Glossary

(The number in parentheses after the glossary term is the chapter in which that term first appears or is most extensively discussed.)

absorption: (5) total spending by domestic residents, firms, and governments, equal to C + I + G.

activist: (14) describes a policy strategy that involves active responses by the central bank to changes in economic circumstances. See discretion.

acyclical: (8) not displaying a regular pattern of behavior over the business cycle. See procyclical, countercyclical.

aggregate demand: (8) the total amount of goods and services demanded by households, businesses, and governments.

aggregate demand (AD) curve: (9) in a diagram with output on the horizontal axis and the price level on the vertical axis, the downward-sloping relation between the price level and the economy-wide demand for output.

aggregate demand for labor: (3) the sum of the labor demands of all employers in an economy.

aggregate demand management: (11) the use of mone­tary and fiscal policies, which shift the aggregate demand curve, to try to smooth out the business cycle; also known as macroeconomic stabilization or stabilization policy.

aggregate demand shocks: (11) shocks to the economy that shift the IS curve or the LM curve and thus affect the aggregate demand for output.

aggregate supply: (8) the total amount of output that producers as a whole are willing to supply at any particular price level.

aggregate supply (AS) curve: (9) in a diagram with output on the horizontal axis and the price level on the vertical axis, the relation between the price level and the total amount of output that firms supply.

aggregate supply of labor: (3) the sum of the labor sup­plied by everyone in the economy.

aggregation: (1) the process of adding individual economic variables to obtain economy-wide totals.

appreciation: (13) see nominal appreciation, real appreciation.

average labor productivity: (1) the amount of output produced per unit of labor input (per worker or per hour of work).

average tax rate: (15) the total amount of taxes paid divided by the taxpayer's income.

balance of payments: (5) the net increase (domestic less foreign) in a country's official reserve assets.

balance of payments accounts: (5) the record of a country's international transactions, consisting of the current account and the financial account.

bank reserves: (14) liquid assets held by banks to meet the demands for withdrawals by depositors or to pay the checks drawn on depositors' accounts.

bank run: (14) a large-scale withdrawal of deposits from a bank, caused by depositors' fear that the bank may go bankrupt and not pay depositors in full.

Board of Governors of the Federal Reserve System: (14) a group of seven governors, appointed by the President of the United States to staggered 14-year terms, that provides the leadership of the Federal Reserve System.

boom: (8) in a business cycle, the period of time during which aggregate economic activity grows; also known as an expansion.

borrowing constraint: (4) a restriction imposed by lenders on the amount that someone can borrow. If a borrow­ing constraint causes an individual to borrow less than he or she would choose to borrow in the absence of the constraint, the borrowing constraint is binding; otherwise it is nonbinding.

budget constraint: (4) a relation that shows how much current and future consumption a consumer can afford given the consumer's initial wealth, current and future income, and the interest rate.

budget deficit: (2) government outlays minus govern­ment receipts. See government outlays, government receipts.

budget line: (4) the graph of the consumer's budget constraint; the budget line shows graphically the com­binations of current and future consumption a con­sumer can afford given the consumer's initial wealth, current and future income, and the interest rate.

budget surplus: (2) government receipts minus govern­ment outlays. See government outlays, government receipts, government saving.

business cycle: (8) a decline in aggregate economic activity (a contraction or recession) to a low point (a trough), followed by a recovery of activity (an expansion or boom) to a high point (a peak). A complete business cycle can be measured from peak to peak or from trough to trough.

business cycle chronology: (8) a history of the dates of business cycle peaks and troughs.

capital good: (2) a good that is produced, is used to produce other goods, and—unlike an intermediate good—is not used up in the same period in which it is produced.

capital-labor ratio: (6) the amount of capital per worker, equal to the capital stock divided by the number of workers.

central bank: (14) the governmental institution responsi­ble for monetary policy, such as the Federal Reserve System in the United States and the Bank of Japan in Japan.

chronically unemployed: (3) workers who are unem­ployed a large fraction of the time.

classical approach: (1) an approach to macroeconomics based on the assumption that wages and prices adjust quickly to equate quantities supplied and demanded in each market. Classical economists generally argue that free markets are a good way to organize the economy and that the scope for government inter­vention in the economy—for example, to smooth out the business cycle—should be limited.

closed economy: (1) a national economy that does not have trading or financial relationships with the rest of the world.

coincident variable: (8) a variable with peaks and troughs that occur at about the same time as the corresponding business cycle peaks and troughs. See lagging variable, leading variable.

cold turkey: (12) a rapid and decisive reduction in the growth rate of the money supply aimed at reducing the rate of inflation; contrast with gradualism.

comovement: (8) the tendency of many economic vari­ables to move together in a predictable way over the business cycle.

consumer price index: (2) a price index calculated as the current cost of a basket of consumer goods and services divided by the cost of the basket in the base period.

consumption: (2) spending by domestic households on final goods and services.

consumption-smoothing motive: (4) the preference of most people for a relatively constant or stable pattern of consumption over time, as opposed to having high consumption at some times and low consumption at others.

contraction: (8) in a business cycle, the period of time during which aggregate economic activity is falling; also known as a recession.

