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puu spoo8 pug Jo lunorue eqlireetrleq drqsuorleleg a'unc (5y) '{1ddns a1e8ar88e

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crsselc € sr s0L6I ,(1ree eqt;o o8reqrue IIo JgdO eql IuoJ.+ pellnsel l€ql [Io 5o ecud

eql ur eseercur eqJ 'elrnc [1ddns elu8erSSe eql uI UIqs pJe,4 uI >poqs 'dlddns esJeApB'effJIea\

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ur sa8ueqc el€r lserelul eql qclq,^A uI u€ol eruoq V fi,ttUV) a8u8poru aler alqelsnfpe'seJnleeJ 1uct1c,{crelunoc eleq luql selnd salnJ lslAIlJB

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',i1ddns elu8erSSu ur do-rp ,{rerodruel e o1 esuodsel ur 3uq1e;

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Sl/ ul UHs pJelAlno uror; 3utl1nseJ eleJ lseJelul uI eseeJcul lue'terd o-1 -{1ddns '{euout

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,{rolue,tur Jo Jor1pqeq eqt seqrJrsep lplrdec Jo lsoc eql {q petceJJe lou sr pue lndlno

ur e8ueqc eql ot l€uoluodord sr Surpueds luelulse^.ulleql slressv "l"Hrtfii:il:1""

sen1e,r. e1e1s-,{peels rleql JoJ pue elull Je^.o Jeqlo qcee qceordde ol solrlunoc lueJeJJlp

ur lndlno Jo selur qla,rorS pue sle^el eql qloq ;o ,(cuepuel acuaSra,luoc elnlosqe

ruvs s oT c

V

616 GLOSSARY

anticipatory monetary policy Monetary policy adopted in response to a:,:€rr-(i.e., inflationary pressure) that are expected to arise in the future.

appreciation Increase in the value ofthe domestic currency relative the currer-r=. rother countrie* Used when exchange rates are flexible.

arbitrage Buying/selling assets to take advantage ofdifferences in returns.augmented Phillips curve Phillips curve that includes inflationary expectatiLaD- .b r

determinant of the inflation rate.austerity Reducing government spending and raising taxes, particularly in the ct-::r;

of trying to reduce the national debt.automatic adjustment mechanisms Mechanisms that automatically act to elimir-rc

balance-of-payments problems.automatic stabilizer Policy that reduces the impact of an economic shock s irhc'r

requiring case-by-case intervention. Proportional income taxes and unemplolm:=insurance are examples.

Bbalance of payments Measures the net flow of currency into the country from abroac-balance-of-payments deficit Occurs when more money is leaving the country than i=

entering it.balance-of-payments surplus Occurs when more money is entering the country than

is leaving it.balanced budget multiplier Increase in output that results from equal increases in

taxes and government purchases.basis point Interest rate measure equal to l/100 of an annual percent. For example, an

interest rate equal to one-quarter of one percent at an annual rate would also be calleda 25 basis point rate.

Barro-Ricardo equivalence proposition See Ricardian equivalence.beggar-thy-neighbor policy Attempt to increase domestic output at the expense of

the output of other countries.Beveridge curve Relationship between job vacancies and the unemployment rate.Board of Governors of the Federal Reserve A government agency that oversees

regional Federal Reserve Banks, has sole authority over changes in reserve require-ments, and forms a part of the Federal Open Market Committee (FOMC). Its chair-man has traditionally had the power to determine U.S.gronetary policy.

bubble See speculative bwbble.budget constraint Limit to the amount of money an individual, a firm, or the govemment

can spend. An individual's purchases might be constrained by his or her income (or wealth).budget deficit The difference between the amount of money the government spends

and the revenue that it receives in the form of taxes.budget surplus Opposite of budget deJicit.buffer-stock saying Excess consumer savings used to maintain consumption when

income is lower than usual (saving for a rainy day).Bundesbank Germany's central bank, now part of the European System of Central

Banks (ESCB).

burden ofthe debt Each individual's share ofthe national debt.business cycle Pattern ofexpansion and contraction ofthe economy.

GLOSSARY

business fixed investment Annual increase in machinery, equipment, and structuresused in production.

business saving Saving by firms; profits not paid out to owners/stockholders.

Ccapital account Net flow of dollars into the country resulting from the acquisition of

domestic assers by foreigners.capital gains The amount an asset appreciates in value over time.capital stock rhe amount of capital available for use in the economr,,capital-labor ratio The amount of capital available for use by each worker; the

capital stock divided by the labor supply.central bank Bank that has control over the money supply. In the United States, the

Federal Reserve. In Europe, the European Central Bank.certainty-equivalence policy A policy made under the assumption that there is no

uncertainty regarding future events.chained-weighted index This index is used to help correct for the fact that when

prices do not grow proportionately, consumers shift their purchases away from therelatively more expensive goods toward less expensiv. on.i.

classical adjustment process process by which the economy automatically movestoward internal and external balance.

classical aggregate supply curve verticalAS curve; output equals potential output.classical case Vertical LM carve; case in which money a.-una is completely insensi-

tive to changes in the real interest rate.classical quantity theory See quantity tlrcory: of money.clean floating Flexible exchange rate system in which the central bank does not inter-

vene in foreign exchange markets. Contrast dirty Jloating.Cobb-Douglas production function Production function with constant returns to scale,

constant elasticity of output, and unit elasticity of substitution between input factors.COLA See cost-of-liying adjustment.cold-turkey strategy Strategy of moving immediately to the desired target rather

than trying to spread the cost of adjustment out over time.competitive depreciation Occurs when one country allows its currency to depreciate

in order to improve its trade balance, hurting another country; a series of retaliatorydepreciations

composition of output Relative amounts of consumption, investment, and qovernmentpurchases that make up GDp.

