Glossary
Appreciation (of currency)
An increase in the value of one currency relative to another, meaning it can buy more units of the foreign currency.
Example:
If the U.S. dollar strengthens from 1 = €1.05, the dollar has experienced appreciation against the euro.
Capital Flow
The movement of money across international borders for investment, trade, or production purposes.
Example:
When a large investment fund decides to move a significant portion of its portfolio from European stocks to Asian bonds, this constitutes a major capital flow.
Capital Flows
The movement of money for investment purposes between countries, driven by factors like real interest rate differentials.
Example:
Global investors constantly analyze economic conditions to determine the direction of capital flows, seeking the highest risk-adjusted returns.
Central Bank Tools
Instruments used by a central bank to implement monetary policy and influence the money supply and interest rates.
Example:
The Federal Reserve uses various central bank tools like open market operations to manage the economy.
Currency Appreciation
An increase in the value of one country's currency relative to another, often caused by higher demand for that currency.
Example:
When foreign investors flock to the U.S. bond market, the increased demand for dollars can lead to currency appreciation of the U.S. dollar.
Deposit Interest Rates
The interest paid by banks to savers on their deposited funds, influencing the incentive to save versus spend.
Example:
Higher deposit interest rates on savings accounts can encourage people to save more money rather than spending it immediately.
Depreciation (of currency)
A decrease in the value of one currency relative to another, meaning it can buy fewer units of the foreign currency.
Example:
If the British pound falls from £1 = 1.20, the pound has experienced depreciation against the U.S. dollar.
Discount Rate
The interest rate at which commercial banks can borrow money directly from the central bank.
Example:
A central bank might raise the discount rate to signal a tightening of monetary policy, making it more expensive for banks to borrow reserves.
Foreign Exchange Market
A global decentralized market where national currencies are traded, determining their relative values or exchange rates.
Example:
When a U.S. company needs to pay for imported goods from China, it must exchange U.S. dollars for Chinese yuan in the foreign exchange market.
Inbound Capital Flow
Money entering a country from foreign investors who purchase domestic assets like stocks, bonds, or real estate.
Example:
If Japanese investors buy a substantial amount of U.S. Treasury bonds because of attractive interest rates, this represents an inbound capital flow into the United States.
Inbound Capital Flow
When foreign investors purchase domestic assets (like stocks or bonds) in a country, typically attracted by higher real interest rates.
Example:
A surge in Japanese investment in U.S. Treasury bonds represents an inbound capital flow into the United States.
Loan Interest Rates
The cost of borrowing money from banks, which influences consumer and business spending and investment.
Example:
When banks raise their loan interest rates, it becomes more expensive for individuals to buy homes or for businesses to expand.
Loanable Funds Market
A conceptual market where the supply of funds from savers and the demand for funds from borrowers interact to determine the equilibrium real interest rate.
Example:
An increase in foreign investment due to higher domestic real interest rates would shift the supply curve to the right in the loanable funds market, lowering the equilibrium real interest rate.
Long-Run Aggregate Supply (LRAS)
A vertical curve representing the economy's potential output or full employment output, determined by factors of production and technology, not by the price level.
Example:
Significant advancements in robotics and artificial intelligence that boost productivity across industries would cause the Long-Run Aggregate Supply curve to shift to the right.
Monetary Policy
Actions undertaken by a central bank to influence the availability and cost of money and credit to help promote national economic goals.
Example:
The Federal Reserve's decision to lower interest rates is an example of expansionary monetary policy aimed at stimulating economic growth.
Net Capital Inflows
The total amount of foreign investment coming into a country minus the total amount of domestic investment going out.
Example:
When a country's interest rates are significantly higher than global rates, it often experiences substantial net capital inflows.
Net Exports
The total value of a country's exports minus the total value of its imports.
Example:
If a country exports 850 billion, its net exports would be -$150 billion, indicating a trade deficit.
Net Exports
The total value of a country's exports minus the total value of its imports; impacted by currency values.
Example:
A strong dollar makes U.S. goods more expensive abroad, potentially leading to a decrease in U.S. net exports.
Nominal Interest Rates
The stated interest rate on a loan or investment, not adjusted for inflation.
Example:
If a savings account offers a 5% annual return, that is the nominal interest rate before considering the impact of inflation on purchasing power.
Open Market Operations
The buying and selling of government bonds by the central bank to influence the money supply and interest rates.
Example:
If the Federal Reserve wants to increase the money supply, it will conduct open market operations by buying government bonds from commercial banks.
Outbound Capital Flow
Money leaving a country as domestic investors purchase foreign assets.
Example:
An American tech company building a new manufacturing plant in Mexico is an example of outbound capital flow from the U.S.
Outbound Capital Flow
When domestic investors purchase foreign assets, often occurring when domestic real interest rates are relatively low.
Example:
If American mutual funds start heavily investing in European tech companies, it signifies an outbound capital flow from the U.S.
Real Interest Rate
The nominal interest rate adjusted for inflation, reflecting the true cost of borrowing or the true return on saving.
Example:
If a bank offers a 6% nominal interest rate on a loan, but inflation is 3%, the real interest rate you are paying is 3%.
Real Interest Rate Differentials
The difference in real interest rates between two countries, which acts as a primary driver for international capital flows.
Example:
If Canada's real interest rate is 4% and the U.S.'s is 2%, investors will likely move funds to Canada to take advantage of the higher real interest rate differential.
Reserve Requirements
The fraction of deposits that banks are legally required to hold in reserve, rather than lend out.
Example:
If the central bank increases reserve requirements, banks have less money available to lend, which can contract the money supply.