contractionary monetary policy: (11) a monetary or fiscal policy that reduces aggregate demand.

countercyclical: (8) tending to move in the opposite direction of aggregate economic activity over the business cycle (up in contractions, down in expan­sions). See procyclical, acyclical.

credibility: (14) the degree to which the public believes the central bank's announcements about future policy. currency: (7) paper money and coin issued by the gov­ernment; cash.

currency union: (13) a group of countries that agree to share a common currency.

current account: (5) the record of a country's interna­tional trade in currently produced goods and services.

current account balance: (2, 5) payments received from abroad in exchange for currently produced goods and services (including factor services and unilateral transfers), minus the analogous payments made to foreigners by the domestic economy.

cyclical unemployment: (3) the excess of the actual unem­ployment rate over the natural rate of unemployment; equivalently, unemployment that occurs when output is below its full-employment level.

deflation: (1) a situation in which the prices of most goods and services are falling over time.

demand for money: (7) the quantity of monetary assets, such as cash and checking accounts, that people choose to hold in their portfolios.

depository institutions: (14) privately owned banks and thrift institutions (such as savings and loans) that accept deposits from and make loans directly to the public.

depreciation: 1. (2) the amount of capital that wears out during a given period of time. 2. (13) a decline in the exchange rate; see nominal depreciation, real depreciation.

depression: (8) a particularly severe and prolonged down­turn in economic activity.

desired capital stock: (4) the amount of capital that allows a firm to earn the highest possible expected profit.

devaluation: (13) a reduction in the value of a currency by official government action under a fixed-exchange-rate system.

diminishing marginal productivity: (3) a feature of production functions that implies that, the more a particular factor of production is used, the less extra output can be gained by increasing the use of that factor still further (with the usage of other factors of production held constant). For example, for a given capital stock, adding an extra worker increases output more when employment is initially low than when it is initially high.

discount rate: (14) the interest rate charged by the Fed when it lends reserves to banks.

discount window lending: (14) the lending of reserves to banks by the Fed.

discouraged workers: (3) people who stop searching for jobs because they have become discouraged by lack of success at finding a job; discouraged workers are not included in the official unemployment rate.

discretion: (14) the freedom of the central bank to con­duct monetary policy in any way that it believes will advance the ultimate objectives of low and stable inflation, high economic growth, and low unemploy­ment; in contrast to rules.

disinflation: (12) a fall in the rate of inflation.

distortions: (15) tax-induced deviations in economic behavior from the efficient, free-market outcome.

diversification: (7) the idea that spreading out invest­ment in different assets can reduce an investor's overall risk.

duration: (3) the length of time that an unemployment spell lasts.

economic model: (1) a simplified description of some aspect of the economy, usually expressed in mathe­matical form.

economic theory: (1) a set of ideas about the economy that have been organized in a logical framework.

effective labor demand curve: (11) in a diagram with out­put on the horizontal axis and the quantity of labor on the vertical axis, an upward-sloping curve that shows how much labor is needed to produce a given amount of output, with productivity, the capital stock, and effort held constant.

effective tax rate (on capital): (4) a single measure of the tax burden on capital that summarizes the many provisions of the tax code that affect investment.

efficiency wage: (11) the real wage that maximizes worker effort or efficiency per dollar of real wages received.

efficiency wage model: (11) a model of the labor market in which, because workers exert more effort when they receive a higher real wage, profit-maximizing employers choose to pay a real wage that is higher than the real wage that clears the labor market; the efficiency wage model can be used to help explain real-wage rigidity and the existence of unemployment.

effort curve: (11) the relation between the level of effort put forth by workers and the real wage; its positive slope indicates that a higher real wage induces work­ers to exert greater effort.

empirical analysis: (1) a comparison of the implications of an economic theory or model with real-world data. employment ratio: (3) the fraction of the adult popula­tion that is employed.

endogenous growth theory: (6) a branch of growth theory that tries to explain productivity growth (hence, the growth rate of output) within the context of a model of economic growth.

endogenous variable: (6) a variable determined by a model.

equilibrium: 1. (1) a situation in which the quantities demanded and supplied are equal in a market or a set of markets. 2. (11) in the labor market, the absence of any upward or downward pressure on wages.

equilibrium condition: (6) an equation that is satisfied in equilibrium.

exchange rate: (13) the number of units of foreign currency that can be purchased with one unit of the home cur­rency; also known as the nominal exchange rate.

exogenous variable: (6) a variable that is given, or deter­mined outside a model.

expansion: (8) in a business cycle, the period of time during which aggregate economic activity is rising; also known as a boom.

expansionary monetary policy: (11) a monetary policy that increases aggregate demand.

expectations-augmented Phillips curve: (12) an inverse relation between unanticipated inflation and cyclical unemployment.

expectations theory of the term structure: (7) the idea that investors compare the expected rates of return on a long-term bond and on a sequence of short-term bonds over the same horizon as the long-term bond; in equilibrium, the expected rate of return on an N-year bond equals the average of the expected rates of return on one-year bonds during the current year and the N-1 succeeding years.

expected real after-tax interest rate: (4) the nominal after-tax rate of return (equal to the nominal interest rate times 1 minus the tax rate) minus the expected rate of inflation; equals the expected increase in the real value of an asset after payment of taxes on interest income.

expected real interest rate: (2) the nominal interest rate minus the expected rate of inflation; equals the expected increase in the real value of an asset.

expected returns: (7) the rates of return on real or finan­cial assets that financial investors expect to earn on average.

expenditure approach: (2) a procedure for measuring economic activity by adding the amount spent by all purchasers of final goods and services.

factors of production: (3) inputs to the production pro­cess, such as capital goods, labor, raw materials, and energy.

