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.

Which One-Liners 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 is commonly described as 2 consecutive quarters of declining GDP, but that is a shorthand, not an official threshold; the NBER's Business Cycle Dating Committee is the body that officially dates recessions, and it does so only after the fact. Depression has no fixed quarter count; it is defined by severity and duration.
• Monetary policy = the Federal Reserve Board (the Fed) via open market operations, administered rates (including the discount rate), the discount window, and reserve requirements. Fiscal policy = Congress and the President via spending and taxation. The Fed has nothing to do with fiscal policy.
• Expansionary Fed: buy securities, lower administered rates, lower reserve requirements. Contractionary Fed: the reverse. Reserve requirements are currently 0% for all depository institutions (since March 2020); the exam still tests the raise/lower relationship as a theoretical tool.
• Open market operations (OMOs) are the most-used Fed tool; the Fed directly sets multiple administered rates (the discount rate is not the only one); the federal funds rate is what banks charge each other, and the Fed only targets it.
• The 50% initial margin requirement (Regulation T) is a Fed-set securities-credit rule, not one of the Fed's monetary policy tools.
• 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.

Which Numbers Matter Most?

• Recession shorthand: 2 consecutive quarters of falling GDP (not an official legal threshold); the NBER's Business Cycle Dating Committee officially dates recessions, retrospectively.
• Depression: no official fixed quarter count; severity and duration define it, not a number.
• Reserve requirement ratio: currently 0% for all depository institutions (since March 26, 2020); still tested as a theoretical monetary policy lever.
• Fed inflation target: roughly 2%.
• Regulation T initial 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.

What Is the Memory Aid for the Business Cycle Stages?

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

Which Gotchas Trip Students Up?

• 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).
• Do not treat the discount rate as the only rate the Fed sets directly; the Fed directly sets other administered rates too.
• The NBER's Business Cycle Dating Committee, not a GDP-quarters count, is the official body that dates recessions.

One-Breath Recap

The business cycle moves trough, expansion, peak, contraction, and everything else keys off where you are on it: two down quarters of gross domestic product is a common recession shorthand rather than the official test, the NBER's Business Cycle Dating Committee dates recessions after the fact, and a depression has no fixed quarter count. Monetary policy is the Fed steering money supply and rates through open market operations, administered rates, the discount window, 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, and a strong dollar quietly eats a U.S. investor's foreign returns.

Need more than the recap? Read the full Basic Economic Concepts unit.