conditional "otto".g".t.. Tendency of growth rates of output in different countries to

approach each other over time. Contrast absolute ,orr"rgrnrn.consol (or perpetuity) An asset that pays a frxed amount (coupon) each period forever-.consumer durables consumer goods that yield service. ou". a period of time;

washing machines are an example.consumer price index (CP! Fixed-weight price index that measures the cost of the

.goods purchased by the typical urban family.consumer spending Spending by consumers.consumption function Equation relating consumption to disposable income.convergence See conditional and absoLute conversence.

617

618 GLOSSARY

core inflation Measures change in prices of all goods and services except for fo<rland energy.

cost-of-living adjustment (COLA) Indexes wages to the inflation rate.coupon Periodic payment made to the holders of a bond.coYered interest parity Relation linking domestic and foreign interest rate differen-

tials to the difference between spot and forward exchange rates.coordination approach Study of synchronization by hrms of price adjustments.crawling peg Exchange rate policy; exchange rate is devalu ed at a rate roughly equal

to the inflation differential between a country and its trading partners.credibility The degree to which the public believes that the government will

implement its announced policies.credibility bonus The extra reduction in inflation due directly to the public's belief in

the central bank's commitment to fighting inflation.credible policy Policy that people believe their govemmenr will follow.credit rationing Limiting the amount of money that individuals can borrow at the

prevailing interest rate.credit targeting Using monetary policy to achieve a particular level of debt.crowding out Reduction in some component of aggregate demand-usually

investment-that results from an increase in government spending.currency appreciation, or depreciation See appreciation and depreciation.currency board The requirement that a specific amount of foreign currency must

back up each unit of domestic culrency that is printed.currency-deposit ratio Ratio of the currency to bank deposits; a primary determinant

of the money multiplier.current account Net flow of dollars into the country resulting from the sale of

domestic goods and services, and from net transfers from abroad.current dollar Values measured at cuffent price levels, i.e. not adjusted for inflation.cyclical component of GDP Fluctuations of output around its trend; the output gap.cyclical deficit Portion of the budget deficit that results from business cycle

fluctuations. Contrast structural deficit.cyclical unemployment Unemployment resulting from business cycle fluctuations.

Ddebt held by the public Government debt held by investors, as distinct from debt

held by other government agencies or the Federal Reserve.debt-to-GDP ratio Ratio of national debt to GDP.decision lag Period of time required to decide on the proper response to a macroeco-

nomic shock.deep parameters Parameters that describe the preferences of individuals and the

production of firms, and that can be identihed from microeconomic studies.deflation Rate at which the price level falls, in percentage terms; opposire of inflation.demand for real balances Quantity of real money balances people wish to hold.demand shock A shock that causes the AD curve to shift.demand-side policy Policy that causes the aggregate demand curve to shift.depreciation Decrease in the value of the domestic currency relative to the currencies

ofother countries; used when exchanse rates are flexible.

depreciadesired c

devaluatof otht

differenrA ran<

diminishmargllfactor:

dirty floforeigContr:

discountdiscounr

recer\discretediscretit

sionaldisinter

lnteredisposa

plus tdissarirdistribt

discrtdistribt

sron )

diversifdollari;

for er

domestgo\-el

domestL\,IF

durabltdynam

otheldpam

in tirdlnam

trme:

dynamchan

dpantrrmDSCreal

GLOSSARY 619

depreciation Rate at which the capital stock wears out'

aeiired capital stock Capital stock that maximizes profits'

devaluation Decrease in ihe value of the domestic currency relative to the currencies

of other countries'; used when exchange rates are fixed'

difference stationary Temporary shocks to a variable permanently affect its level'

A random walk is an example of a difference statlonary process'

diminishing marginal product A characteristic of a production function whereby the

marginal"produit of u factor falls as the amount of the factor increases while all other

factors are held constant.

dirty floating Flexible exchange rate system rn which the central bank intervenes in

foreign .*ihung" markets in order to affect the short-run value of its currency'

Contrast clean ;floatingdiscount rate Interest rate charged by the Fed to banks that borrow money lrom 1t'

discounted cash flow analysis Method of determining the present value of cash to be

received in the future.

discrete lag Time that passes before an effect is felt. Contrast distributed lag'

discretionary outlays Fortion ofthe federal budget under immediate annual congres-

sional control. Contrast entitlement pro granTs.

disintermediation Withdrawal of deposits from financial intermediaries when

interest rates rise above the regulated ceiling rates on time deposits'

disposable income Income available for a household to spend; total income less taxes

plus transfers.dissaving Negative saving; borrowing/spending out of accumuiated wealth.

distribuied lag Time that passes while an e ect gradually accumulates. contrast

discrete lag.distributional consequences of unemployment The costs of unemployment (reces-

sion) are borne very unevenly, namely by those people who lose their job.

diversifrcation of policy instruments Simultaneous use of different policy instruments'

dollarization Replacement of a domestic culrency with another country's currency

for example, the U.S. dollar.

domestic credit The monetary authority's holdings of claims on the public sector-government debt-and on the private sector-usually loans to banks.

domestic credit ceiling A limit on domestic credit expansion, often suggested by the

IMF as part of a stabilization plan.

durable goods Goods that yield services over a period oftime. See con'sumer durables.

dynamiJbehavior Behavior that depends on values of economic variables in periods

other than the current Period.dynamic inconsistency Tendency of optimal policy to be different at different points

in time.dynamic programming A way of solving a problem by working backward through

time; choices made at one point in time anticipate choices that will need to be made later'

dynamic scoring The process of incorporating the macroeconomic effects of a tax

change into the revenue estimates.

dynamic stochastic general equilibrium (DSGE) Macroeconomic models in which

firms and consumers optimize over time, although often subject to sticky prices'

DSGE models u.. .o-"ii."s regarded as the union of traditional macro models and

real business cycle models.

