Chapter 11 Flashcards
What are the 3 functions of money?
- medium of exchange
- Unit of account
- Store of value
Medium of exchange
item buyers give to sellers when they want to purchase goods or services, method of payment (debit card)
Unit of accounts
something that can be used to value goods and services, record debts, and make calculations. The US dollar for example, allows you to understand the value of something in a currency.
Store of Value
item people can use to transfer purchasing power from the present to the future, many assets take this form and are good stores as they can avoid inflation. purchase it to hold and increase in value over long period of time
what can take on all 3 functions of money?
Cash
what are the two kinds of money
commodity money and fiat money
commodity money
intrinsic value, has value even if not used as money, gold coins, cigarettes in POW camps
fiat money
no intrinsic value, use as money due to governments say, The US dollar
what are the different measures of money
M1 and M2
What is included in M1
checking accounts + currency +savings deposits
What is included in M2
checking accounts + currency + savings deposits + small time deposits + mutual funds
what does the money supply include
currency as well as deposits in banks
when is money created
when the bank loans money and the money supply is increased
max change in money supply =
1/R * change in resources
what is the fed?
central bank of the us, regulates banking system and control money supply domestically and foreign currency market.
what is the structure of the fed
independent private institution owned by its members. makes policy without approval from govt. has a board of governors. The chair person is appointed by the pres for 4 yrs, and there are 6 other board members serving 14 year terms. 12 regional banks, main one in NY, meet every 6 weeks
what is in a typical balance sheet of a commercial bank
- banks liabilities: amt bank owes in deposits and borrowing
- banks assets: amt bank owns in reserves loans and sercurities
- reserve ratio = R = reserves/deposits * 100
what is the reserve ratio
fraction of deposits bank holds as reserves, total reserves as a percentage of total deposits
R = reserves/deposits * 100
what are the goals of the fed
low unemployment, low inflation. monetary policy,
hold bank reserves, lend money to banks, influence value of $ in foreign exchange market
what is monetary policy
policy created by the fed that influences, interest rates, discount rates, ffr, money supply, inflation, unemployment
what do the banks do with their reserves
they use a fractional reserve banking system. they keep a fraction of deposits as reserves, use rest to make loans. reserves are received deposits that have not been loaned out.
how do reserves affect money supply
- banks holds certain % as reserves and extend loans with rest, loans create currency, adding to the money supply
- deposits in banks + currency = money supply
how does a change in reserves result in a multiplier affect on the money supply?
- the money multiplier = 1/R
- the higher the reserve ratio the smaller the money multiplier
why may the true change in money supply be less than what is predicted by the multiplier
when the bank holds excess reserves than what is required, they dont contribute to money multiplier effect as they are not being lent out
what are the two ways the fed can influence the money supply?
open market operations and discount rate policy
what are open market operations
buying and selling of government bonds.
what is the discount rate policy
interest rate at which banks can borrow from federal bank
how is the money supply and AD increased.
- lower reserve ratio
- lower the discount rate, this encourages banks to borrow more
- fed buys govt bonds from public and pays for bonds with new money created from loans
how is money supply and AD decreased
- raise discount rates to discourage borrowing, leads to lower reserves and lower MS
- ## raise reserve ratio which lowers the money multiplier and lowers the MS
