CH13: The Monetary System

Question 1

What are the 4 functions of money?

Answer 1

Medium of exchange - item buyers give to sellers when they want to purchase G/S. Anything readily acceptable as payment.

Unit of Account - prices of a good stated in terms of money.

Store of Value - Retains its value over time.

Standard of Deferred Payment - Accepted method of settling debt.

Question 2

Function of Central Bank?

Answer 2

• Regulates quantity of money in the economy.

Objective: “ensure price stability” by meeting the PTA.

Question 3

What is the OCR?

Answer 3

Official cash rate set by bank every 6 weeks.
Determines interest rate bank earn on their deposit with the RBNZ (settlement cash balance), as well as the interest banks pay to borrow overnight cash from the RBNZ.

Question 4

What are reserves? + Reserve Ratio?

Answer 4

• Deposits banks have received but have not loaned out.
  (If there are no banks, money supply would equal quantity of currency).
• Reserve ratio is fraction of deposits that banks hold as reserves.

Question 5

T account for banks?

Answer 5

Assets = $10 reserve, $90 loans = $100
Liabilities = $100 deposits = $100

Question 6

What is the money multiplier?

Answer 6

Formula = M = 1/R (R = reserve ratio).
Amount of money the banking system generates with each dollar of reserves.

When one bank loans money, it is generally deposited in another bank. This creates more deposits and reserves to be lent out.

Question 7

What are the 3 central bank tools for monetary control?

Answer 7

Open-Market Operations: buying govt bonds from (MS increases) or selling govt bonds to the public (MS decreases).

Changing Reserve Requirement: Increasing RR (MS decreases, decreasing RR (MS increases).

Changing the Discount Rate: Changing interest rate CB charges banks for loans. Increasing DR decreases MS, decreasing DR increases MS.

Question 8

What is the settlement cash balance?

Answer 8

Bank with net surplus of funds can deposit them at RBNZ.

RBNZ holds these surplus cash reserves, called the settlement cash balance.

Question 9

Effects of OCR on MS?

Answer 9

Raising OCR:

• Trading banks with surplus settlement balance earn higher interest, negative balances pay higher interest.
• Trading banks increase reserve ratio or decrease fraction of deposits they put into the economy as new loans.
• MS decreases.