620 GLOSSARY

Eeconometric model Model used to make quantitative economic predictions.Economic and Mo4etary Union (EMU) The European countries that have sitd

the Maastricht Treaty and adopted a common currency, the euro. History Speaks l3{in the textbook reviews the status of this union.

efficiency wage theory Theory suggesting that wages might be set above the mrhclearing rate in order to motivate workers; a possible explanation for wage rigidrslabor market disequilibrium.

employed person A person who has a job. An employed person is defined by tbBureau of Labor Statistics as one who, during the reference week (the week includinEthe lzth of the month) , (a) did any work at all (at least one hour) as a paid employa-worked in his or her own business, profession, or on his or her own farm, or worked15 hours or more as an unpaid worker in an enterprise operated by a member of thefamily, or (b) was not working but who had a job or business from which he or shewas temporarily absent because of vacation, illness, bad weather, child care problems-maternity or paternity leave, a labor-management dispute, job training, or otherfamily or personal reasons, whether or not he or she was paid for the time off or wasseeking anotherjob.

employment stability Low rute of job layoff , turnoveLendogenous growfh Steady-state output growth determined by endogenous variables,

for example, the saving rate.endogenous variable Variable that is determined within a particular model (whose

value is affected by the values of other variables).entitlement programs Programs that transfer money from the government to indi-

viduals; social security, unemployment insurance and Temporary Assistance forNeedy Families (TANF) are examples.

equilibrium level of output Level of output at which aggregate supply equals aggre-gate demand.

equity Share of ownership in a company; claim to a fraction of its profits.euro The common curency of the European Monetary Union.European Exchange Rate Mechanism (ERM) Agreement between a number of

European countries to loosely fix their exchange rates, allowing them to fluctuateonly in a narrow band.

Eurozone The countries that share the euro as their commgn culrency.excess reserves Reserves held by banks over and above the level required by the

Federal Reserve.excess sensitivity When one variable's response to changes in another is larger than

theory predicts. Consumption, for example, is said to exhibit excess sensitivity; itchanges more in response to predictable income changes than the life-cycle-permanent-income theory suggests.

excess smoothness When one variable's response to changes in another is smallerthan theory predicts. Consumption, for example, exhibits excess smoothness; itchanges by a smaller amount than the life-cycle-permanent-income theory suggestsin response to unexpected changes in income.

exchange rate Price offoreign culrency per unit ofdomestic currency.

GLOSSARY

ex shootingrates towa

exosenous "- t",1;il that is d

value is iexpansion the values of a

e theory of the term structure .states that long-term lnrerest rates are

.:;:"r"t. of currenr and expected tutur" ,rrort_i.?_ inr"."r, rares, plus a

expectations-augmented philrips curve see augmented ph,rips cut-ve.*ff;t:t inflation rate The lnflation .ui" ."p".t"d in the future by workers and

""11t1",91;I.interest rate The real cosr of borowing, or rhe real return on a deposir,

ies policies aimed at offsetting the effects

aimed at increasing purchases of domesticted goods.

rment insurance tax higher for firms whoseS.

ce of payments is nsilhgl in surplus norcapital account exactly omset ea.tt other.

rcit.

F'

face value The amoun^t that a bond pays its holder on expiration. The market value of;iJ:l,xlt :Hr

irs face uuru. *niJtrr" ,ou.r.t interesr rate is equar ro rhe coupon

":rJ:.t"il;1rj."" paymenrs made ro facrors of producrion; wages paid ro labor are

factor shaies portion of national income paid to each productivd"-input.*::::'^:liroduction rnp"' io f'oilil;, capital, rabor, anJ,iutu,ur resources

11ce which shifts the aggregare supply

e more at any given price level.

C). Government agency that insuresuat savrngs banks to a maximum of

nowing from other banks.es open market operations. setsof the Federal Resene System.and the presidenrs of four other

62r

622 GI.OSSARY

Federal Reserye The central bank of the United States. See Federal Reserve Sl,stem.