FE line: (9) see full-employment line.

Federal Open Market Committee (FOMC): (14) a twelve­member committee (consisting of the seven governors of the Federal Reserve Board, the president of the Federal Reserve Bank of New York, and four of the presidents of the other regional Federal Reserve Banks) that decides the course of U.S. monetary policy.

federal funds rate: (14) the interest rate charged on reserves that one bank lends to another; also known as fed funds rate.

fed funds rate: (14) the interest rate charged on reserves that one bank lends to another; also known as federal funds rate.

final goods and services: (2) goods and services that are the end products of the productive process, in con­trast to intermediate goods and services.

financial account: (5) the record of a country's flow of assets into or out of the country (other than assets transferred unilaterally).

financial account balance: (5) equals the value of finan­cial inflows minus the value of financial outflows.

financial inflow: (5) an entry in a country's financial account that arises when a resident of the country sells an asset to someone in another country.

financial outflow: (5) an entry in a country's financial account that arises when a resident of the country buys an asset from abroad.

fiscal policy: (1) policy concerning the level and compo­sition of government spending and taxation.

fixed-exchange-rate system: (13) a system in which exchange rates are set at officially determined levels and are changed only by direct governmental action.

flexible-exchange-rate system: (13) a system in which exchange rates are not officially fixed but are deter­mined by conditions of supply and demand in the foreign exchange market; also known as a floating­exchange-rate system.

floating-exchange-rate system: (13) see flexible-exchange-rate system.

flow variable: (2) a variable that is measured per unit of time; an example is GDP, which is measured as out­put per year or quarter. See stock variable.

foreign direct investment: (5) the purchase or construc­tion of capital goods by a foreign business firm; for example, a Japanese auto company builds a new plant in the United States.

foreign exchange market: (13) the market in which the currencies of different nations are traded.

forward guidance: (14) a tool that the Fed can use to influ­ence long-term interest rates by signaling its expecta­tions about future short-term interest rates.

fractional reserve banking: (14) a banking system in which banks hold reserves equal to a fraction of their deposits so that the reserve-deposit ratio is less than 1.

frictional unemployment: (3) the unemployment that arises as the result of the matching process in which workers search for suitable jobs and firms search for suitable workers.

full-employment deficit: (15) what the government budget deficit would be, given the tax and spending policies currently in force, if the economy were operating at its full-employment level.

full-employment level of employment: (3) the equilib­rium level of employment, achieved after wages and prices fully adjust.

full-employment (FE) line: (9) in a diagram with output on the horizontal axis and the real interest rate on the vertical axis, a vertical line at full-employment out­put. Points on the FE line correspond to points of equilibrium in the labor market.

full-employment output: (3) the level of output that firms supply when wages and prices in the economy have fully adjusted to their equilibrium levels.

fundamental identity of national income accounting: (2) the accounting identity that states that total pro­duction, total income, and total expenditure during a given period are equal.

fundamental value of the exchange rate: (13) the value of the exchange rate that would be determined by the forces of supply and demand in the foreign exchange market, in the absence of government intervention.

GDP: (2) see gross domestic product.

GDP deflator: (2) a measure of the price level, calculated as the ratio of current nominal GDP to current real GDP.

general equilibrium: (9) a situation in which all markets in an economy are simultaneously in equilibrium.

GNP: (2) see gross national product.

Golden Rule capital-labor ratio: (6) the level of the capital­labor ratio that maximizes consumption per worker in the steady state.

government capital: (15) long-lived physical assets owned by the government, such as roads and public schools.

government debt: (15) the total value of government bonds outstanding at any given time.

government outlays: (2) the government's purchases of goods and services plus transfers and interest payments; also known as government expenditures.

government purchases: (2) spending by the government on currently produced goods and services.

government receipts: (2) taxes and other revenues collected by the government.

government saving: (2) net government income minus government purchases; equivalently, the government's tax receipts minus its outlays; equal to the government budget surplus.

gradualism: (12) a prescription for disinflation that involves reducing the rate of monetary growth and the rate of inflation gradually over a period of several years; contrast with cold turkey.

gross domestic product (GDP): (2) the market value of final goods and services newly produced within a nation's borders during a fixed period of time.

gross investment: (4) the total purchase or construction of new capital goods.

gross national product (GNP): (2) the market value of final goods and services newly produced by domesti­cally owned factors of production during a fixed period of time.

growth accounting: (6) a method for breaking down total output growth into parts attributable to growth of capital, labor, and productivity.

