What Is Economics? part 2

Three Key Phases in Economics

1. Recession

In times of recession, there isn’t much money circulating among people, businesses lack vitality, and overall demand is low. Economic growth slows, production weakens, and financial markets like the stock market typically underperform.

2. Inflation

(Defined in detail previously.)

3. Stagflation

In stagflation, liquidity is high but production is low. Due to a decrease in consumption, unemployment rises, demand falls, and this leads to higher inflation.

Causes of Stagflation:

High interest rates
Lack of public trust (reduced investment)

Quick Comparisons:

Inflation = Increased production → higher prices
Recession = Decreased production → lower prices
Stagflation = Decreased production but higher prices

Market Psychology: Having the Right Perspective

Also known as market sentiment, it follows this emotional cycle:
Optimism → Excitement → Pride → Satisfaction → Anxiety → Thoughts → Fear → Despair → Panic → Capitulation → Discouragement → Depression → Hope → Relief → Optimism

Key Insight:
Ups and downs, drops, and rallies are a normal part of financial markets. Learn to be adaptable and continue educating yourself.

Types of Risks in Financial Markets

Systematic Risk: Market-wide risk (e.g., war, pandemic) — unavoidable
Unsystematic Risk: Specific to an industry or company (e.g., hacking or failed projects)

Essential Economic Concepts Everyone Should Know

Market Nature
Types of Risk
Behavioral Economics & Market Psychology
Fear & Greed Index
Potential vs. Actual Production
- Potential Output: With economic stability
- Actual Output: Based on real-time market developments

Major Global Banks

Banks are a cornerstone of economic systems, facilitating global transactions and policy implementation.

Examples of Major Central Banks:

FED (Federal Reserve, USA)
RBJ (Reserve Bank of Japan)
ECB (European Central Bank)
BOE (Bank of England)
BOC (Bank of Canada)

Key Websites for Economic Education

One of the most important resources is the Federal Reserve’s official website, where users can access:

Dates
Economic reports
News releases
Policy statements

Main Types of Economic Policies

Monetary Policy

Used to control inflation, implemented by central banks (e.g., interest rate changes, money supply).

Fiscal Policy

Used to tackle recession, implemented by governments (e.g., taxation, spending).

Key Balance:
To manage inflation and recession, we must balance supply and demand.

Two Main Schools of Economic Thought

1. Classical Economics

Famous economist: Adam Smith
Belief in free markets with minimal government intervention

2. Neoclassical Economics

Famous economists: John Maynard Keynes, Milton Friedman
Advocates government management of demand and centralized planning

Taxes in Economics

Taxes are a key component of economic policy. They involve the transfer of a portion of income or profit to the government, which provides the infrastructure for earning those incomes.

Lower taxes → More disposable income for people
Higher taxes → Less money in the hands of people

The Laffer Curve

Tax revenue increases with higher tax rates up to a point
Beyond a certain level, too high a tax rate discourages work and leads to reduced tax revenue
Tax rates must be optimized to balance productivity and revenue

Capitalist Countries

In capitalist economies, markets are free, not centrally planned.
People can run businesses freely, but must pay taxes.

Examples: Hong Kong, Singapore, New Zealand, Australia, USA

Communist Countries

Governments control all aspects of the economy; people have no economic freedom. Decisions are centrally planned.

Interest Rate

The cost of borrowing money or the return on investment over time. Interest rates are a major economic tool and reflect the time value of money.

Countries with strong economies typically have well-managed interest rates.

Monetary Base (High-Powered Money)

This refers to money held by the central bank, including:

Currency
Reserves
Gold
Foreign assets
Government debts

When this money enters the economy, it gets multiplied by a factor known as the money multiplier.

Balance Sheet

A financial statement showing the assets and liabilities of a company or government at a specific point in time.

Shrinking the balance sheet = contractionary policy
Example: Russia reduced its dependence on the U.S. dollar and increased gold reserves to control its monetary base

Government Borrowing (Overdrafts)

When a government borrows from its central bank, it leads to:

Money printing → larger monetary base
Money multiplier effect
Higher inflation

Causes of an Expanding Monetary Base:

Government debt
Increase in foreign reserves
Bank borrowing from central banks

Securities in Financial Markets

Financial instruments that represent ownership or debt with measurable value.

Types:

Stocks
Bonds
Participation securities

Why Are Bonds So Important?

Show the relationship between bond prices and interest rates
Reflect the central bank’s balance sheet operations
Help identify recession and inflation trends
Reveal government and bank policies
Allow market forecasting

Important Notes About Bonds

Note 1:
Bond prices and interest rates are inversely related (like a seesaw)
Note 2:
Bond prices and yields are inversely related
Note 3:
Bonds are safer and less risky than stocks
Note 4:
Bond yields send strong signals about recessions and inflation
Note 5:
Longer maturity = higher expected yield
Note 6:
Investor sentiment is often reflected in bond demand

Types of Bonds by Duration

Short-Term: Under 1 year
Mid-Term: 1–10 years
Long-Term: Over 10 years

10-Year Bond Benefits:

Shows investor confidence in the economy
Considered a safe asset
Attracts large institutional investors

Bond Purchases and Money Supply

Increased bond purchases = More money in circulation → Expansionary monetary policy
Decreased bond purchases = Less money supply → Contractionary policy

Repo Market (Repurchase Agreement)

When one bank temporarily lends money to another using bonds as collateral, usually for short periods (e.g., 24 hours). Known as Repo Agreements.

Quantitative Easing (QE)

An unconventional monetary policy used to boost money supply when traditional methods fail.

Benefits:

Increases money supply
Expands central bank balance sheet
Encourages bond purchases by central banks

Tapering

A gradual reduction of QE asset purchases to:

Control interest rates
Influence investor expectations

Emergency Asset Purchases (PEPP)

Used during crises like COVID-19 to stabilize markets.

Hawkish Market

Also called the “Hawk Market”
Contractionary
Falling bond purchases
Optimism about future growth
Usually linked with tapering

Dovish Market

Also called the “Dove Market”
Expansionary
Interest rates fall
Lower economic optimism
Usually linked with QE

Example FOMC Statement Summary

Economic activity and employment are improving
Job gains are strong, unemployment has fallen
Inflation remains high, driven by supply-demand imbalance and energy prices
Russia’s invasion of Ukraine brings uncertainty and inflationary pressures

Okun’s Law

Unemployment ↓ = Production ↑, and vice versa

Phillips Curve

Wages ↑ → Inflation ↑ → Unemployment ↓