Federal Reserve System Consists oftwelve Federal Reserve Banks, each representingits own district, alloverseen by the Board of Governors of the Federal Reserve System.

final goods Goods that are sold to firms, the public, or the government for any purposeother than use as an input to production; all goods excluding intermediate ones.

finance The sale/purchase of assets.

fine tuning Continuous attempts to stabilize the economy in the face of smalldisturbances.

fiscal accommodation Fiscal response to a supply shock; prevents it from affecting ouQut.fiscal policy Government policy with respect to government purchases, transfer

payments, and the tax structure.fiscal policy multiplier Increase in aggregate demand for a $ I increase in government

purchases (or other changes in autonomous demand).Fisherequation i : r I n'.Fisher relationship Tendency of inflation and nominal interest rates to move

together.fixed exchange rate system A system in which exchange rates are determined by

governments and central banks rather than the free market, and maintained throughloreign exchange market intervention.

flexible accelerator model Asserts that firms plan their investment to close a fractionofthe gap between their actual capital stock and their desired capital stock; a result is

that firms with a larger gap between their actual and desired capital stocks accumulatecapital more quickly than other firms.

flexible (floating) exchange rate system A system in which exchange rates are

allowed to fluctuate with the forces of supply and demand. See also clean Jloatingand dirty floating.

flight out of money Tendency of people to hold goods rather than assets duringperiods of high inflation.

flow of investment The amount of spending per unit of time, usually per quarter oryear, that adds to the physical stock ofcapital.

flow variable A variable that is measured in rates per unit time rather than levels.Contrast stock variable.

foreign exchange market intervention The sale/purchase of currency in foreignexchange markets for the express purpose of increasing ordecreasing the value of the

domestic curency. Carried out by a country's central bank.forward exchange rate Exchange rate guaranteed for a specified future date.

fractional reserye banking Banks are only required to keep a fraction of theirdeposits in the form of cash, or cash equivalents.

frequency of unemployment The dverage number of times, per period, that workersbecome unemployed.

frictional unemployment Unemployment associated with the movement of workersin and out of jobs in "normal" times.

full-employment budget surplus What the budget surplus would be (hypothetically)with existing fiscal policy if the economy were at full employment.

full-employment output See potential output.future value Value of an investment made today at a date in the future. including ac-

cumulated interest.

GGDP deflator Measurg of the price level obtained by dividing nominal GDP by

real GDP.GDP gap Difference between actual GDP and potential GDP See output gap.GDP per capita GDP per person.globalization Notion that the world is moving toward a single global economy.golden-rule capital stock The steady-state level of capital that provides the most

consumption each period. When the capital stock is at the golden-rule level, themarginal product of capital is equal to the rate of depreciation plus the rate ofpopulation growth (and, when there is growth in technology, the rate of techno-logical progress).

goods market equilibrium schedule See IS curve.government budget constraint A limit that says the government can finance its

deficits only by selling bonds (accumulating debt) or by increasing the monetary base.government budget deflrcit (BD) Excess of government expenditure over govern-

ment revenue.government expenditure Total government spending; includes both government

purchases and transfers.government purchases Government spending on goods and services. Contrast

g ov e rnnTent expenditure.government saving Saving by the government; the difference between the revenues

taken in (i.e., from taxes) and the money used/given away (i.e., transfer payments,interest payments on the national debt).

gradualism Policy strategy of moving toward a desired target slowly.Great Depression A historical period of very low output and very high unemploy-

ment that occurred during the years 1929-1941 in the United States. A number ofother countries also experienced severe depressions during this period.

Great Moderation Era of relatively stable economic activity from the early 1980s to2001.

Great Recession Recession of 200'7-2009.gross domestic product (GDP) Measure of all final goods and services produced

within the country. Real GDP measured in constant dollars. Nominal GDP measuredin current dollars. el

gross investment Total investment; flow into the capital stock.gross national product (GNP) Measure of the value of all final goods and services

produced by domestically owned factors of production.gross private domestic investment The total amount of investment spending by

businesses and firms located within a country.gross national income (GNI) Synonym for gross national product.growth accounting The theory of measurement of the sources of economic growth.growth accounting equation The equation that summarizes the relationship between

. input growth and output growth.growth rate Rate at which a variable increases in value; percentage change in the

level of a variable.growth theory Tries to explain why output grows over time and to identify the factors

that affect its srowth rate.

I

624 GLOSSARY

Hheterodox approach to stabilization Coordinated use of trtore ri.-.. . -- - --r4

exchange rate policjes accompanied by wage and price controls.high-powered money Currency (notes and coins) and banks' deposits a, _.--. _- -- - .

called the monetary base.human capital Education and training of individuals to increase producr_ . -. ,

hyperinflation Very rapid price increase, sometimes dehned as more than -..r,r :.---:-per year.

hysteresis Occurs when temporary fluctuations in one variable hare p= --.-effects on another. See also unemplor-ment ht,steresis.

Iimperfect competition Form of competition in which firms have market po\\ e.-_ _

choose, to some extent, the price at which they will sell the goods they produ;-imperfect information Incomplete information. Forecasts based on imperfect :

mation will be less than fully accurate, though not necessarily biased.income elasticity of money Amount that demand for real money balances chans;.

percentage terms, when income increases by 1 percent.income velocity of money Ratio of income to the money stock.incomes policies Attempts to reduce inflation by wage or price controls.increasing returns to scale when, in a production function, doubling all of the inp-.

to the production process more than doubles output.indexation Automatic adjustment of prices and wages according to inflation rate.indexed debt Debt in which interest payments are adjusted upward each year ,

account for inflation.indicators Economic variables that signal us as to whether we are getting close to ou:

desired targets.inflation Percentage rate of increase in the general price level.inflation differential Difference between domestic and foreign rates of inflation.inflation targeting Using monetary and fiscal policy to achieve a particular

inflation rate.inflation tax Revenue gained by the government because of inflation's devaluation of

money holdings.inflation-adjusted dehcit Measure of the budget deficit that adjusts for effects of in-

flation; specifically, the correction reduces the measured budget deficit by the capitalgain on nominal bonds.

inflationary inertia The tendency of inflation rates to only decrease slowly over time.inside lag Period between the time a disturbance occurs and the time action is taken.insider-outsider model Predicts that wages will remain above the market-clearing

level because those who are unemployed do not sit at the bargaining table.instruments The tools policymakers manipulate directly to affect the economy.interest differential Difference between rates of interest paid in different countries

for the same asset, or in the same country for different assets.interest elasticity of money Percentage change in the demand for real money bal-

ances resulting from a 1 percent increase in the interest rate.