growth accounting equation: (6) the production function written in growth rate form; it states that the growth rate of output is the sum of (1) the growth rate of productivity, (2) the elasticity of output with respect to capital times the growth rate of capital, and (3) the elasticity of output with respect to labor times the growth rate of labor.

high-powered money: (14) the liabilities of the central bank, consisting of bank reserves and currency held by the nonbank public, that are usable as money; also known as monetary base.

human capital: (6) the productive knowledge, skills, and training of individuals.

hyperinflation: (12) a situation in which the rate of infla­tion is extremely high for a sustained period of time; one suggested definition is a 50% or higher monthly rate of inflation.

income approach: (2) a procedure for measuring economic activity by adding all income received, including taxes and after-tax profits.

income effect: (4) a change in economic behavior (such as the amount a person saves or works) in response to a change in income or wealth; graphically, a change in behavior induced by a parallel shift in the budget line.

income effect of a higher real wage: (3) the tendency of workers to supply less labor when the real wage increases, as a result of the fact that a higher real wage makes workers wealthier.

income effect of the real interest rate on saving: (4) the tendency of savers to consume more and save less in response to an increase in the real interest rate because they are made wealthier; the tendency of borrowers to consume less and save more in response to an increase in the real interest rate because they are made less wealthy.

income elasticity of money demand: (7) the percentage change in money demand resulting from a 1% increase in real income.

income-expenditure identity: (2) the accounting iden­tity that states that total income (product) equals the sum of the four types of expenditure: consumption, investment, government purchases, and net exports.

inconvertible currency: (13) a currency that cannot be traded freely for other currencies, usually because of government-imposed restrictions.

index of leading economic indicators: (8) a weighted average of economic variables that lead the business cycle, used for forecasting future business activity.

indicators: (14) see intermediate targets.

indifference curve: (4) shows graphically the combina­tions of current and future consumption that yield any given level of utility.

inflation: (1) a situation in which the prices of most goods and services are rising over time.

inflation tax: (15) the resources raised by the government by issuing money and creating inflation; also known as seignorage.

instruments: (14) the policy tools that the Fed can use to influence the economy; they include reserve require­ments, the discount rate, the interest rate on reserves, and, especially, open-market operations.

interest elasticity of money demand: (7) the percentage change in money demand resulting from a 1% increase (different from a 1 percentage point increase) in the interest rate.

interest rate: (2) the rate of return promised by a bor­rower to a lender.

intermediate goods and services: (2) goods and services that are used up in the production of other goods and services in the same period that they themselves were produced; an example is wheat used up in making bread.

intermediate targets: (14) macroeconomic variables that the Fed cannot control directly but can influence fairly predictably and that, in turn, are related to the ulti­mate goals the Fed is trying to achieve; also known as indicators. Examples of intermediate targets are the growth rates of monetary aggregates and short-term interest rates.

inventories: (2) stocks of unsold finished goods, goods in process, and production materials held by firms.

investment: (2) spending for new capital goods, called fixed investment, and increases in firms' inventory holdings, called inventory investment. See gross invest­ment, net investment.

invisible hand: (1) the idea (proposed by Adam Smith) that, if there are free markets and individuals conduct their economic affairs in their own best interests, the economy as a whole will work well.

IS curve: (9) in a diagram with output on the horizontal axis and the real interest rate on the vertical axis, a downward-sloping curve that shows the value of the real interest rate that clears the goods market for any given value of output. At any point on the IS curve, desired national saving equals desired investment (in a closed economy); equivalently, the aggregate quantity of goods demanded equals the aggregate quantity of goods supplied.

J curve: (13) the typical time pattern of the response of net exports to a depreciation of the real exchange rate, in which net exports initially decline but then increase.

job finding rate: (8) the probability that someone who is unemployed will find a job in the next month.

job loss rate: (8) the probability that someone who is employed will lose his or her job in the next month.

Keynesian approach: (1) an approach to macroeconomics based on the assumption that wages and prices may not adjust quickly to equate quantities supplied and demanded in each market. Keynesian economists are more likely than classical economists to argue that government intervention in the economy—for example, to smooth out the business cycle—may be desirable.

labor force: (3) the number of people willing to work, including unemployed people actively searching for work, as well as employed workers.

labor hoarding: (10) a situation that occurs if, because of the costs of firing and hiring workers, firms continue to employ some workers in a recession that they otherwise would have laid off.

lagging variable: (8) a variable with peaks and troughs that tend to occur later than the corresponding peaks and troughs in the business cycle. See coincident variable, leading variable.

large open economy: (5) an economy that trades with other economies and is large enough to affect the world real interest rate.

leading variable: (8) a variable with peaks and troughs that tend to occur earlier than the corresponding peaks and troughs in the business cycle. See coincident variable, lagging variable.

leisure: (3) all off-the-job activities, including eating, sleeping, recreation, and household chores.

life-cycle model: (4) a multi-period version of the basic two-period model of consumer behavior that focuses on the patterns of income, consumption, and saving over the various stages of an individual's life.

liquidity: (7) the ease and quickness with which an asset can be exchanged for goods, services, or other assets.

liquidity trap: (14) a situation in which any additional money supplied by the central bank is held by banks or the public, with no decline in interest rates or increase in spending.

