Basic Economic Concepts

The whole unit on one sheet: cycles, the two policy levers, inflation, rates and curves, indicators, and the global factors the exam loves.

The One-Liners That Win Points

• Business cycle order: Trough (bottom) to Expansion to Peak to Contraction. At the peak, GDP is still positive, just growing slower; contraction starts after it.
• Recession = declining gross domestic product (GDP) for 2 consecutive quarters (6 months); depression = 6 consecutive quarters (18 months).
• Monetary policy = the Federal Reserve Board (the Fed) via money supply and interest rates. Fiscal policy = Congress and the President via spending and taxation. The Fed has nothing to do with fiscal policy.
• Expansionary Fed: buy securities, lower the discount rate, lower reserve requirements. Contractionary Fed: the reverse.
• Open market operations (OMOs) are the most-used Fed tool; the discount rate is the only rate the Fed directly controls; the federal funds rate is what banks charge each other.
• A budget deficit = expansionary fiscal policy; a surplus = contractionary.
• Inflation hurts lenders and fixed-income investors, benefits borrowers. Real return = nominal return minus inflation.
• Inverted yield curve (short-term above long-term) is the most reliable recession signal.
• Credit spreads narrow in expansions (confidence), widen in recessions (default fear).
• A strong dollar hurts U.S. investors in foreign securities; a weak dollar helps them.

Numbers to Lock In

• Recession: 2 consecutive quarters of falling GDP (6 months).
• Depression: 6 consecutive quarters (18 months).
• Fed inflation target: roughly 2%.
• Regulation T margin requirement: currently 50%.
• 1 basis point = 0.01%.
• GDP formula: C + I + G + (X − M), where C = consumer spending, I = business investment, G = government spending, X = exports, M = imports.

Memory Aid: Business Cycle Stages

Trough (bottom) to Expansion (growing) to Peak (top) to Contraction (shrinking) = TEPC cycle (or think: Bottom, Up, Top, Down).

Top Gotchas

• Disinflation is not deflation: prices are still rising, just more slowly. Stagflation = high unemployment plus high inflation plus stagnant growth.
• Rate volatility and price volatility point to opposite ends of the curve: short-term rates are more volatile, but long-term bond prices move more when rates change.
• Initial unemployment claims are a leading indicator; the unemployment rate is lagging. Stock market leads, GDP coincides, consumer price index (CPI) lags.
• Cyclical unemployment rises most in a severe recession; the natural rate is frictional plus structural (cyclical excluded), so "natural" is not itself a type.
• A trade deficit is one line inside the current account, which sits inside the broader balance of payments (BoP); the overall BoP always balances by accounting identity.
• Do not confuse the yield curve (plots maturities) with credit spreads (compares credit qualities).

One-Breath Recap

The business cycle moves trough, expansion, peak, contraction, and everything else keys off where you are on it: a recession is two down quarters of gross domestic product, a depression six. Monetary policy is the Fed steering money supply and rates through open market operations, the discount rate, and reserve requirements; fiscal policy is Congress and the President steering spending and taxes, where a deficit is expansionary and a surplus contractionary. Inflation erodes fixed-income value and helps borrowers, an inverted yield curve warns of recession while credit spreads widen in downturns, indicators either lead, coincide with, or lag the cycle, and a strong dollar quietly eats the foreign returns of a U.S. investor.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Basic Economic Concepts unit for the complete lesson.