ItL

II1l

lt

i

I

I

iiI

I

GLOSSARY

intergenerational accounting Evaluates the costs and benefits oftaxes and spendingfor various age groups in society.

intermediate goods Goods used to produce other goods or services; flour purchasedby bakers is an example.

intermediate targets Policy targets used for control rather than because of their in-herent interest. For example, the money supply might be an intermediate target in theattempt to ultimately control inflation. Contrast ultimate tarpets.

internal balance Occurs when output equals potential output.International Monetary Fund (IMF) Intemational organizition created to promote in-

temational monetary cooperation; makes its resources temporarily available, under strin-gent conditions, to member countries experiencing balance-of-payments problems.

international trade The exchange of goods and services between countries.intertemporal substitution of leisure The extent to which temporarilv hieh real

wages cause workers to work harder today and enjoy more leisure tomoriow.intervention Sales or purchases of foreign exchange by the central bank in order to

stabilize exchange rates.inventory cycle Response ofinventory investment to changes in sales that causes fur-

ther changes in aggregate demand.inventory investment Increase in the stock ofgoods on hands.investment Purchase of new capital, principally by the business sector.investment subsidy Government payment of part of the cost of private investment.investment tax credit rax credit given to firms when they reinvest their earnings.1S curve Shows all of the combinations of the real interest rate and the level of output

_,for whic,hthe goods nrarketis inequi\\hr\un(y -_ C + i + G + NX).IS-LM model Interaction of 15 and LM ctrvesdetermines the real interest rate ancl the

level of income for a given price level, for which both goods and money markets arein equilibrium.

JJ'curve effect Observation that when a currency depreciates, the value ofnet expofis

rises temporarily, and then falls.just-in-time inventory management Inventory managemenr srrategy; firms hold in-

ventories for as short a time as possible by sending goods out u.loon as they areproduced, and ordering parts only as they are needed. s

KKeynesian revolution Modern understanding that aggregate demand affects the level

of economic activity.Keynesian aggregate supply curve Horizontal aggregate supply curve.

Llabor-augmenting technology Technology that makes each hour of labor more pro-

ductive, with particular reference to the production function.labor force consists of people who are working and people who are actively looking

for work.

625

I :E:: l-l

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l --it itt_-:

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:lli.-IS tll il-

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GLOSSARY

labor market turnover The frequency with which workers change jobs in an economy.layoff A suspension without pay lasting or expected to last more than seven consecu-

tive days, initiated by the employer without prejudice to the worker.life-cycle hypothesis eonsumption theory emphasizing that consumers consume and

save out of total life income and plan to provide for retirement.lifetime budget constraint Limits amount of money we can spend over our lifetimes;

the total amount of money that we earnlinheritlfind on the street over our lifetimes.lifetime utility The total benefit we derive from consumption (and whatever other

activities we value) over our lifetimes.liquid assets Assets that can be easily and quickly convefled into the unit of account

(dollars in the United States). Easily used to make transactions.liquidity A measure of the ability to make funds available on shorl notice.liquidity constraint Limitations on ability to borrow in order to finance consumption

plans.liquidity trap Horizontal LM curive due to extreme interest sensitivity of money

demand.LM curve Shows all of the combinations of the real interest rate and the level of out-

put for which the demand for real money balances equals the supply of real moneybalances. Drawn for a given price level.

long run In AS-AD analysis, period of time long enough for prices to clear all markets sothat output is equal to potential output, but shorl enough for potential ouput to be fixed.

loss function A rule used to evaluate the success of a policy. It measures the damagedone when the policy misses its target.

Lucas (econometric policy evaluation) critique Points out that many macroeco-nomic models assume that expectations are given by a particular function, when thatfunction can change.

MMI Currency plus checkable deposits.M2 Ml plus small time and savings deposits, overnight repurchase agreements (RPs)

and eurodollars, and money market funds.M3 M2 pfus other liquid assets (no longer tracked in the U.S.).Maastricht Treaty Treaty that created a common European culrency and central bank.managed (dirty) floating Flexible exchange rate system in which central banks inter-

vene in exchange markets to moderate short-run fluctuations in exchange rates.mandatory outlays Spending made under entitlement programs.marginal loss function Measures the change in the loss function from a small change

in the policy instrument.marginal product of capital (MPK) Increment to output obtained by adding one unit

ofcapital, with other factor inputs held constant.marginal product of labor (MPL) Increment to output obtained by adding one unit

of labor, with other factor inputs held constant.marginal propensity to consume (MPC) Increase in consumption for each $1

increase in disposable income.marginal propensity to import The increase in the demand for imports that results

from a one-unit increase in domestic income.

