Important terms used in economics. It is useful for people who are new to economics. These terms are helpful for ones who are studying in commerce stream.

1. Terms and Terminologies
Prof. Sunny Mondal

2. Inflation - Definition
• The overall price level changes at varying rates during different phases of a business
cycle. Thus, when studying business cycles, it is important to understand this
phenomenon.
• In general, the inflation rate is pro-cyclical (that is, it goes up and down with the cycle),
but with a lag of a year or more.
• Inflation refers to a sustained rise in the overall level of prices in an economy.
• Economists use various price indexes to measure the overall price level, also called the
aggregate price level. The inflation rate is the percentage change in a price index—that is,
the speed of overall price level movements.
• Investors follow the inflation rate closely not only because it can help to infer the state of
the economy, but also because an unexpected change may result in a change in
monetary policy, which can have a large and immediate impact on asset prices.
• In developing countries, very high inflation rates can lead to social unrest or even shifts
of political power, which constitutes political risk for investments in those economies.

3. Deflation, Disinflation & Hyperinflation
• Deflation: A sustained decrease in aggregate price level, which
corresponds to a negative inflation rate—that is, an inflation rate of
less than 0%.
• Hyperinflation: An extremely fast increase in aggregate price level,
which corresponds to an extremely high inflation rate—for example,
500% to 1,000% per year.
• Disinflation: A decline in the inflation rate, such as from around 15%
to 20% to 5% or 6%. Disinflation is very different from deflation
because even after a period of disinflation, the inflation rate remains
positive and the aggregate price level keeps rising (although at a
slower speed).

4. Headline and Core Inflation
• Headline inflation refers to the inflation rate calculated based on the
price index that includes all goods and services in an economy.
• Core inflation usually refers to the inflation rate calculated based on a
price index of goods and services except food and energy.
• Policy makers often choose to focus on the core inflation rate when
reading the trend in the economy and making economic policies.
• As they try to avoid overreaction to short-term fluctuations in food
and energy prices that may not have a significant impact on future
headline inflation.

5. Monetary Policy and Fiscal Policy
• Monetary policy refers to central bank activities that are directed
toward influencing the quantity of money and credit in an economy.
• By contrast, fiscal policy refers to the government’s decisions about
taxation and spending.
• Both monetary and fiscal policies are used to regulate economic
activity over time.
• They can be used to accelerate growth when an economy starts to
slow or to moderate growth and activity when an economy starts to
overheat. In addition, fiscal policy can be used to redistribute income
and wealth.

6. Money Multiplier Effect
• The process of money creation is a crucial concept for understanding the role that money
plays in an economy. Its potency depends on the amount of money that banks keep in
reserve to meet the withdrawals of its customers. This practice of lending customers’
money to others on the assumption that not all customers will want all of their money
back at any one time is known as fractional reserve banking.
• Suppose that the bankers in an economy come to the view that they need to retain only
10 percent of any money deposited with them. This is known as the reserve
requirement.
• Now consider what happens when a customer deposits €100 in the First Bank of Nations.
This deposit changes the balance sheet of First Bank of Nations, and it represents a
liability to the bank because it is effectively loaned to the bank by the customer.
• By lending 90 percent of this deposit to another customer the bank has two types of
assets: (1) the bank’s reserves of €10, and (2) the loan equivalent to €90. Notice that the
balance sheet still balances; €100 worth of assets and €100 worth of liabilities are on the
balance sheet.

8. Money Multiplier Effect
• This process continues until there is no more money left to be deposited and
loaned out.
• The total amount of money ‘created’ from this one deposit of ₹100 can be
calculated as: New deposit/Reserve requirement = ₹100/0.10 = ₹1,000 (1)
• It is the sum of all the deposits now in the banking system. You should also note
that the original deposit of ₹100, via the practice of reserve banking, was the
catalyst for ₹1,000 worth of economic transactions. That is not to say that
economic growth would be zero without this process, but instead that it can be
an important component of economic activity.
• The amount of money that the banking system creates through the practice of
fractional reserve banking is a function of 1 divided by the reserve requirement, a
quantity known as the money multiplier. In the case just examined, the money
multiplier is 1/0.10 = 10. Equation 1 implies that the smaller the reserve
requirement, the greater the money multiplier effect.

9. Negative Interest Rates
• The term negative interest rate refers to interest paid to borrowers
rather than to lenders. Central banks typically charge commercial
banks on their reserves as a form of non-traditional expansionary
monetary policy, rather than crediting them. This is a very unusual
scenario that generally occurs during a deep economic recession
when monetary efforts and market forces have already pushed
interest rates to their nominal zero bound. This tool is meant to
encourage lending, spending, and investment rather than hoarding
cash, which will lose value to negative deposit rates.

10. Negative Interest Rates
• Negative interest rates are a form of monetary policy that sees interest
rates fall below 0%.
• Central banks and regulators use this unusual policy tool when there are
strong signs of deflation.
• Borrowers are credited interest instead of paying interest to lenders in a
negative interest rate environment.
• Central banks charge commercial banks on reserves in an effort to
incentivize them to spend rather than hoard cash positions.
• Although commercial banks are charged interest to keep cash with a
nation's central bank, they are generally reluctant to pass negative rates
onto their customers.