Chapter 10 - THE MONETARY SYSTEM

Question 1

What are the three functions money has in the economy?

Answer 1

• Medium of exchange
• Unit of Account
• Store of Value

These 3 functions distinguish money from other assets in the economy (such as stocks, bonds, real estate…)

Question 2

What is Medium of exchange?

Answer 2

Medium of exchange is an item that buyers give to sellers when they want to purchase goods or services.

Question 3

What is Unit of Account?

Answer 3

Unit of Account is the yardstick people use to post prices and record debts. We measure in dollars/SEK, and not in a quantity of goods and services.

Question 4

What is Store of Value?

Answer 4

Store of Value purchasing power from the present to the future. If you want to save something today to spend it tomorrow.

Question 5

What is Commodity money ?

Answer 5

money that takes the form of a commodity (handelsvara/råvara) with intrinsic value. One example of commodity money is gold. Gold has an intrinsic value because it is used in industry and in the making of jewelry. Although today we no longer use gold as money,
[Intrinsic value means that the item would have value even if it were not used as money.]

Question 6

What is Fiat money?

Answer 6

money without intrinsic value that is accepted as money because of government decree. A fiat is an order or decree (förordning). For example, you cannot pay with Monopoly cash but dollar cash. This is because the government has decreed its dollars to be valid money.

Question 7

What is money stock?

Answer 7

The quantity of money circulating in the economy is called money stock. It has a powerful influence on many economic variables.

Question 8

Why is it hard to determine who is holding all currency?

Answer 8

One explanation is that much of the currency hold abroad.

The other explanation is that much of the currency is held by drug dealers, tax evaders (bedragare) and other criminals.

Question 9

What is Deposits?

Answer 9

The balance in bank accounts that depositors can access on demand simply by writing a check or swiping a debit card at a store.

Question 10

How to calculate money stock?

Answer 10

M = Currency + Deposits

Question 11

What is the primary responsibility the central bank has? And what other functions?

Answer 11

The primary responsibility of the central bank is to act in the national interest.

Other functions:
* Issue currency
* Banker to the commercial banks
* Banker to the government
* Control the money supply (money supply is the quantity of the money available in the economy)

Question 12

What are reserves?

Answer 12

Deposits that banks have received but have not loaned out are called reserves.

Question 13

What is Fractional-reserve?

Answer 13

Fractional-reserve banking is a banking system in which banks hold only a fraction of deposits as reserves.

Question 14

What is Reserve ratio?

Answer 14

Reserve ratio is the fraction of deposits that banks hold as reserves.
m = 1/R

Question 15

What is Leverage?

Answer 15

The use of borrowed money to supplement existing funds for investment projects.

Question 16

What is Leverage Ratio?

Answer 16

Bank’s total assets to bank capital. Leverage ratio = Assets/bank capital

Question 17

What is money multiplier?

Answer 17

The amount of money the banking system generateswith each dollar it receives.

Question 18

What three main tools does the central bank have for monetary control?

Answer 18

Open-market operations
Changes in reserve requirements
Changes in the overnight rate

Question 19

What is open-market operations?

Answer 19

When the central bank buys or sells governments bonds.

Question 20

What happens to the money supply if the central bank BUYS bonds from the public in the nation’s bond markets.

Answer 20

Increase in the money supply. The dollars that the central bank pays for the bonds increase the number of dollars in the economy.

Question 21

What happens to the money supply if the central bank SELLS bonds?

Answer 21

Decrease in the money supply. The public pays for these bonds with holdings of currency and bank deposits, directly reducing the amount of money in circulation.

Question 22

What is Quantitative easing?

Answer 22

The purchase and sale by the central bank of nongovernment securities or government securities with long maturity terms.

Question 23

What is overnight rate?

Answer 23

Traditionally, banks borrow from the central bank’s discount window and pay an interest rate on that loan called the discount rate.
The central bank can alter the money supply by changing the discount rate (called overnight rate in Canada).

Question 24

What does a higher overnight rate result in?

Answer 24

A higher discount rate discourages banks from borrowing reserves from the central bank. –> reduces the quantity of reserves in the banking system –> reduces money supply.

Question 25

What does a lower overnight rate result in?

Answer 25

A lower discount rate encourages banks to borrowing from the central bank. –> increasing the quantity of reserves and the money supply.

Question 26

What does an increase in reserve requirements result in?

Answer 26

An increase in reserve requirements –> banks must hold more reserves, and therefore can loan out less of each dollar that is deposited. –> raises the reserve ratio –> lowers the money multiplier –> and decreases the money supply.

Question 27

What does a decrease in reserve requirements result in?

Answer 27

A decrease in reserve requirements –> lowers the reserve ratio –> raises the money multiplier –> and increases the money supply.

Question 28

What is Sterilization?

Answer 28

The process of offsetting foreign exchange market operations with open-market operations, so that the effect on the money supply is cancelled out.