Glossary
Aggregate Demand
The total demand for all goods and services produced in an economy at a given price level and in a given time period.
Example:
A decrease in interest rates typically leads to an increase in consumer and business spending, thereby boosting aggregate demand.
Contractionary Monetary Policy (Tight Money)
A policy used by the Fed to decrease the money supply and raise interest rates, typically implemented during periods of high inflation to cool down the economy.
Example:
If inflation is rising too quickly, the Fed might implement contractionary monetary policy by selling bonds to reduce the money supply.
Discount Rate
The interest rate at which commercial banks can borrow money directly from the Federal Reserve.
Example:
If the Fed lowers the discount rate, banks are more likely to borrow from the Fed, increasing their reserves and allowing them to lend more.
Expansionary Monetary Policy (Easy Money)
A policy used by the Fed to increase the money supply and lower interest rates, typically implemented during a recession to stimulate economic activity.
Example:
During the 2008 financial crisis, the Fed used expansionary monetary policy to inject liquidity into the banking system and prevent a deeper recession.
Federal Funds Rate
The target interest rate at which commercial banks lend their excess reserves to other banks overnight.
Example:
The Fed influences the federal funds rate by adjusting the money supply through open market operations, which then impacts other interest rates in the economy.
Federal Reserve (the Fed)
The central bank of the United States, responsible for conducting monetary policy, supervising and regulating banks, and maintaining financial stability.
Example:
The Federal Reserve decided to lower interest rates to stimulate economic growth after a period of low consumer confidence.
Fiscal Policy
Government decisions regarding taxation and public spending to influence the economy.
Example:
Unlike monetary policy, which is controlled by the Fed, fiscal policy involves the government directly changing tax rates or increasing infrastructure spending.
Inflationary Gap
A situation where the actual output (real GDP) in an economy is above its full employment potential, leading to upward pressure on prices.
Example:
If the economy is experiencing an inflationary gap, demand is outstripping supply, causing prices to rise rapidly, and contractionary policies are often used.
Investment Spending
Spending by businesses on new capital goods, such as machinery, equipment, and buildings, and by households on new homes.
Example:
Lower interest rates encourage firms to undertake more projects, leading to an increase in investment spending and economic growth.
Monetary Policy
Actions undertaken by a central bank, like the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.
Example:
When the economy is slowing down, the Fed might implement an expansionary monetary policy to encourage borrowing and spending.
Money Supply
The total amount of currency in circulation and demand deposits within an economy.
Example:
The Fed's primary goal with monetary policy is to manage the money supply to achieve economic stability and growth.
Nominal Interest Rates
The stated interest rate on a loan or investment, not adjusted for inflation.
Example:
When the Fed increases the money supply, it typically leads to a decrease in nominal interest rates, making borrowing cheaper.
Open Market Operations (OMO)
The buying and selling of government securities (treasury bonds) by the Federal Reserve in the open market, its most frequently used monetary policy tool.
Example:
When the Fed wants to increase the money supply, it conducts open market operations by buying government bonds from commercial banks.
Recessionary Gap
A situation where the actual output (real GDP) in an economy is below its full employment potential, leading to high unemployment.
Example:
During a recessionary gap, the economy is operating below its capacity, and expansionary policies are needed to boost production and employment.
Reserve Ratio (Reserve Requirement)
The percentage of deposits that banks are legally required to hold in reserve and cannot lend out.
Example:
A decrease in the reserve ratio means banks have more money available to lend, which can increase the overall money supply.