A monetary union (also known as currency union) is an exchange rate regime where two or more countries use the same currency. However, in some special cases there may also be a monetary union even if there is more than a single currency, if…
A crawling peg is an exchange rate system mainly defined by two characteristics: a fixed par value of the currency which is frequently revised and adjusted due to market factors such as inflation; and a band of rates within…
A target zone arrangement is an agreed exchange rate system in which certain countries pledge to maintain their currency exchange rate within a specific fluctuation margin or band. This margins can be set vis-à-vis another currency, a cooperative…
Under a no separate legal tender regime, a country uses another one’s currency and thus gives away its capacity of using monetary policies. As stated by the IMF, under an exchange arrangement with no separate legal tender, “the currency of another country circulates as…
A currency board is an exchange rate regime based on the full convertibility of a local currency into a reserve one, by a fixed exchange rate and 100 percent coverage of the monetary supply backed up with…
A free floating exchange rate, sometimes referred to as clean or pure float, is a flexible exchange rate system solely determined by market forces of demand and supply of foreign and domestic currency, and where Managed float A managed or dirty float is a flexible exchange rate system in which the government or the country’s central bank may occasionally intervene in order to direct the country’s currency value into a certain direction. This is generally done in order to act…
Flexible exchange rates can be defined as exchange rates determined by global supply and demand of currency. In other words, they are prices of foreign exchange determined by the market, that can rapidly change due to supply and…
A fixed exchange rate, also referred to as pegged exchanged rate, is an exchange rate regime under which the currency of a country is fixed, either to another country’s currency, a basket of currencies or another measure of value, such as gold. A…
An exchange rate regime is the system that a country’s monetary authority, -generally the central bank-, adopts to establish the exchange rate of its own currency against other currencies. Each country is free to adopt the exchange-rate regime that it considers optimal, and will…
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, most commonly referred to as The Nobel Prize in Economic Sciences, is the most prestigious prize that can be awarded in Economics. Every year the Laureates in Economics are selected by the Royal Swedish Academy of Science,…
Government intervention is any action carried out by the government or public entity that affects the market economy with the direct objective of having an impact in the economy, beyond the mere regulation of contracts and provision of public goods.
Government intervention advocates defend the…
Economic growth is defined as an increase in the real value of the goods and services that an economy produces. It is important to emphasize the word “real” in this definition, and to understand the difference when talking in nominal terms,…
International trade is the exchange of capital, goods and services between countries. Along with international finance it forms the larger branch of international economics. Although research on international trade has been carried out since the start of the study of the economic science, its importance…
Net capital outflows (NCOs, also called net foreign investment) make reference to the difference between the acquisition of foreign assets by domestic residents and the acquisition of domestic assets by non-residents. Therefore, it has to do with savings and
Net capital outflows (NCOs, also called net foreign investment) make reference to the difference between the acquisition of foreign assetsby domestic residents and the acquisition of domestic assets by non-residents. Net capital outflows takes two forms: foreign direct investment, and portfolio investment. Foreign direct investment implies actively managing the…
The IS-LM-BP model (also known as IS-LM-BoP or Mundell-Fleming model) is an extension of the IS-LM model, which was formulated by the economists Robert Mundell and Marcus Fleming, who made almost simultaneously an analysis…
The financial account is one of the components of the balance of payments. It shows the net acquisition and disposal of both financial assets and liabilities. As stated in the sixth edition of the Balance of Payments Manual (BPM), by the International Monetary…
The capital account is one of the components of the balance of payments. It mainly reflects net foreign holdings of capital. When a country incurs on a deficit on current account, it needs to be financed by capital…
The current account is one of the components of the balance of payments. It mainly shows the value of movements in exports and imports and income derived form transactions related to net purchases of
The balance of payments consists of a series of accounts that reflect the transactions made between an open economy and the rest of the world. As stated in the sixth edition of the Balance of Payments Manual, by the International Monetary Fund, “the balance of payments a statement…
The transformation curve is defined, in international economics, as the maximum amount of commodity X obtainable for any given amount of commodity Y, and vice versa. This concept is basically the same as the production-possibility frontier studied in…
Terms of trade is used in international trade theory as a measure of the relative price of exports and imports. It is calculated as the ratio according to which two commodities are exchanged between two countries.
Ricardian trade theory David Ricardo developed this international trade theory based in comparative advantage and specialization, two concepts that broke with mercantilism that until then was the ruling economic doctrine. He introduced this…
The principle of comparative advantage explains why countries obtain gains from international trade. This term was first mentioned by Adam Smith when talking about specialization, and later by David Ricardo, who developed the concept…
The IS-LM (Investment Savings-Liquidity preference Money supply) model focuses on the equilibrium of the market for goods and services, and the money market. It basically shows the relationship between real…
In international trade theory we say a country has absolute advantage in the production of a good with regards to another country when it can produce more units of this good with fewer inputs. Logically it…
The exchange rate can be understood as the price of one currency in terms of another currency. It is the ratio between two currencies, the rate at which one can be exchanged for another. This ratio is very important since it is widely used when dealing with Purchasing power parity The purchasing-power parity (also known as PPP) theory states that a unit of any currency should purchase the same amount of goods in all countries. In the long run this theory may explain the behaviour of exchange rates. The base of…
When defining the commercial relations that a country establishes with the rest of the world, we should look at its degree of openness. A closed economy is an economy that does not interact at all with other economies, which does not establish any exchange. Nowadays, closed economies are an…
Net exports (also known as balance of trade or commercial balance), are one of the components of the gross domestic product. Net exports of a country are the difference between that country’s exports and imports of goods and services….