LM curve: (9) in a diagram with output on the horizontal axis and the real interest rate on the vertical axis, an upward-sloping curve that shows the value of the real interest rate that clears the asset market for any given value of output. At any point on the LM curve, the quantities of money supplied and demanded are equal.

long-run aggregate supply (LRAS) curve: (9) in a dia­gram with output on the horizontal axis and the price level on the vertical axis, a vertical line at full­employment output; indicates that in the long run the supply of output does not depend on the price level.

long-run Phillips curve: (12) in a diagram with unem­ployment on the horizontal axis and inflation on the vertical axis, a vertical line at the natural rate of unemployment; indicates that in the long run the unemployment rate equals the natural rate, indepen­dent of the rate of inflation.

lump-sum tax cut: (4) a tax cut in which every taxpayer's taxes are reduced by the same amount.

M1: (7) a monetary aggregate that includes currency and travelers' checks held by the public, demand deposits (non-interest-bearing checking accounts), and other checkable deposits.

M2: (7) a monetary aggregate that includes everything in M1 and a number of other assets that are somewhat less moneylike, such as savings deposits, small­denomination (under $100,000) time deposits, nonin- stitutional holdings of money market mutual funds (MMMFs), and money market deposit accounts (MMDAs).

macroeconomics: (1) the study of the structure and per­formance of national economies and of the policies that governments use to try to affect economic performance.

macroeconomic stabilization: (11) the use of monetary and fiscal policies to moderate cyclical fluctuations and maintain low inflation; also known as aggregate demand management or stabilization policy.

marginal cost: (11) the cost of producing an additional unit of output.

marginal product of capital (MPK): (3) the amount of output produced by an additional unit of capital.

marginal product of labor (MPN): (3) the amount of output produced by an additional unit of labor.

marginal propensity to consume (MPC): (4) the amount by which desired consumption rises when current income rises by one unit.

marginal revenue product of labor (MRPN): (3) the extra revenue obtained by a firm when it employs an addi­tional unit of labor and sells the resulting increase in output; for competitive firms, equal to the price of output times the marginal product of labor.

marginal tax rate: (15) the fraction of an additional dollar of income that must be paid in taxes.

markup: (11) the difference between the price charged for a good and its marginal cost of production, expressed as a percentage of marginal cost.

medium of exchange: (7) an asset used in making transactions.

menu cost: (11) the cost of changing prices—for example, the cost of printing a new menu or remarking merchandise.

misperceptions theory: (10) predicts that, because of producers' inability to observe directly the general price level, the aggregate quantity of output supplied rises above the full-employment level when the aggregate price level is higher than expected; hence the short-run aggregate supply curve is upward-sloping.

monetarism: (14) a school of macroeconomic thought that emphasizes the importance of monetary factors in the macroeconomy, but which opposes the active use of monetary policy to stabilize the economy.

monetary aggregates: (7) the official measures of the money supply, such as M1 and M2. See M1, M2.

monetary base: (14) the liabilities of the central bank, consisting of bank reserves and currency held by the nonbank public, that are usable as money; also known as high-powered money.

monetary neutrality: (9) characterizes an economy in which changes in the nominal money supply change the price level proportionally but have no effect on real variables. The basic classical model predicts neutrality; the classical model with misperceptions and the Keynesian model predict that neutrality holds in the long run but not in the short run.

monetary policy: (1) policies determining the level and rate of growth of the nation's money supply, which are under the control of a government institution known as the central bank (the Federal Reserve System in the United States).

money: (7) assets that are widely used and accepted as payment.

money demand function: (7) the function that relates the real demand for money to output and the interest rate paid by nonmonetary assets.

money supply: (7) the total amount of money available in an economy, consisting of currency held by the nonbank public and deposits; also known as the money stock.

monopolistic competition: (11) a market situation in which some competition exists but in which a rela­tively small number of sellers and imperfect standard­ization of the product allow individual producers to act as price setters rather than as price takers.

multiple expansion of loans and deposits: (14) in a frac­tional reserve banking system, the process in which banks lend out some of their deposits, the loaned funds are ultimately redeposited in the banking system, and the new deposits are lent out again; as a result of the multiple-expansion process, the money supply can greatly exceed the monetary base.

multiplier: (11) for any particular type of spending, the short-run change in output resulting from a one-unit change in that type of spending.

national income: (2) the amount of income available to distribute among producers, equal to the sum of employee compensation, proprietors' income, rental income of persons, corporate profits, net interest, taxes on production and imports, business current transfer payments, and current surplus of govern­ment enterprises. Also measured as gross domestic product plus net factor payments less depreciation and statistical discrepancy.

national income accounts: (2) an accounting framework used in measuring current economic activity.

national saving: (2) the saving of the economy as a whole, including both private saving (business and household) and government saving.

national wealth: (2) the total wealth of the residents of a country, consisting of the country's domestic physi­cal assets (such as its stock of capital goods and land) and its net foreign assets.

natural rate of unemployment: (3) the rate of unemploy­ment that exists when the economy's output is at its full-employment level; consists of frictional unemployment and structural unemployment.

net exports: (2) exports of goods and services minus imports of goods and services.

