2. Money & Banking Flashcards
Yield Curve
Curve showing several interest rates across different contract maturity lengths
Positive Yield Curve
Investors expect strong future economic growth and higher future inflation, increasing inflationary expectations thus, higher interest rates
Inverted Yield Curve
Investors expect sluggish economic growth and lower inflation, falling inflationary expectation thus, lower interest rates
Flat Yield Curve
Investors are unsure about economic growth and inflation
Money
Any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another
4 Functions of Money
- Medium of Exchange
- Measure of value, unit of account or mean of valuation
- Store of value
- Standard of deferred payment
Measures of Money Supply - M1
Includes cash and checking deposits
Measures of Money Supply - M2
All elements of M1 as well as “near money”
e.g. savings deposits, money market securities, mutual funds and other deposits
Measures of Money - M3
Measure of money supply that includes M2 as well as large time deposits, institutional money market funds, short-term repurchase agreements and larger liquid assets
Keynesian Theory of Liquidity Preference
The interest rate adjusts to balance the supply and demand for money
Keynesian Liquidity Preference Model - what does the equilibrium of MS and MD determine?
Nominal Interest Rate
Keynesian Liquidity Preference Model - why is MD downward sloping?
Because nominal interest rate is the opportunity cost of holding money
Keynesian Liquidity Preference Model - why is MS vertical?
Independent of the interest rate
Factors that affect demand for money
Income, interest rates, inflation, uncertainty
3 motives for demanding money
- Transactions Motive
- Precautionary Motive
- Speculative Motive
Transactions Motive
Demand for money arises from the fact most transactions involve an exchange of money - hence as income or GDP rises, transactions demand for money also rises.
Precautionary Motive
People often demand money as a precaution against an uncertain future - unexpected expenses
Speculative Motive
Arises in situations where holding money is perceived to be less risky than the alternative of lending the money or investing it into some other asset
What is money demand dependent on?
Both price level and real GDP, which together comprise the nominal GDP
3 mechanisms for influencing money supply
- Open Market Operations
- Reserve Ratio Requirements
- Discount Rates
Open Market Operations (OMO)
Buying and selling of securities to increase/decrease funds in the market
Reserve Requirement Ratio
The portion of deposits that banks must have on hand as cash set by the central bank.
Increasing/decreasing the required reserve ratio, increases/decreases the amount of cash banks are required to hold in reserves, increasing/decreasing availability of loans. This increases/decreases money supply.
Discount Rate
Interest rate charged to commercial banks and other depository institutions for loans received from a central bank, primarily to meet reserve requirements when cash on hand is low before the close of business
Expansionary Monetary Policy
when the central bank uses any of its instruments of monetary policy in a way that causes an increase in the supply of money
Incr. MS Decr. Interest Rate
