Krugman's AP Macroeconomics: Section 6

Terms in this set (34)

government budget balance

X = tax revenue - government spending - transfer payments. If X>0, surplus. If X<0, deficit. If X=0, balanced.

Government spending is greater than revenues. Financed by government borrowing.

government debt

Total debt government has. Surpluses must occur in order to pay off debt.

automatic stabilizers

Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the government expands. Examples include: aggregate movements among tax brackets, unemployment benefits, social security, medicare and medicaid, and food stamps. Compresses business cycles a bit.

Fed's impact on interest rates

Fed can lower interest rates by increasing money supply and raise interest rates by decreasing money supply. Decides on target federal funds rate for banks to use, and uses open market operations to achieve this target.

monetary policy

The central bank's use of changes in the quantity of money or the interest rate to stabilize the economy. Affects money supply, interest rates, and reserve requirement. Changes in these cause changes in aggregate demand.

how monetary policy affects AD

Money supply increases, interest rates increase, AD shifts right, and vice versa.

chain of events to eliminate inflationary gap

1. Fed sees inflationary gap.
2. Fed makes open market sale to banks.
3. Money supply decreases.
4. Nominal interest rate increases.
5. Consumer spending and investment spending decrease.
6. AD shifts left.
7. Price level decreases, real GDP decreases, and unemployment increases.

chain of events to eliminate recessionary gap

1. Fed sees recessionary gap.
2. Fed makes and open market purchase from banks.
3. Money supply increases.
4. Nominal interest rate decreases.
5. Consumer spending and investment spending increase.
6. AD shifts right.
7. Price level increases, real GDP increases, and unemployment decreases.

short run vs. long run of monetary policy

Monetary policy has a short term, but no long term, effect on the economy. Money supply will have no effect. In the long run, interest rates will remain relatively constant.

unemployment and inflation

Trying to expand an economy past full employment will just cause inflation.

classical model of the price level

Before Keynes, economists assumed that the real quantity of money is always at its long-run equilibrium level, and ignored SRAS and its by only focusing on LRAS.

A reduction in the value of money held by the public caused by inflation.

cost-push inflation

Inflation that's caused by a significant increase in the price of an input with economy-wide performance (SRAS left).

demand-pull inflation

Inflation that's caused by an increase in aggregate demand.

relationship between output gap and unemployment

When aggregate output is equal to potential output, the actual unemployment rate is equal to the natural rate of unemployment. When output gap is positive, unemployment rate is below natural rate, and vice versa.

short-run Phillips curve

The negative short-run relationship between the unemployment rate and the inflation rate.

movements of Phillips curve

Shift left of AD - movement right along SRPC.
Shift right of AD - movement left along SRPC.
Shift left of SRAS - shift SRPC up.
Shift right of SRAS - shift SRPC down.

effects of expected inflation

Can shift SRPC up or down. Higher expectations lead to higher inflation.

nonaccelerating inflation rate of unemployment (NAIRU)

The unemployment rate at which inflation doesn't change over time. Where expected inflation = actual inflation. Another name for natural rate of unemployment.

long-run Phillips curve

Shows relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience. Vertical at NAIRU.

costs of disinflation

Increased unemployment and a recession. Often unfavorable views of government.

The reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation. Lenders win and borrowers lose.

When nominal interest rate is at zero and can't go lower. Causes liquidity trap.

A situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound.

natural rate hypothesis

To avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate.

Can monetary/fiscal policy reduce unemployment in the long run?

No, most economists believe natural rate hypothesis, and think that the unemployment rate must be high enough to keep inflation low.

political business cycle

Results when politicians use macroeconomic policy to serve political ends.

Asserts that GDP will grow steadily if the money supply grows steadily.

new classical macroeconomics

An approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output.

rational expectations

The view that individuals and firms make decisions optimally, using all available information.

new Keynesian economics

Market imperfections can lead to price stickiness for the economy as a whole.

real business cycle theory

Claims that fluctuations in the rate of growth of total factor productivity cause the business cycle.

LOOK AT THE TABLE ON PAGE 356

It's table 36.1

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