuring Productivity

    Output per worker or per hour worked; real GDP per hour is standard metric.

  • Balance of Payments Current Account

    Exports minus imports of goods, services, investment income, and transfers.

  • Financial Account and U.S. Exorbitant Privilege

    Capital inflows offset current account deficit; U.S. borrows in its own reserve currency.

  • Exchange Rate Regimes

    Fixed pegs require intervention; floating rates determined by market supply and demand.

  • Comparative Advantage Example

    Countries specialize in goods with lower opportunity cost, enabling gains from trade.

  • Terms of Trade and Exchange Rate Effects

    Exchange rate changes affect relative prices and trade flow directions.

  • Seller's Inflation

    Firms raise prices beyond cost increases due to weaker competition and input cost shocks.

  • Monetary Policy Lag

    Interest rate changes take time to affect borrowing, investment, and output.

  • Fiscal Policy Lag

    Infrastructure projects and tax cuts affect economy with delay, risking pro-cyclical effects.

  • Federal Reserve Independence

    Protected by law to prevent political interference in monetary policy decisions.

  • Oil Price Shock and Stagflation (1970s)

    Supply shock raised costs, shifted AS left, causing inflation and recession simultaneously.

  • Trade Feedback Effect

    Higher income increases imports, boosting foreign producers' income and demand for exports.

  • Price Feedback Effect

    Price increases in one country raise export prices, feeding inflation back into importing countries.