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GLOSSARY

marginallncreaseinincreaseindis.posable e marginal Pr

marginal The increase uming an addi-

tional unit of some good.

market share The fraction of a market's sales made by a firm, or by firms from aparlicular country.

maturity (or term) of bond Length of time until a bond expires.

medium of exchange One of the roles of money; asset used to make payments.

menu cost Small cost incurred when the nominal price of a good is changed; for ex-

shock from affecting output.monetary approach to the balance of payments Emphasizes monetary causes ot

balance-of-payments problems.

monetary base See high-powered money.

monetary poticy muttiplier Increase in aggregate demand for $1 increase in the

money supply.monetary-base targeting Using monetary policy to keep the monetary base at a

particular level.monetization See monetizing budget deficits.

monetizing budget deflrcits Purchase of government debt by the Federal Reserve,

thus indirectly funding the defrcit by printing money.

money (money s ent'

money illusion nce-thatchanges in the s'

money market equilibrium schedule See LM curve'

money multiplier Ratio of mo

multiplier Increase in endog exogenous

variable; particularly, increase tpurchases'

multiptier uncertainty Uncert uncertainty

about value of fiscal policy multiplier, monetary policy^multiplier. and so on.

Mundell-Fteming model Model hrst proposed by Robeit Mundell and Marcus Flem-

ing that explores economy with flexible exchange rates and perfect capital mobility.

myopia Shortsightedness by households regarding future income streams.

Nnationalincomeaccountingidentity Y= C -l I + G +NX.natural rate of unemployment Rate of unemployment at which the flows into and

out of the unemployment pool balance; also the point on the augmented Phillips

curve at which expected inflation equals actual inflation.neoclassical growth theory Theory that asserts that the growth rate of output is deter-

mined by exogenous technological growth'

net domestic product (NDP) GDP minus allowance for depreciation of capital.

627

6 rn an @onom\-_r seven consecu-

ers consume and

;er our lifetimes:r our lifetimes-I s'hatever other

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the level of out-r of real monev

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tements (RPs)

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rts that results

628 GLOSSARY

net exports Exports minus imporls.net investment Gross investment less depreciation; measures the increase in the

capital stock each period.

net investment income ThE interest and profits that result from foreign assets held by

domestic residents less the income foreigners earn on the domestic assets /hey own.

net present value Same as present value; amount today that is equivalent to a future

payment-the amount of money that, invested at the market interest rate, would

generate that amount of money.

neutrality of money Proposition that equiproportional changes in the money stock

and prices leave the economy unaffected.

New Classical economics Belief that the private economy is inherently efficient and

that the government ought not to attempt to stabilize output and unemployment.

New Deal Slogan for Franklin D. Roosevelt's economic policy reforms'

New Economics Economic policy of the Kennedy-Johnson years, emphasizing the

theory full emPloYment.

N onomi whose basis is rational behavior and conclude

is not ff,rcient and that, at times, the government ought

to stabilize output and unemployment.

nominal exchange rate The price of one cunency in terms of another'

nominal GDP Value of all final goods and services produced in the economy; not

adjusted for inflation.nominal GDP targeting Using monetary policy to achieve a certain level of GDP, or

to achieve a particular rate of growth of GDP.

nominal interest rate Expresses the payment in current dollars on a loan or other

investment (over and above principal repayment) in terms of an annual percentage.

nominal money supply Nominal value of bills and coins in circulation; says nothing

about the amount that these bills and coins can purchase'

nonsterilized intervention Occurs when the central bank does not use monetary

policy to offset the effect of foreign exchange market intervention on the domestic

money supply. Contrast sterilized intervention.

oOkun's law Empirical law relating GDP growth to changes in unemployment; named

for its discoverer. the late Arthur Okun. qr

OPEC Organization of ational oil carlel.

open economy An econ with other countries.

open market desk The ch the Fed buys and

sells government securities on the secondary market on a daily basis'

open market operation Federal Reserve purchase or sale of Treasury bills inexchange for money.

open market purchase An operation in which the Fed buys government bonds on the

secondary market. Contrast open market sale.

open market sale An operation in which the

secondary market.

Fed sells sovernment bonds on the

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operational bequest motive A reason for saving;

money behind for descendants, friends, or charity.desire to leave some of one's

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GLOSSARY

opportunity cost What is forgone to take an action. For example, one opportunity costof attending college is the lost wages the student could be earning in a full-time job.

optimal Best.output gap Difference between actual GDP and potential GDP.outside lag Time required for a policy change to take effect.own rate of interest The interest rate Daid on monev (often zero).

Pparameter Type of exogenous variable; gives a function its specific form. The

parameter 0 in the function K0 lr 0 is an example.pay-as-you-go social security system Social security system in which payments to

retirees are made with funds provided, not by their social security taxes, but by thesocial security taxes paid by the working population.

pegging the interest rate The practice of using monetary policy to keep the interestrate near a target level.

perfect capital mobility Capital is perfectly mobile when it has the ability to moveinstantly, and with a minimum of transactions costs, across national borders in searchof the highest return.

perfect foresight Assumption that people know the future value of all relevant vari-ables, or that their expectations are always correct.

perfectly/imperfectly anticipated inflation The extent to which people have perfectforesight with regards to the inflation rate.

permanent-income theory Says that people form expectations of their futureincome and choose how much to consume based on those as well as their currentincome.

personal consumption expenditure (PCE) Measures inflation in consumer pur-chases based on the consumption sector of the national income accounts.

personal saving Saving by individuals and families.Phillips curve Relation between inflation and unemployment; in a sense, a dynamic

version ofthe aggregate supply curve.policy irrelevance Refers to the inability of monetary or fiscal policy to affect output

in rational expectations equilibrium models.policy mix Combination of fiscal and monetary policy to achieve bolh internal and

external balance.policy variable An exogenous variable whose value is determined by government policy.political business cycle theory Theory that politicians deliberately manipulate the

economy to produce an economic boom at election time.portfolio The mix of assets someone owns.portfolio disequilibrium Occurs when people are holding more of some asset (i.e.,

money) at the prevailing interest rate than they wish to.portfolio of policy instruments The range of policy instruments available to the

policymaker.potential GDP See potential output.potential output Output that is produced when all factors are fully employed.precautionary motive A reason people hold money; they do not know how much

they'll need to spend.

