Chapter 10: Monetary Policy Flashcards
What is money
1) A medium of exchange
2) A store of value
3) A unit of account
Commodity money
- Object that is the money but is also intricately valued (value of the object)
- Ex: Gold, salt
- Has value as an object and as currency, money
Fiat money
Piece of paper, intricately worthless but has a higher face value
Electronic money
Credit cards
M1 equation
M1 = cash + checking accounts (doesn’t pay interest)
Equal to the total deposits in a balance sheet of bank
M2 equation
M2 = M1 + savings accounts (pays interest)
Net worth equation
Net worth (how much you are worth at a given time, stock value) = Assets (everything you own) - liabilities (money you owe)
Assets equation
Assets = Liabilities + net worth
Assets include
1) Reserves: Physical money the bank holds on reserve (as back up money)
2) Loans: Money that people owe the bank
How do banks make money?
From the interest rate on loans
Liabilities include
1) Deposits: Money the bank owes to someone else
2) Capital: Net worth of the bank = 0
Monetary policy
Federal Reserve controls the supply of money that intervenes with demand and determines the interest rate
3 Types of monetary policy
- Required reserve ratio (controlled by the Board of Governors)
- Discount rate (controlled by the Board of Governors)
- Open market operations (used the most, controlled by the Federal Operational Market Committee)
Required reserve ratio
- Requires banks to hold a fraction of their assets as reserves
- Part of the fractional reserve system controlled by the Board of Governors
- Total Assets = Reserves/Required reserve ratio (as a decimal)
- Loans = Total assets - reserves
Run on the bank
People demand money that the bank doesn’t have, bank goes bankrupt
Discount rate
- When the bank borrows money from the Federal Reserve
- If the discount rate increases, Ms decreases (Federal Reserve gives out more money to banks decreasing the supply of money)
- If the discount rate decreases, Ms increases (Federal Reserve gives out less money to banks increasing the supply of money)
Excess Reserves
- Money that the bank has left over that they’re not paying
- When bank reserves > required reserves
- = Required reserves - actual reserves
- Required reserves = total deposits x required reserve ratio
Insufficient Reserves
- When banks don’t have enough required reserves
- When bank reserves < required reserves
- Negative number = Required reserves - actual reserves
- Required reserves = total deposits x required reserve ratio
- Will go first to the Federal Funds Market (borrow money from other banks) and then will go to the discount window (borrow money form the Federal Reserve, Ms decreases, moves to the left as the discount rate increases (banks can borrow more money)
Open market operations
- When the Federal Reserve buys or sells Government bonds
- Used the most
- Controlled by the Federal Operational Market Committee
- Selling bonds = taking money out Ms decreases, moves to the left
- Buying bonds = ejecting money in Ms increases, moves to the right
Federal Operational Market Committee
- Chairman: Jerome Powell, controls the supply of money
- 7 board members of the board of governors of the Federal Reserve 4 chairs taken, 3 open, Jerome Powell is chair (leader)
- 12 total Federal Reserve banks, each with their own president
Federal Reserve System Hierarchy
Board of governors (BOG) at top: Jerome Powell is chairman, Lael Brainard, 7 seats total, 4 taken, 14 year terms, chosen by president, meets monthly in DC
Then the 12 Federal Reserve Banks and the Federal Operational Market Committee (FOMC): Includes 7 members of the BOG and 4 rotating seats = 12 total
Loose monetary policy
Ms up caused by a decrease in the required reserve ratio and the purchase of government securities by the Fed
