1- Intro

Question 1

What are the 4 main frictions that make money essential?

Answer 1

-Lack of double coincidence of wants
-Lack of commitment
-Imperfect enforcement
-Anonymity

Question 2

Why is Lack of double coincidence of wants a friction?

Answer 2

Rarely two agents will want exactly what each is offering

Question 3

Why is Lack of commitment a friction?

Answer 3

If people can commit they can promise to repay debts and there is no need for a medium of exchange

Question 4

Why is Imperfect enforcement a friction?

Answer 4

If people cannot record and punish defaulters, then they will get away with not paying back IOUs

Question 5

Why is Anonymity a friction?

Answer 5

If agents do not know who you are, they cannot deduce your credibility in an exchange

Question 6

What is the main difference between bank deposits and currency?

Answer 6

Bank deposits are the liability of the issuing commercial bank whereas currency is the liability of the central bank

Question 7

What are the 3 main functions of money?

Answer 7

-Unit of account
-Medium of exchange
-Store of value

Question 8

How does money help as a unit of account?

Answer 8

We can use a single reference point to price goods; we don’t have to quote them in terms of other goods.

Question 9

What main economic information can money transmit?

Answer 9

An increase in a good’s price implies an increase in its relative demand

Question 10

How can inflation distort the economic information money transmits?

Answer 10

When there is an increase in the general price level, not all firms change at the same time so broad-based rises may appear to be relative changes

Question 11

What 2 inefficiencies of bartering does a medium of exchange eliminate?

Answer 11

-Eliminates needing double coincidence of wants
-Promotes specialisation as agents do not have to worry about satisfying many coincidences

Question 12

What is a medium of exchange?

Answer 12

Something that people hold because they want to swap it for something else, not because they want to directly derive utility from the medium itself

Question 13

What are 3 main features a medium of exchange must have?

Answer 13

-Homogenous & verifiable
-Widely accepted
-Predictable value

Question 14

Why must a medium of exchange be Homogenous & verifiable?

Answer 14

Agents won’t be willing to accept something they cannot tell is legitimate

Question 15

Why must a medium of exchange be Widely accepted?

Answer 15

The fewer people that accept it the less value it has because you can’t get anything with it

Question 16

Why must a medium of exchange have Predictable value?

Answer 16

If what money can buy vastly changes from day to day, agents will be more hesitant to accept it

Question 17

What 2 ways does money as a store of value save purchasing power over time?

Answer 17

-Protects against liquidity shocks
-Money’s divisibility allows consumption smoothing; don’t have to swap loads of goods at once

Question 18

What is the Rate of return equality assumption?

Answer 18

All assets are perfect substitutes, so agents will only hold 2 if they offer the same return

Question 19

Why do people hold money if it returns less than other assets violating return equality assumption?

Answer 19

Because money offers benefits that other assets do not

Question 20

What are the 3 components of the market value of any monetary unit?

Answer 20

-Intrinsic value
-Promise of payment
-Liquidity premium

Question 21

What is Intrinsic value of a monetary unit?

Answer 21

You can derive utility from consuming it or you can use it as a factor of production e.g. Gold

Question 22

What is the Promise of payment value of a monetary unit?

Answer 22

No risk with currency, but bank deposits are an IOU from the bank to depositor

Question 23

What is the Liquidity premium of a monetary unit?

Answer 23

No need for asset conversion, can directly exchange money for goods

Question 24

What is the value of fiat money based on?

Answer 24

Expectations regarding its future acceptance and marketability- has no fundamental value

Question 25

Why is an infinite time horizon important for fiat money to be valued?

Answer 25

Agents won’t accept worthless asset in last period of time, same for second last period, domino effect no one will accept

Question 26

What is the value of money in monetary models (vₜ)?

Answer 26

The inverse of the price level i.e. how many goods a unit of money can buy: vₜ = 1/pₜ

Question 27

What 2 types of money do central banks issue?

Answer 27

-Currency (fiat money): to everyone
-Reserves (digital money): to banks

Question 28

What is the monetary base?

Answer 28

Money issued by the central bank

Question 29

What are Reserves?

Answer 29

Overnight balances eligible financial institutions hold in an account at the central bank

Question 30

What is the System of scarce reserves?

Answer 30

Monetary policy stance implemented through operations in local money markets (changing the supply of money)

Question 31

What is the System of abundant reserves?

Answer 31

Monetary policy stance implemented through interest rate paid on reserves (remuneration of the money supply)

Question 32

How does the rate paid on Reserves by the central bank affect prevailing interest rates?

Answer 32

Reserve rate effectively sets a floor on rates offered because it’s the benchmark liquid risk-free rate

Question 33

What are the 2 main reasons Fiat money coexists with assets which yield a higher return?

Answer 33

-Risk level
-Liquidity