S-Cool Revision Summary

S-Cool Revision Summary

Aggregate demand

This is the aggregate of all the demand in the economy. It includes consumption by households, investment by firms, government spending and consumption by foreigners on exports. Consumption by UK households on foreign imports must be subtracted because it is included in the measure called 'consumption by households'. An aggregate demand curve shows the total demand in the whole economy at any given price level.

Base rate

This is the base rate of interest. It is the rate set by the Bank of England on which all other rates are based (hence 'base' rate). Savings rates are usually lower and rates on loans are usually higher.

Bretton Woods exchange rate system

In 1948, the Bretton Woods conference was one of the most important of the century. Not only did they set up the International Monetary Fund (IMF) and the General Agreement on Tariffs and Trade (GATT, which became the World Trade Organisation), but they set up a fixed exchange rate system which gave the international monetary system much stability over the next twenty years.

Classical economist

Classical economists are, more or less, all economists before Keynes. They believed that all markets worked according to the rules of supply and demand. They believed in supply side polices to improve the productive potential of the economy. They did not approve of government intervention in terms of demand management. This would distort the free workings of the far more efficient markets. The term 'neo-classical economists' is used for modern economists who believe in, and revived, the theories used by the old classical economists.

Confederation of British Industry (CBI)

This is an employers' organisation that represents over 12,000 companies in the UK. Although the majority of the companies are manufacturing, all types of companies (big and small, service sector as well as manufacturing) are members. The CBI is there to speak up for the interest of businessmen. Its surveys are acknowledged as being a good barometer of the opinion of business.

Cost-push inflation

This is a Keynesian explanation of inflation. Inflation can be caused when excessive rises in costs in an economy (wages, raw materials and government taxes) 'push' up prices. The word 'push' is used (rather than 'pull' as in demand-pull inflation) because the price is being 'pushed' up from below, in a sense. The increased costs force firms to raise their prices in order to maintain their profit margins. The quadrupling of the oil price in the mid 70s is a good example.

Demand-pull inflation

This is a Keynesian explanation of inflation. Inflation can be caused if there is excessive demand in the economy. This excessive demand will 'pull' the price level up, hence the name.

Exchange Rate Mechanism (ERM)

This is the fixed (but adjustable) exchange rate system for EU currencies. In began in 1979 (without the UK). Currencies were fixed to a central rate (a weighted average of all the currencies), but countries were allowed to vary their exchange rate within a two and a quarter percent band. Realignments were allowed in exceptional circumstances. The UK joined in 1990 at too high a rate. The £ was allowed a 6% band, but it didn't help much. The £ was at the bottom of this band for most of 1992, and was forced out in September. Those currencies that survived the turmoils of 1992 and 1993 stayed in the ERM until their currencies were subsumed into the EURO in January 2000.

Gross Domestic Product (GDP)

GDP is a measure of the size of an economy. It can be measured using three methods. One can add up all the output (of goods and services) in an economy; one can add up all the expenditure (on the goods and services) in the economy or one can add up all the incomes earned (used to spend on the goods and services) in the economy. See the topic called 'Aggregate demand and aggregate supply' for more detail.

Harmonised Indices of consumer prices (HICP)

This is a bit like the RPI except that the 'basket' of goods and services under consideration is a different. Almost 90% of the 'basket' is the same as for the RPI. The annual rate of inflation calculated from this index is the 'harmonised' measure that is used to compare the inflation rates of the different countries of the EU. The annual inflation rate for the UK using this measure tends to be lower than that calculated using the RPI.

Headline rate of inflation

This is the term used for the annual rate of inflation that is calculated from the RPI. For any given month this is the percentage change of that month's RPI compared with the figure for the same month in the previous year.

Index

An index is a set of numbers with no units that are used to measure the relative changes in a statistic from one time period to another. All of these 'numbers' are set against a base year, or base month, which is always 100. For example, the Retail Price Index (RPI) has no units. The percentage difference between each monthly 'number' and the last is the percentage change in the average price level for a given basket of goods and services.

Indirect tax

An indirect tax is one that is levied indirectly. One only pays VAT, for example, if one actually buys the good on which it is levied. To a certain extent, there is a choice.

Inflationary gap

A term used with 45 degree diagrams to illustrate the gap between the level of aggregate demand that gives full employment and a larger level of aggregate demand that is inflationary.

Keynesian economist

A follower of the economics devised by John Maynard Keynes. Briefly, Keynesian economists believe that the market is not always the answer. They work in perfect conditions, but things are not always perfect. In particular, at the time of the depression in the 1930s, Keynes believed that markets were not working. He felt that there was insufficient demand in the economy and it was up to the government to increase demand through government spending and lowering taxes. Keynesians believe in demand management, whereas classical (and monetarist) economists do not believe in this sort of government intervention.

Long run aggregate supply curve

An aggregate supply curve shows the level of real output, or real national income, for the whole economy at any given price level. In the long run, the aggregate supply curve is thought to be vertical if one believes in classical (or monetarist) economics. All markets are in equilibrium and fully efficient, so any increase in aggregate demand will simply raise the price level. Keynesians believe that the long run aggregate supply curve can be horizontal at low levels of real national income (when excess capacity is high). In this situation, aggregate demand can shift to the right without necessarily raising the price level.