net factor payments from abroad (NFP): (2) income paid to domestic factors of production by the rest of the world minus income paid to foreign factors of production by the domestic economy.

net foreign assets: (2) a country's foreign assets (for example, foreign stocks, bonds, and factories owned by domestic residents) minus its foreign liabilities (domestic physical and financial assets owned by foreigners).

net government income: (2) the part of GDP that is not at the disposal of the private sector. It equals taxes paid by the private sector minus payments from the gov­ernment to the private sector (transfers and interest payments on the government debt).

net investment: (4) the change in the capital stock over the year, equal to gross investment minus deprecia­tion of existing capital.

net national product (NNP): (2) GNP minus depreciation.

no-borrowing, no-lending point: (4) on the budget line, the point at which current consumption equals cur­rent income plus initial wealth; if the consumer chooses the consumption combination correspond­ing to this point, he or she neither borrows nor carries over resources into the future.

nominal appreciation: (13) an increase in the nominal exchange rate in a flexible-exchange-rate system.

nominal depreciation: (13) a decrease in the nominal exchange rate in a flexible-exchange-rate system.

nominal exchange rate: (13) the number of units of foreign currency that can be purchased with one unit of the home currency; also known as the exchange rate.

nominal GDP: (2) the value of an economy's final output measured using current market prices; also known as current-dollar GDP.

nominal interest rate: (2) the rate at which the nominal value of an interest-bearing asset increases over time; equivalent to the market interest rate.

nominal shock: (10) a shock to money supply or money demand, which causes the LM curve to shift.

nominal variables: (2) variables measured in terms of current market prices.

normative analysis: (1) an analysis of policy that tries to determine whether a certain policy should be used; involves both analysis of the consequences of the policy and value judgments about the desirability of those consequences. See positive analysis.

official reserve assets: (5) assets held by central banks, other than domestic money or securities, that can be used in making international payments; examples are gold, foreign bank deposits, and special assets created by the International Monetary Fund.

Okun's law: (3) a rule of thumb that says that output falls by 2% for each percentage point increase in the unemployment rate.

100% reserve banking: (14) a banking system in which banks hold reserves equal to 100% of their deposits.

open economy: (1) a national economy that has signifi­cant trading and financial relationships with other national economies.

open-market operation: (7) an open-market purchase or sale of assets by the central bank, used to affect the money supply. See open-market purchase, open-market sale.

open-market purchase: (14) a purchase of assets (such as Treasury securities) from the public by the central bank, used to increase the money supply.

open-market sale: (14) a sale of assets (such as Treasury securities) to the public by the central bank, used to reduce the money supply.

optimum currency area: (13) a geographic region for which the benefits of having a common currency exceed the costs.

overvalued exchange rate: (13) in a fixed-exchange-rate system, an exchange rate that is higher than its fundamental value. Seefundamental value of the exchange rate.

participation rate: (3) the fraction of adults who are in the labor force.

peak: (8) in a business cycle, the point in time when economic activity stops increasing and begins to decline.

perfect competition: (11) a market situation in which there is a standardized good and many buyers and sellers so that all buyers and sellers are price takers.

permanent income theory: (4) a theory that states that consumption depends on the present value of lifetime resources, with the implication that consumption responds much less to temporary than to permanent changes in income.

persistence: (8) the tendency for declines in economic activity to be followed by further declines and for growth in economic activity to be followed by more growth.

Phillips curve: (12) a downward-sloping relationship between the inflation rate and the unemployment rate; theory suggests that a Phillips curve will be observed in the data only in periods in which expected inflation and the natural rate of unemploy­ment are relatively stable. See expectations-augmented Phillips curve, short-run Phillips curve, long-run Phillips curve.

portfolio allocation decision: (7) a wealth holder's deci­sion about which assets and how much of each asset to hold.

positive analysis: (1) an analysis of the economic conse­quences of a policy that doesn't address the question of whether those consequences are desirable. See normative analysis.

present value: (4) the value of a future payment in terms of today's dollars; equal to the amount of money that must be invested today at a given interest rate to be worth the specified payment at the specified date in the future.

present value of lifetime consumption (PVLC): (4) the present value of current and future consumption, which equals PVLR according to the budget constraint.

present value of lifetime resources (PVLR): (4) the present value of current and expected future income plus initial wealth; corresponds to the horizontal intercept of the budget line.

price index: (2) a measure of the average level of prices for some specified set of goods and services, relative to the prices of a specified base period.

price setter: (11) a market participant with some power to set prices; see monopolistic competition.

price stickiness: (11) in Keynesian theory, the tendency of prices to adjust only slowly to changes in the economy; also known as price rigidity.

price taker: (11) a market participant who takes the mar­ket price as given; see perfect competition.

primary government budget deficit: (15) a measure of the deficit that excludes government interest payments from total outlays; equal to government purchases of goods and services plus transfers minus tax revenues.

private disposable income: (2) the income of the private sector (households and businesses taken together) after payment of taxes and receipt of transfer pay­ments and interest from the government.

private saving: (2) the saving of the private sector (house­holds and businesses), equal to private disposable income minus consumption.

