Basic Economic Concepts Flashcards
Monetary Policy
The financial policy of managing the money supply to achieve specific goals (reducing inflation, or achieving full employment). Bank of Canada is responsible for monetary policy
Tools to carry out monetary policy
1) Raise/lower interest rates
2) Raise/lower reserve rates
3) Buy/sell government bonds and T-Bills.
Expansionary Monetary Policy
Increase money supply and stimulate the economy.
(Lower interest rate, lower reserve rate or buying government bonds and T-Bills).
**Increase money supply results in lower interest rates and increase business investing leading to increase in GDP
Restrictive Monetary Policy
Decrease money supply and slow down the economy.
(Raise interest rate, raise reserve rate or sell government bonds and T-Bills)
**Decrease money supply results in higher interest rates and decrease business investing leading to decrease in GDP
Business Cycle
Periodic swings in an economy’s pace of demand and production activity
Economic Expansion
Period in which GDP is rising steadily.
Economic Recession
Period in which GDP is falling steadily.
Economic Recovery
The early stage of an expansion, following a recession
Recession
A significant decline in activity spread across the economy, lasting more than a few months.
Begins after an economy has reached its peak.
Ends as the economy reaches its trough
Expansion
When the economy is in between a trough and a peak
Leading Indicators
Change prior to changes in economic activity
Used to judge what is going to happen in the near future
Ex. Housing starts, changes in profits, stock prices etc.
Coincident Indicators
Change at the same time as changes in economic activity
A broad-based measurement of current economic conditions
Ex. GDP, personal income, retails sales etc.
Lagging Indicators
Follow economic changes
Used as an after-the-fact way to help confirm economists’ assessment of current economic conditions
Ex. Business investment, unemployment rate, inflation etc.
Deflation
Tendency, over an extended period of time, for prices and incomes to decline, creating pessimism, and the economy could fall into a recession
Inflation
A rise over time in the average price of goods and services (cost of living)
Affects purchasing power
Consumer Price Index (CPI)
Measure of inflation
Reflects changes in the price of a representative “basket” of goods and services sold in Canada (food, housing, transportation, other)
When CPI rises, the purchasing power of the average consumer’s dollar falls
CPP and OAS use CPI to calculate changes in government payments
High Inflation
Prices increase as the demand for goods and services exceed the normal capacity of producers to supply goods and services.
Excess supply of goods and services puts downward pressure on prices.
Creates uncertainty for consumers and investors.
It erodes the value of incomes and savings
Cost of High Inflation
1) Erodes the value of money. Future prices are less predictable.
2) Encourages speculative investing that take advantage inflation rather than production.
3) Businesses and investors respond to signs of inflation by pushing up prices, wages and interest rates to protect themselves
4) Individuals on fixed incomes may fall into hardship as their incomes won’t keep up with rising level of prices.
Benefits of Low Inflation
1) Consumers and businesses can make longer-plan since they know that their money is not losing its purchasing power
2) Encourages investment to improve productivity and businesses can prosper without raising prices.
3) Self-reinforcing since businesses and individuals do not react so quickly to short-term price pressures by seeking to raise prices and wages
Interest Rate
The percentage fee received or paid by individuals are organizations when they lend or borrow money.
Overnight target rate is set by Bank Of Canada. A change in this rate will lead to changes in other interest rates.
Yield Curve
A graph that plots the yields of similar quality bonds against maturities.
Shows the various yields that are currently being offered on bonds of different maturities
Normal Yield Curve
Short term yields are lower than long term yields (sloping upwards)
Inverted Yield Curve
Short term yields are higher than long term yields (sloping downwards)
