4 Monetary System Flashcards

1
Q

Functions of money

A

Medium of exchange
Unit of account
Store of value

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2
Q

Commodity money

A

Satisfies the 3 functions of money and also has an intrinsic value (e.g gold)

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3
Q

Fiat money

A

Satisfies the 3 functions of money but has no intrinsic value. It is used because of government decree

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4
Q

What is a potential problem with fiat money

A

If people lose faith in it then it’ll lose its value

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5
Q

Money stock

A

Sum of all fiat money which is government approved (legal tender)

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6
Q

M1

A

Currency + demand deposits +checkable deposits

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7
Q

M2

A

M1+ savings deposits (short term) + money market mutual funds

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8
Q

What does the central bank do?

A

Oversees the banking system

Regulates the quantity of money in the economy

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9
Q

What is the goal of the monetary policy committee?

A

2% CPI inflation rate

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10
Q

What is the MPC?

A

Monetary Policy Committee, they work at the Bank of England and are independent from the government

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11
Q

Federal reserve main goal

A

To ensure the health of the nation’s banking system

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12
Q

What is the ECB’s main goal?

A

To achieve price stability, inflation below but close to 2% in the medium term

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13
Q

Reserves

A

Deposits that banks have received but have not loaned out

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14
Q

Reserve ratio

A

Fraction of deposits that banks hold as reserves

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15
Q

Reserve requirement

A

The minimum amount of reserves that banks must hold. Exists in US and EU but not UK

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16
Q

Excess reserve

A

Any reserves held above the legal minimum

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17
Q

Money multiplier

A

The amount of money that the banking system generates from each dollar of reserves

18
Q

What is the equation for the money multiplier

A

MM=1/reserve ratio

19
Q

Tools for monetary control

A
  • open market operations (conventional or unconventional)
  • the refinancing rate
  • reserve requirements
20
Q

Open market operations

A

The purchase and sale of government bonds by the central bank

21
Q

What happens when the central bank buys government bonds?

A

The money supply increases

22
Q

The refinancing rate

A

The interest rate at which the central bank will lend to commercial banks on a short term basis

23
Q

Other names for refinancing rate

A

Repo rate

Discount rate

24
Q

Why do central banks prefer not yo change the reserve requirements?

A

It messes up the plans of commercial banks

25
Q

Why is it hard for the central bank to control the money supply?

A

They don’t know how much money the public will put into deposits or how club banks will keep in reserve

26
Q

What does inflation do to the value of money?

A

Inflation causes the value of money to drop (1/P)

27
Q

What is the classical theory of money

A

It is the overwhelming consensus amongst economists today for the long run explanation of inflation

28
Q

What does the graph of money supply and demand look like in the long run?

A

Vertical supply curve, downward sloping demand curve with value of money on y axis and quantity of money on x axis

29
Q

Nominal variables

A

Anything measured in monetary units e.g pounds

30
Q

Real variables

A

Variables measured in physical units

31
Q

Explain how the classical dichotomy works

A

There is a separation of nominal and real variables which means a change in one won’t cause a change in the other. E.g a change in money supply doesn’t affect real wages

32
Q

Quantity equation

A

M x V= P x Y

M= quantity of money
V= velocity of money
P= GDP deflator
Y= GDP
33
Q

The fisher effect

A

Real interest rate= nominal interest rate- inflation rate

34
Q

What does the fisher effect say?

A

There is a one for one adjustment of nominal interest rate to inflation rate with changes in the rate of money growth in long run

35
Q

What is inflation tax

A

When the government can raise revenue by inflation increasing prices and therefore decreasing the value of money

36
Q

What is the inflation fallacy

A

“Inflation robs people of purchasing power from their hard earned money” this only occurs if wages don’t rise with inflation

37
Q

Shoe leather costs

A

The transaction costs associated with constantly taking small amounts of money from your current account

38
Q

Menu costs

A

The costs associated with having to continuously change prices

39
Q

Market economies and misallocation

A

Prices allocate scarce resources. Inflation distorts relative prices so resources aren’t allocated to their best use

40
Q

Arbitrary redistribution of wealth

A

Surprise inflation redistributed wealth from creditors to debtors

41
Q

Debt deflation

A

When people don’t want to buy goods because they will be cheaper tomorrow. Interest rates are reduced but this means there is little incentive for the banks to lend money