procyclical: (8) tending to move in the same direction as aggregate economic activity over the business cycle (up in expansions, down in contractions). See acycli­cal, countercyclical.

product approach: (2) a procedure for measuring economic activity by adding the market values of goods and ser­vices produced, excluding any goods and services used up in intermediate stages of production; equivalently, by summing the value added of all producers.

production function: (3) a function that shows the amount of output that can be produced (by a firm or by an entire economy) by using any given quantities of capital and labor.

productivity: (3) a measure of the overall effectiveness with which the economy uses capital and labor to produce output; also known as total factor productivity.

productivity shock: (10) a change in an economy's pro­duction function; equivalently, a change in the amount of output that can be produced using given quantities of capital and labor; also known as a supply shock.

propagation mechanism: (10) an aspect of the economy, such as the behavior of inventories, that allows short-lived shocks to have longer-term effects on the economy.

purchasing power parity (PPP): (13) the idea that similar foreign and domestic goods, or baskets of goods, should have the same price in terms of the same currency.

quantitative easing: (14) a tool used by the Fed in which it increases its total holdings of assets by buying secu­rities in the open market.

quantity theory of money: (7) a theory that asserts that nominal money demand is proportional to nominal GDP so that velocity is constant.

rational expectations: (10) expectations about the values of economic variables that are based on reasoned and intelligent examination of available economic data; although they may make forecast errors, people with rational expectations cannot be systematically sur­prised by changes in macroeconomic policy or in the economy.

real appreciation: (13) an increase in the real exchange rate, which increases the quantity of foreign goods that can be purchased with a given quantity of domestic goods.

real balances: (7) the real amount of money held by the public, measured as the nominal amount of money divided by the price level.

real business cycle (RBC) theory: (10) a version of the classical theory that assumes that productivity shocks (supply shocks) are the primary source of cyclical fluctuations.

real depreciation: (13) a fall in the real exchange rate, which decreases the quantity of foreign goods that can be purchased with a given quantity of domestic goods.

real exchange rate: (13) the quantity of foreign goods that can be obtained in exchange for one domestic good; also known as the terms of trade.

real GDP: (2) the market value of an economy's final out­put measured in terms of the prices that prevailed during some fixed base period; also known as constant- dollar GDP.

real interest rate: (2) the rate at which the real value or purchasing power of an interest-bearing asset increases over time; equal to the nominal interest rate minus the rate of inflation.

real shocks: (10) disturbances to the “real side" of the economy, such as shocks that affect the production function, the size of the labor force, the real quantity of government purchases, or the spending and sav­ing decisions of consumers; real shocks affect the IS curve or the FE line.

real variable: (2) a variable measured in terms of the prices of a fixed base year; a measure intended to rep­resent physical quantities produced or used.

real wage: (3) the real value (measured in terms of goods) of what firms must pay per unit of labor input that they employ; equal to the nominal (dollar) wage divided by the price level.

real-wage rigidity: (11) from the Keynesian perspective, the apparent tendency of real wages to move too little over the business cycle to keep the quantity of labor sup­plied equal to the quantity of labor demanded.

recession: (8) in a business cycle, the period of time dur­ing which aggregate economic activity is falling; also known as a contraction.

relative purchasing power parity: (13) the idea that the rate of appreciation of the nominal exchange rate equals the foreign inflation rate minus the domestic inflation rate.

reserve-deposit ratio: (14) the ratio of reserves held by banks to the public's deposits in banks.

reserves: 1. (14) see bank reserves. 2. (5) see official reserve assets.

revaluation: (13) an increase in the value of a currency by official government action under a fixed-exchange-rate system.

reverse causation: (10) the tendency of expected future changes in output to cause changes in the current money supply in the same direction; used by real business cycle theorists to explain why the money supply leads the cycle.

Ricardian equivalence proposition: (4) the proposition that changes in the government budget deficit caused entirely by changes in (lump-sum) tax collections have no effect on the economy.

risk: (7) the possibility that the actual return received on an asset will be substantially different from the expected return.

risk premium: (7) the amount by which the expected return on a risky asset exceeds the return on an other­wise comparable safe asset.

rules: (14) a set of simple, prespecified, and publicly announced guidelines for conducting monetary policy; in contrast to discretion.

sacrifice ratio: (12) the amount of output lost when the inflation rate is reduced by one percentage point.

saving: (2) current income minus spending on current needs.

seignorage: (15) government revenue raised by printing money; also known as the inflation tax.

shoe leather costs: (12) the costs incurred in the process of economizing on holdings of cash—for example, in more frequent trips to the bank.

short-run aggregate supply (SRAS) curve: (9) in a dia­gram with output on the horizontal axis and the price level on the vertical axis, the relationship between the price level and the amount of output supplied that applies in the short run. In the short run, prices remain fixed and producers produce the quantity of output demanded at the fixed price level, so the SRAS curve is horizontal. In the extended classical model based on the misperceptions theory, the SRAS curve slopes upward, as producers are fooled into supplying more output when the price level is higher than expected; the short run in this model is the period of time during which the expected price level remains unchanged.

short-run Phillips curve: (12) the curve relating the infla­tion rate to the unemployment rate for a given natu­ral rate of unemployment and a given expected rate of inflation.

small open economy: (5) an economy that trades with other economies but is too small to affect the world real interest rate.