629

630 GLOSSARY

present value See net present value.price stickiness when prices are unable to adjust quickly enough to keep markets in

equilibrium.primary (or nonin@rest) budget defrcit The budget deficit except for interest payments.private saving Saving by individuals, by families, and by firms; saving by everyone

other than the government.producer price index (PPf Price index based on a market basket of goods used in

production. The PPI replaced the wholesale price index (WPI).production function Technological relation showing how much output can be

produced for a given combination of inputs.productivity shock Change in technology that affects workers' productivity. See also

supply shock.propagation mechanism Mechanism by which current economic shocks cause

fluctuations in the future, for example, intertemporal substitution of leisure.purchasing power parity (PPP) Theory of exchange rate determination arguing that

the exchange rate adjusts to maintain equal purchasing power of foreign and domesticcu1Tency.

o\<4 theory of investment Investment theory emphasizing that investment will be high

when assets are valuable relative to their reproduction cost. The ratio of asset value tocost is called q.

quantitative easing Central bank policy to reduce long-term interest rates by buyingfinancial assets such as long-term bonds.

quantity equation Money times velocity equals price times quantity (M x V : P x Y).quantity theory of money Theory of money demand emphasizing the relation of

nominal income to nominal money. Sometimes used to mean a vertical LM curve.

Rrandom walk A variable in which changes over time are unpredictable.random walk of GDP Theory that suggests most shocks to output have permanent

effects-that supply shosks play a more important role in explaining business cyclefluctuations than demand shocks.

random-walk model of consumption Model that suggesttuQonsumption should followa random walk. Because consumption is supposedly based on expected future incomeas well as current income, changes in consumption should not be predictable.

rational expectations Theory of expectations formation in which expectations arebased on all available information about the underlying economic variable; frequentlyassociated with New Classical macroeconomics.

rational expectations equilibrium model A model in which expectations are formedrationally, and markets are always in equilibrium.

real balances Real value of the money stock (number of dollars divided by the pricelevel).

real business cycle (RBC) theory Theory that recessions and booms are dueprimarily to shocks in real activity, such as supply shocks, rather than to changes inmonetary factors.

GLOSSARY

real deYaluation A decline in the purchasing power of the dollar relative to othercurrencles.

real exchange rate Purchasing power of foreign culrency relative to the U.S. dollar.real GDP A measrre of output; adjusts the value of final goods and services to reflect

changes in the price level.real GDP targeting Using monetary and fiscal policy to achieve a particular rate of

real GDP growth.real interest rate Retur-n on an investment measured in dollars of constant value; roughly

equal to the difference between the nominal interest rate and the rate of inflation.real money balances See real balances.real money supply Real value of the bills and coins in circulation; equal to the nominal

money supply divided by the price level.recession Period of diminishing economic activity, usually, but not always, marked by

two quarters or more of declining RGDP.recognition lag Period between the time a disturbance occurs and the time policv-

makers discover the disturbance.recoyery A sustained period ofrising real income.rental (user) cost of capital Cost of using a dollar's worth of capital for a given unit

of time, usually a year.repercussion effects Feedback of domestic economic changes through foreign econ-

omies and back into the domestic economy.replacement ratio The ratio of after-tax income while unemployed to after-tax

income while employed.reporting effects Changes in the measurement of some variable due to a change in

the number of people who claim to be in a certain group; unemployment can appearto rise, for example, when more people register for unemployment benefits.

required-reserve ratio Fraction of a bank's deposits that it is required to keep onreserve.

required reserYes The amount ofreserves a bank is required to keep at the central bank.reservation wage The lowest wage an individual is willing to accept; if you were of-

fered a job that paid a wage lower than your reservation wage, you would turn it down.reserve ratio Ratio of bank reserves to bank deposits; a primary determinant of the

money multiplier.reserves Part of a bank's deposit kept at the Fed, or in its vaults; money that a bank

keeps on hand instead oflending out.residential investment lnvestment in housing.revaluation Increase in the value of the domestic currency relative to the currencies

ofother countries. Used when exchange rates are fixed.Ricardian (or Barro-Ricardo) equivalence Under Barro-Ricardo equivalence, there

is no difference between taxes and ihe accumulation of debt; debt is thought to be thesame as future taxes.

risky asset Asset whose future payoffis uncertain.rules versus discretion The issue of whether or not monetary and fiscal authorities

should conduct policy in accordance with preannounced rules.run on a bank A rapid withdrawal of deposits from a bank. This can result in the

forced sale of a bank's illiquid assets at fire-sale prices, causing the bank, even ifhealthy, to fail.