Monetarist economist

Monetarist economists are, basically, neo-classical economists. The reason for the name 'monetarist' is their strong belief in the growth of an economy's money supply being the main determinant of the economy's price level (the Quantity Theory of Money). Of course, they believe in the power of the market and supply side policies as well, and they do not like government intervention unless it is absolutely necessary (as with the classical economists).

Monetary policy

This is government policy concerned with the money supply, the rate of interest and the exchange rate. At any one time, the government can only really try to control one of these three things. Whilst it is quite easy to set the base rate, some would argue that it is futile to try and control the money supply (see the early 80s) and attempts to control the exchange rate (e.g. within the ERM) can also lead to disaster. Monetary policy in the UK is now, sensibly, centred on the adjusting the interest rate (the job of the MPC) with the goal of controlling the inflation rate.

Monetary Policy Committee

Four days after the election of the Labour government in May 1997, the Chancellor, Gordon Brown, announced that decisions on whether interest rates should change would be transferred to the independent Monetary Policy Committee (MPC) of the Bank of England. The nine members of the committee meet once a month and announce their decision at midday on the first Thursday of each month.

Money supply

Put simply, the money supply is the amount of money in the economy. The question is, what can one define as money? Obviously notes and coins count. But what about bank accounts, both current and savings accounts? What about things like Treasury bills? There are many different definitions of the money supply depending on how narrow or broad the definition is. One of the reasons why Thatcher found it so hard to control the money supply in the early 80s was because so many 'near' monies could be changed into liquid money very easily (like Treasury bills, for example)

Multiplier

Imagine there is a new injection into the economy, a German company investing money (£100 million, say) and setting up a car factory in the UK, for example. This will not be the only affect on real national income. The builders who build the factory will take their wages and spend it elsewhere, at Sainsbury's, for example. Mr. Sainsbury will use this money to pay his workers, and they may spend some of this money down the pub. And so on. The initial £100 million gets multiplied into a larger final increase in real national income. The multiplier is the number by which you multiply the initial injection to get the final increase in real national income.

Negative real interest rates

If the nominal (i.e. actual) interest rate is 6% (as it was for much of 2000), but the annual inflation rate is 8% (it was more like 2.5% during 2000), then the effective real interest rate is -2% (6 - 8). If you had £100 in the bank for that year, you would earn £6 interest, giving you £106. But something that cost £100 a year ago will now cost £108. So in real terms, the money has lost value sitting in your savings account!

Quantity Theory of Money

This is the theory of inflation that forms the basis of the beliefs of monetarist economists. Quite simply, the theory states that, given the assumptions of a fixed velocity of circulation and predictable rate of growth in the economy, a rise in the money supply will cause a rise in the price level.

Recession

Officially, this is defined as an economy that experiences two consecutive quarters of negative growth in real GDP. Basically, the economy is not doing well. Unemployment probably rises. Recessions tend not to last too long. Very long recessions become depressions.

Retail Price Index (RPI)

The Retail Price Index (RPI) has no units. The percentage difference between each monthly 'number' and the last is the percentage change in the average price level for a given basket of goods and services. The RPI is a weighted average. The weights depend on the importance of each of the items in the basket. This, in turn, depends on the results of the Family Expenditure Survey taken each year. The headline rate of inflation for any given month is the percentage change of that month's RPI compared with the figure for the same month in the previous year.

RPIX

This is exactly the same as the RPI except that mortgage interest payments are taken out of the 'basket' of goods and services under consideration.

Supply side policies

These are government policies that improve the supply side of the economy. This means that the productive potential of the economy improves. The economy can make more at any given price level. Another way of looking at it is that the production possibility frontier shifts outwards (away from the origin). Examples include privatisation in the goods market (which increases competition, efficiency and, therefore, productivity) and education in the labour market (again, this improves the productivity of the workforce).

Thrift

Thrift is another word that economists use when they are referring to saving. If an individual is being thrifty, then they are being virtuous and careful in the sense that they are saving money.

Trade union

A trade union is an organisation of workers who get together because they find that they are more powerful collectively than as individuals. The main goals of a trade union are improving the working conditions of their members and negotiating above inflation wage rises with the employer.

Treasury bills

The government as a way of borrowing money issues treasury bills. They are a short-term form of borrowing, typically being repaid after three months. The government is borrowing from the people who buy these bills. The investor's return on the bill is higher than the initial price paid.

Underlying rate of inflation

This is the term used for the annual rate of inflation that is calculated from the RPIX. For any given month this is the percentage change of that month's RPIX compared with the figure for the same month in the previous year.

Velocity of circulation

This is the 'speed' (or velocity) with which money in the economy (especially notes and coins) circulates.

Wage-price spiral

This is a situation where an initial price rise (due to an oil price rise, for example) causes wage rises, which, in turn, cause further price rises, which cause further wage rises, and so on. The price can spiral out of control.