Solow residual: (10) an empirical measure of total factor productivity.

speculative run: (13) a situation in which financial inves­tors, fearing the imminent devaluation of a currency in a fixed-exchange-rate system, rush to sell assets denominated in that currency.

spell of unemployment: (3) see unemployment spell.

stagflation: (1) the simultaneous existence of both high unemployment (stagnation) and high inflation, as occurred in the United States in the mid 1970s.

statistical discrepancy: 1. (2) arises because of errors of measurement and incomplete reporting. 2. (5) the amount that would have to be added to the sum of the current account balance and financial account bal­ance for this sum to reach its theoretical value of zero. steady state: (6) a situation in which the economy's out­put per worker, consumption per worker, and capital stock per worker are constant over time.

stock variable: (2) an economic quantity that is defined at a specific time; examples are wealth or the money supply. See flow variable.

store of value: (7) a means of holding wealth over time.

structural unemployment: (3) long-term and chronic unemployment arising from imbalances between the skills and other characteristics of workers in the mar­ket and the needs of employers.

substitution effect of a higher real wage: (3) the tendency of workers to substitute work for leisure, and thus sup­ply more labor, in response to an increase in the reward for working when the real wage increases.

substitution effect of the real interest rate on saving: (4) the tendency of consumers to save more, and thereby substitute future consumption for current consump­tion, in response to a higher reward for saving.

supply shock: (3) a change in an economy's production function—that is, in the amount of output that can be produced by using given quantities of capital and labor; also known as a productivity shock.

supply-side economics: (15) a school of economic thought based on the premise that all aspects of eco­nomic behavior—such as labor supply, saving, and investment—respond strongly to economic incen­tives, and, in particular, to incentives provided by the tax code.

tax-adjusted user cost of capital: (4) indicates how large the before-tax expected future marginal product of capital must be to make a proposed investment profitable; equivalently, the (unadjusted) user cost of capital divided by 1 minus the effective tax rate.

tax rate smoothing: (15) a policy of maintaining stable tax rates over time so as to minimize the distortions created by the tax code. See distortions.

Taylor rule: (14) a guideline for monetary policy, it relates the real Fed funds rate to the difference between out­put and full-employment output and the difference between inflation and its target.

terms of trade: (13) the quantity of foreign goods that can be obtained in exchange for one domestic good; also known as the real exchange rate.

term premium: (7) the higher interest rate paid to holders of long-term bonds to compensate them for the added risk compared with short-term bonds, so that the inter­est rate on long-term bonds exceeds that suggested by the expectations theory of the term structure.

time to maturity: (7) the amount of time until an asset matures and the investors receive their principal.

total factor productivity: (3) a measure of the overall effectiveness with which the economy uses capital and labor to produce output; also known as productivity.

trade deficit: (1) a nation's excess of imports over exports. trade surplus: (1) a nation's excess of exports over imports. transfers: (2) payments by the government, excluding interest payments and payments made in exchange for current goods or services; examples of transfers are Social Security and Medicare benefits, unemploy­ment insurance, and welfare payments.

trough: (8) in a business cycle, the time when economic activity stops falling and begins rising.

turning points: (8) peaks or troughs in the business cycle. turnover costs: (11) the costs associated with firing exist­ing workers or hiring and training new workers.

unanticipated inflation: (12) the actual rate of inflation minus the rate of inflation that was expected to occur.

underground economy: (2) the portion of the economy that includes both legal activities hidden from gov­ernment record keepers and illegal activities.

undervalued exchange rate: (13) in a fixed-exchange-rate system, an exchange rate that is lower than its funda­mental value. See fundamental value of the exchange rate.

unemployment: (1) the number of people who are avail­able for work and actively seeking work but cannot find jobs.

unemployment rate: (3) the fraction of the labor force that is unemployed.

unemployment spell: (3) the period of time that an indi­vidual is continuously unemployed.

unilateral transfers: (5) payments made from one country to another that do not correspond to the purchase of any good, service, or asset; examples are foreign aid and gifts by domestic residents to foreigners.

unit of account: (7) the basic unit for measuring eco­nomic value (dollars, for example).

user cost of capital: (4) the expected real cost of using a unit of capital for a specified period of time; equal to the depreciation cost plus the interest cost.

uses-of-saving identity: (2) the accounting identity that states that private saving equals the sum of invest­ment, the government deficit, and the current account balance.

utility: (4) an individual's economic satisfaction or well-being.

value added: (2) for any producer, the value of output minus the value of purchased inputs.

velocity: (7) the number of times the money stock “turns over" each period; calculated as nominal GDP divided by the nominal money supply.

wealth: (2) the assets minus the liabilities of an individ­ual, firm, or country; also known as net worth.

world real interest rate: (5) the real interest rate that pre­vails in the international capital market in which individuals, businesses, and governments borrow and lend across national borders.

zero lower bound: (14) a situation in which the nominal interest rate is zero and cannot decline further because a nominal interest rate below zero would make it more profitable for an investor to hold cash rather than make a loan.