Government spending, or government expenditure, is one of the components of a country’s gross domestic product. It includes all the spending on goods and services made by the government at all levels: local, regional, federal, national, etc. This component corresponds to the sum…
Investment is one of the four components of a country’s gross domestic product. It is the use of money in order to accumulate capital, which will be used by other entities. For this reason, it is called productive investment, because it is an…
Consumption is one of the components of a country’s gross domestic product. It can be defined as the spending on goods and services made by households. Consumption includes only the expenses for final use, not with the intention of…
Gross domestic product (GDP) is the market value of all final goods and services produced within an economy in a given period of time. This means that we take into account the market value of products of a given country,…
The circular-flow diagram (or circular-flow model) is a graphical representation of the flows of goods and money between two distinct parts of the economy:
-market for goods and services, where households purchase goods and services from firms in exchange for money;
-market for…
Macroeconomics is the study of the economy as a whole, by means of aggregate variables, this is, the part of economic theory that studies the behaviour of economic agents in large aggregates of demand and supply, monetary aggregates, gross…
Stagflation is a term that refers to the economic situation where there is a simultaneous combination of high unemployment levels and declining productivity growth, also known as stagnation, and high levels of inflation over long periods of time. This term was coined by…
Inflation is the economic term that refers to a continuous general rise in the level of prices over a period of time. This will consequently be translated into a fall in the value of money and a loss in purchasing power. The main measures to calculate inflation are Consumer…
Unemployment refers to the situation of a jobless worker. The unemployment rate measures the number of unemployed workers as a percentage of the labour force. Massive unemployment levels are the result of situations of economic crisis followed by depressions, and are the result of a large economic readjustment studied…
Money illusion refers to the situation in which some nominal income increases, can generate the mistaken feeling that a person, or a particular group is increasing its real purchasing power, when in fact monetary erosion due to inflation may be decreasing their purchasing power in real…
Fiscal policies are demand-side economic policies through which the government acts over its income and expenditure in order to influence the levels of income, output and unemployment of the economy. The government may do this via income taxes and unemployment benefits, or by…
Monetary policies are demand-side economic policies through which the central bank of a country acts on the amount of money and interest rates in order to influence on the income levels, output and unemployment in the economy, being the interest rate the link binding money and…
The purpose of supply-side economic policies is to increase the amount of supply and therefore the productive potential that the economy is able to produce. This kind of policies shift rightward the long-run aggregate supply curve and outward the production…
Reducing unemployment and stimulating the economy has been one of the biggest, if not the only, concerns of governments since the dawn of economic science. Economic policies have been very much theorized, and by many doctrines. As a result, a rich and plentiful literature has been…
The static theory of labour demand does not specify how, or how long adjustments between production factors take. It is therefore necessary to consider the notion of adjustment costs, such as costs incurred by a company to change the number of factors.
We will follow the lines followed in the…
Rational expectation models are those where an agent’s future predictions affect the value they assign to a variable in their current time period. In this sort of self-fulfilling prophecy, expectations become truths, and errors in forecasting future variables become random. This makes those forecasts valid, because present expectations about…
Adaptive expectation models are ways of predicting an agent’s behaviour based on their past experiences and past expectations for that same event. They are first used by Irving Fisher in his book “The Purchasing Power of Money”, 1911, and further developed in the 1940s…
New Classical Macroeconomics takes expectations one step further than monetarists did when using adaptive expectations. Rather than supposing that agents will learn to adjust their behaviour based on past experiences, they apply rational…
The term natural rate of unemployment was introduced by Milton Friedman in 1968, in his article “The Role of Monetary Policy”, following his presidential address delivered at the annual meeting of the American Economic Association, in 1967. It is based in…
The term NAIRU (non-accelerating inflation rate of unemployment) is a term first used by James Tobin in 1980, in his article “Stabilization Policy Ten Years After”. It refers to the level of unemployment at which the economy settles if Expectations-augmented Phillips curve The expectations-augmented Phillips curve introduces adaptive expectations into the Phillips curve. These adaptive expectations, which date from Irving Fisher’s book “The Purchasing Power of Money”, 1911, were introduced into the Phillips curve by monetarists,…
The Layard-Nickell NAIRU model emerged as a reply from New Keynesian Economics to the natural rate of unemployment, devised by Milton Friedman as a criticism of the
Business cycle, as Joseph Schumpeter saw it, is the economic activity fluctuation that occurs over time, and that comes from the succession of expansionary and contracting seasons. It is analysed comparing real GDP to potential GDP (Y*). There are a few common characteristics,…
John R. Hicks, in his article “Mr. Keynes and the Classical; a Suggested Interpretation”, published in 1937 in the journal Econometrica, developed a model known as IS-LL, which will later become IS-LM. The purpose of the article was to compare…
In 1958, A. W. Phillips wrote a paper on Economica (London School of Economics), entitled “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”. Analysing data concerning money wages and unemployment rates in the…
Thomas Robert Malthus stated this theory, which indicated that the population would increase geometrically, while food production would only increase in arithmetical proportion, thus creating the conditions for a shortage in the…
First circulatory diagram explaining how a national economy works. It was a contribution to economics by French physician and economist François Quesnay. Contrary to the prevailing mercantilist thought at the time, which…
