Chapter 11- The Monetary System Flashcards
Medium of Exchange
An asset that can be traded for goods and services.
Money
An asset that people use to make and receive payment when buying and selling goods and services.
What 3 functions does money serve?
- A medium of exchange
- A store of value
- A unit of account
Store of value
An asset that enables people to transfer purchasing power into the future
Unit of account
A universal yardstick that is used to express relative prices of goods and services
Fiat Money
An asset that is used as legal tender by government decree and is not backed by a physical commodity like gold.
The money supply (M2)
The sum of currency in circulation, checking accounts and other types of accounts.
Monetary measure is calculated by
Currency in circulation/GDP and Money Supply/GDP
Nominal GDP
The total value of production using the prices from the same year .
Real GDP
The total value of production using fixed prices taken from a particular base year.
Quantity Theory of Money
Money Supply/ Nominal GDP = Constant
A constant ratio is a good approximation of how an economy
Behave in the long run
The growth rate of money supply= growth rate of nominal GDP is the same as
Growth rate of money supply = inflation rate + growth rate of real GDP
Growth rate of money supply =
Inflation rate + Growth rate of real GDP
Inflation rate=
Growth rate of money supply- growth rate of real GDP
When does long term inflation occur?
When there is a positive gap between growth in money supply and real GDP
Inflation
A situation of rising prices
Deflation
A situation of falling prices (negative inflation)
Hyperinflation
A situation of extreme inflation where prices double within three years.
Do all wages and prices move together during inflation?
No
Relative prices
Wages compared to the price of a good .
Who wins from unexpected inflation ?
Borrowers
Who loses from unexpected inflation?
Savers and Lenders
Banks receiving payments on a mortgage of fixed interest or a retiree receiving a pension
All lose during an inflation.
What does the central bank do ?
Monitor Financial institutions
- control certain key interest rates
- indirectly controls the money supply
What activities encompass the central bank?
Monetary Policy
What is the Federal Reserve Bank?
The central bank of the United States
What parts are the fed composed of?
12 District banks throughout the country
7 Board of governors
12 Federal open market committee
What does the central bank do ?
Influences short term interest rates
Influences Money Supply
Influences Long Term Real interest rates
What are bank reserves?
The combination of deposits that private banks hold at the central bank and cash in their vaults which provide liquidity to private banks.
Liquidity
The funds and assets that can be used immediately to conduct transactions.
Federal Funds Market
The market where banks borrow and lend reserve to one another
Federal Funds Rate
The 24hour interest rate charged in the market
Demand curve for reserves
This curve plots the total quantity of reserves demanded by private banks for each level of the federal funds rate.
Why does the demand curve for reserves slope downward?
Because optimizing banks choose to hold more reserves as the cost of those reserves.
When does the demand curve for bank reserves shift?
When there is Economic Expansion Changing deposit base Changing reserve requirement Changing interest paid by the fed for deposits at the fed
An economic contraction decrease bank lending. What happens to the curve?
The curve moves to the left because they are not to lend as much money .
What is supply curve for reserves?
Plots the quantity of reserves supplied by the federal reserve via market operations.
Open Market Purchase
Where the fed buys government bonds from private banks and in return give the private banks more reserves.
Open Market Sale
The fed sells the government bonds to private banks and in return the private banks give some of their reserves.
What does the supply curve for reserves plot?
The quantity of reserves supplied by the federal reserve.
Which way do the supply curve for reserves go ?
It goes vertical because the federal reserves supplies reserves not to earn economic profits .
Can the federal reserve control either the quantity of reserves or the federal funds rate ?
NEEEOOOPPPEEE..
How can the fed shift demand curve for reserves?
By changing the reserve requirement and by changing interest paid on reserves
How can the fed shift supply curve reserves?
By using open market operations
What happens when the fed manipulates the nominal interest rate?
It affects rates charged by banks on loans therefore rectifying the point that the fed is in direct control over the nominal interest rates.
How does the fed influence long term interest rates?
Long term loans are the same as lots of short run loan so when you change the short tem interest rate it will also affect the long term interest rate (at a smaller amount)
