Key Macroeconomic Concepts: Definitions and Explanations
Key Macroeconomic Concepts
Marginal Propensity to Consume
Marginal propensity to consume: is a metric that quantifies induced consumption, the concept that the increase in personal consumer spending (consumption) occurs with an increase in disposable income (income after taxes and transfers).
Planned Investment
Planned Investment: includes all types of fixed capital investments and planned inventory investments. This depends negatively on the interest rate and on existing production capacity; it depends positively on expected future real GDP.
Unplanned Investment
Unplanned Investment: changes in inventories are not a deliberate decision but the result of mistakes in forecasts about sales.
Consumption Multiplier
Consumption multiplier: the effect of income on consumption that magnifies changes in aggregate expenditure. =1/(1-MPC).
Tax Multiplier
Tax multiplier: The tax multiplier is negative in value because as taxes decrease, demand for goods and services increases. The multiplier examines the marginal propensity to consume (MPC), or ratio of income spent and not saved.
Accommodative Monetary Policy
Accommodative Monetary Policy: a decision by the central bank to keep the real interest rate constant when a supply shock occurs, allowing inflation to change.
Non-Accommodative Monetary Policy
Non-Accommodative Monetary Policy: decision by the central bank to adjust interest rates to offset a supply shock and keep inflation constant.
Long-Run Monetary Neutrality
Long-run monetary neutrality: is the principle that monetary policy cannot permanently affect real variables. The only permanent effect on monetary policy is to change inflation and nominal variables.
Income Expenditure Equilibrium
Income expenditure equilibrium: when planned aggregate spending is equal to the actual output and the unplanned inventory investment is zero.
Expansionary Fiscal Policy
Expansionary fiscal policy: a macroeconomic policy that seeks to expand the money supply to encourage economic growth or combat inflationary price increases.
Contractionary Fiscal Policy
Contractionary fiscal policy: Fiscal authorities use contractionary fiscal policy to slow down the economy, which offsets – or reverses – an inflation problem.
Implicit Inflation Target
Implicit inflation target: inflation level that policymakers seek without a formal announcement.
Explicit Inflation Target
Explicit inflation target: a rate or range that a central bank announces as its long-run goal for inflation.
Rational Expectations
Rational expectations: when making decisions, individual agents will base their decisions on the best information available and learn from past trends.
Adaptive Expectations
Adaptive expectations: Adaptive expectations is an economic theory which gives importance to past events in predicting future outcomes. A common example is for predicting inflation. Adaptive expectations state that if inflation increased in the past year, people will expect a higher rate of inflation in the next year.
Taylor Rule
Taylor Rule: is a reduced form approximation of the responsiveness of the nominal interest rate, as set by the central bank, to changes in inflation, output, or other economic conditions.
Sterilized Forex Intervention
Sterilized Forex intervention: the purchase or sale of foreign currency by a central bank to influence the exchange value of the domestic currency, without changing the monetary base.
Unsterilized Forex Intervention
Unsterilized forex intervention: a method by which a country’s monetary authorities can try to influence a country’s exchange rates and its money supply.
Dollarization
Dollarization: Dollarization is the term for when a foreign currency is used in addition to or instead of the domestic currency as legal tender. This process can also be called currency substitution.
Clean Float
Clean float : also known as a pure exchange rate… a clean float occurs when the value of a currency, the exchange rate, is determined purely by supply and demand.
Managed Float
Managed float: the current international financial environment in which exchange rates fluctuate from day to day, but central banks attempt to influence their countries’ exchange rates by buying and selling currencies. It is also known as a dirty float.
Impossible Trinity
Impossible trinity: is a concept in international economics which states that it is impossible to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement (absence of capital controls), and an independent monetary policy.