Ch 25 the monetary system

Question 1

three functions of money

Answer 1

medium of exchange
store of value(enables people to transfer purchasing power into the future)
measure of relative value, or unit of account

Question 2

fiat money

Answer 2

legal tender under govt decree, not backed by physical commodity

Question 3

growth rate of nominal gdp

Answer 3

inflation rate + growth rate of real gdp

Question 4

quantity theory of money

Answer 4

in the long run, the ratio of money supply to nominal gdp is exactly constant

ex growth rate of money = growth rate of nominal gdp

ex growth rate of money supply = inflation rate + growth rate of real gdp

Question 5

hyperinflation

Answer 5

country’s price level doubles in 3 years

Question 6

consequences of inflation

Answer 6

wages do not change in sync with inflation
workers in contracts can lose out
mortgages and interest rates

Question 7

social costs of inflation

Answer 7

1. a high inflation rate creates logistical cost
2. distorts relative prices
3. sometimes leads to counterproductive policies like price controls

Question 8

social benefits of inflation

Answer 8

1. govt revenue is generated when the govt prints currency, called seignorage (benefit if the creation is low enough)
2. can sometimes stimulate economic activity, ex if company has fixed wages, and inflation occurs, they now are able to higher more workers because the real wage of the original worker has fallen

Question 9

dual mandate of central bank/ federal reserve bank/ fed

Answer 9

monitors financial institutions

1. low and predicable levels of inflation
2. maximum levels of employment

Question 10

what does the fed do

Answer 10

audits financial statements
oversees interbank payments
holds reserves of private banks
allows fed to
1. influences short term interest rates
2. influences money supply and inflation rate
3. influence long term real interest rates

Question 11

how does interest rate affect employment

Answer 11

lowering interest rates = more borrowinng = stimulates spending = demand curve to right

Question 12

liquidity

Answer 12

needs funds to immediately conduct transactions

Question 13

federal funds market/ federal interest rate

Answer 13

banks borrow and lend reserves to one another

interest rate in this market is the federal interest rate

Question 14

shifts in demand curve for federal funds market

Answer 14

1. economic expansion/ contraction
2. changing liquidity needs, ex bank run
3. changing deposit base, banks need to always have 10% of consumeres bank accounts in vault cash or in reserve
4. changing reserve requirement from the fed
5. changing interest rate paid by the fed for having reserves on deposit at the fed

Question 15

federal funds market supply curve

Answer 15

vertical, does not respond to shifts, can be moved by the fed

Question 16

how does the fed shift the supply curve

Answer 16

buys bonds from banks, increases reserves, shifts right

called open market operations

Question 17

what is realized real interest rate

Answer 17

when the fed gives loans, it gives loans with a nominal short term interest rate
this is different from the real interst rate that will occur over the life of the loan

realized real interest = nominal interest rate - realized inflation rate

Question 18

expected interest rate

Answer 18

we do not know the realized innflatoinn rate, so we have an expected inflation rate

expected real interest rate = nominal interest rate - expected inflation rate