63r

GLOSSARY

S

sacrifice ratio During a period of anti-inflation policy, the ratio of cumulative GDPlost to reduction in the inflation rate.

saving Money that is not spent.scatterplot A graph made up of a number of unconnected points on an X-y plane.search unemployment Unemployment that exists because people have quit one job

to search for another.seigniorage Revenue derived from the government's ability to print money.self-fulflrlling expectations Expectations that cause a variable to change in the ex-

pected manner; if enough people expect a culrency to depreciate, capital flows gener-ated by their expectations will cause it to do so.

short-run A period of time short enough that markets are unable to clear, so thatoutput can deviate from potential output.

slump Part of the business cycle. Period of time starting when unemployment risesabove normal levels and ending when unemployment returns to normal levels.

social infrastructure All the institutions and government policies that determine theeconomic environment.

Solow residual A measure oftotal factor productivity; change in the level ofproduc-tion that cannot be accounted for by changes in factor inputs.

sovereign debt Debt issued by a government.speculative bubble Occurs when the value of a variable departs from the level that

the factors that determine its value suggest; when people argue that a stock is over- orundervalued, they are suggesting that such a bubble exists.

speculative motive A reason peopte hold money; although the retum on holding money issmall, people hold it because it reduces the risk associated with their portfolio of assets.

speed of price adjustment Amount of time that it takes prices to fully adjust so thatall markets are in equilibrium and output equals potential output.

spell of unemployment rhe amount of time that the average person spends in theunemployment pool.

spillover (interdependence) effects occur when policy changes or supply/demandshocks in one country affect output in another.

spot exchange rate The current exchange rate.stable equilibrium An equilibrium that draws nearby variables into itself; if a vari-

able is moved slightly away from a stable equilibrium, it will lpturn.stagflation Simultaneous inflation andrecession.staggered price adjustment Occurs when firms set their prices or negotiate their

contracts at different times.standard of deferred payment Asset normally used for making payments due at a

later date.steady-state equilibrium State in

constant.which real (per capita) economic variables are

sterilization Open market purchase or sale by the Fed in order to offset effects offoreign exchange market intervention on the monetary base,

sterilized intervention Occurs when the central bank uses monetary policy to offsetthe effect of foreign exchange market intervention on the domestic money supply.

sticky real wages See wage stickiness.

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GLOSSARY

stock ofcapital See capital stock.stock variable A variable that is measured in levels rather than rates of change.Contrastflow variable.store of value Asset that maintains its value over time.structural deficit Deficit that would exist with current fiscal policy if the economy

were.at full employment. Formerly calred "high-employment','or ,,flr-employment,,deficit. Contrast cyclical deficit.

supply shock An economic disturbance whose first impact is a shift in the aggregatesupply curve.

supply-side policy policy that causes the aggregate supply curve to shift.

Ttarget zone A specihed range to which central banks limit exchange rate fluctuations.targets Identified goals ofpolicy.tzrriff A tax imposed on imporred goods.Taylor rule Summarizes how the -on"tu.y authority sets rnterest rates in response toeconomic activity.term of bond See maturity of bond.term premium Premium paid holders of bonds for the risk associated with a particular

matuflty.term structure ofinterest The relationship between interest rates on bonds ofdifferent

maturities.total factor productivity (TFp) Rate at which productivity of inputs increases; mea_sure oftechnological progress. See also Solow residual.trade See intemational t de.trade balance The net flow of dollars into the country due to sares of goods abroad.transactions motive A reason peopre hold money-they use it to purchase goods

and services.transfer payments

Ygn"y given by the govemment to individuais. not in exchange forgoods or services; welfare payments *" in ."u-ple. See also e,titlenter.u programs.transmission mechanism process by which monetary poricy affects ag_sregate demand.trend (secular) component of GDp potentiar ourDut.trend path of GDp See trend path of output.trend path of output The path followed ty potential outputdver time.trend stationary A variabre is trend stationary when temporary shocks do not per_manently affect its lever. changes in AD, for example, can only temporarily affectoutput' If changes in output were driven primarily by demand shocks, output wouldbe trend stationary.trend stationary with breaks Tiend staiionary, but with a trend that sometimes chanses.

Uultimate targets Policy targets of inherent interest. For example, the inflation ratemight be an ultimate target. Contrast intetmecliate tarsets.uncovered interest parity Relationship between inte"rest differentials and expected

currency appreciation.

633

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GLOSSARY

unemployed person A person who does not have a job but is actively seekin-e oneunemployment gap The difference between the actual unemployment rate and r=

natural rate.unemployment hysteresis Theory that argues that recessions may permanentll.att-e-:

the natural rate of unemployment.unemployment pool Group of individuals in transition between jobs.unemployment rate The fraction of the labor force that is out of work and lookil:

for ajob or expecting a recall from a layoff.unit of account Asset in which prices are denoted.unit labor cost The total amount a firm pays to labor divided by the number ..1

units produced.unstable equilibrium An equilibrium that pushes nearby variables away from itselr:

if a variable is moved slightly away from an unstable equilibrium, forces will push ireven further away.

Vvalue added Increase in value of output at a given stage of production. Equivalentll-

value of output minus cost of inputs.velocity of money The number of times the typical dollar changes hands durins

the year.very long run A period of decades or more, over which potential output is expectetl

to grow.

wwage-price spiral A process in which changes in prices feed back into wages, and

from there again into prices.wage stickiness when wages are unable to adjust quickly enough to clear the labor

market.world r[ade organization (wro) International organization that works out

rules of trade between its member nations; created January l, 1995, as a result of theUruguay Round of the General Agreement on Tariffs and Trade (GATT).

Yyield curve

Z

Shows how interest rates change as bond -utu.it", increase.

zero lower bound (zLB) Lowest value (zero) to which the central bank can pushshort-term interest rates.

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