Chapter 4 Flashcards
Inflation
Inflation is the economic condition characterized by continuously rising prices for goods and services. As a result, the purchasing power of a country’s currency deteriorates as its value decreases and interest rates rise.
Demand-Pull Inflation
The money supply is seen as the cause of this type of inflation. In this situation, the money supply is too large when compared with the supply of produced goods in the economy. Interest rates rise as a result, making it more expensive to borrow money. As a result, the money supply begins to shrink with the drop in lending activity.
Cost-Push Inflation
The rising cost of raw materials used to produce goods is seen as the cause of this type of inflation. Since manufacturers now need to pay more for these materials, they raise the prices on their products to compensate. As a result, retailers must pay more for goods, so they increase prices to pass the difference on to the consumer.
deflation
is a persistent decline in the prices of goods and services usually caused by slowing market demand with a level supply. Purchasing power increases as a result of stagnant demand, fixed-income securities become more appealing, and producers must lower their prices to compete for the limited demand.
monetary policy
is that the quantity of money, or the money supply, is the major determinant of price levels. Monetarists believe that price stability allows private businesses to plan their growth, invest in their businesses and keep the economy growing at a steady pace without an over- or undersupply of goods and services. The primary driver of all monetary policy decisions is the Federal Reserve Board.
The Federal Reserve Board (FRB
consists of seven members appointed by the President of the United States, subject to Senate confirmation, who serve 14-year terms. It governs the regional Federal Reserve Banks and a system of hundreds of state and national banks, all of which make up the Federal Reserve System.
Expanding the Money Supply
When the Fed wants to expand the money supply, it buys securities from banks, which receive direct credit in their reserve accounts.
As such, banks are able to make more loans and lower interest rates.
Tightening the Money Supply
If the money supply is too expansive and needs “tightening”, the Fed will sell securities to the banks by charging the banks’ reserve balance.
As a result, banks are unable to lend money as readily and must reduce their credit activities and raise interest rates.
discount rate
which is the interest rate it charges its members for short-term loans. A lower discount rate reduces the cost of money that banks must pay for loans, while a higher discount rate results in a shrinking demand for the loans. Banks will alter the federal funds rate - the rate one bank charges another to borrow money - to compensate for these fluctuations in the discount rate.
Fiscal policy
addresses changes in the allocation and levels of economic resources and is generally associated with the economic theory of John Maynard Keynes, also called Keynesian Theory.
includes government budget decisions regarding federal spending, money raised by the government through taxes and budget deficits or surpluses. By adjusting overall demand for goods and services through changes in taxation and government spending, the government hopes to control unemployment levels and inflation, which adversely affect the economy’s health.
Expansionary fiscal policy
is appropriate when the economy is operating below its normal output, as in recessions and troughs in the business cycle when unemployment is high, business profits are low and businesses are not operating at full capacity. Government spending will be increased and/or taxes for individuals (and perhaps small businesses) will be reduced to stimulate the economy.
Contractionary fiscal policy
occurs when the business cycle is near its peak, businesses are at full capacity, unemployment is low and business profits are high. The government decreases spending and may increase taxes for individuals and businesses. A government will often wipe out its deficit and create a surplus during a contractionary fiscal period.
Economic Indicators
Leading Indicators: A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but are not always accurate. Bond yields are typically a good leading indicator of the market because traders anticipate and speculate trends in the economy.
Other types of leading indicators include:
building permits (new private housing)
industrial production rates
money supply
S&P 500
average of weekly unemployment insurance claims
Lagging Indicators: A measurable economic factor that changes after the economy has already begun to follow a particular pattern or trend. Lagging indicators confirm long-term trends, but do not predict them. Interest rates (especially the prime interest rate) are a good lagging indicator; rates change after severe market changes. Other examples are:
unemployment rates
corporate profit
labor cost per unit of output
Coincident Indicators: An economic factor that varies directly and simultaneously with the business cycle, thus indicating the current state of the economy. Some examples include: nonagricultural employment personal income inventory/sales ratio
Currency Exchange Rates
Changes in currency exchange ratescan have a huge impact on both business profits and on securities prices. These rates are expressed as the ratio of the price of one currency against the price of the other.
Balance of trade
difference between exports and imports. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy.
