Chapter 17: Money and the Federal Reserve

Question 1

The paper bills and coins used to buy goods and services

Answer 1

Currency

Question 2

Any generally accepted means of payment.

Answer 2

Money

Question 3

Functions of a money:

Answer 3

(1) Medium of exchange
(2) Unit of account
(3) Store of value

Question 4

What people trade for goods and services

Answer 4

Medium of Exchange

Question 5

Involves the trade of a good or service in the absence of a commonly accepted medium of exchange

Answer 5

Barter

Question 6

The use of an actual good for money such as gold or silver.

Answer 6

Commodity Money

Question 7

Money you can exchange for a commodity at a fixed rate. Solved transportation problem of using commodity money.

Answer 7

Commodity-Backed Money

Question 8

Money with no value except as the medium of exchange

Answer 8

Fiat Money

Question 9

Commodity Money

Answer 9

• Links money to something tangible
• Limits inflation
• Fluctuations in the commodity value changes all prices
• New gold discovery leads to inflation

Question 10

Fiat Money

Answer 10

• Not backed with a commodity
• Not subject to macroeconomic risk by changing commodity value
• Subject to rapid monetary expansion and inflation

Question 11

The measure in which prices are quoted

Answer 11

Unit of Account

Question 12

Unit of Account

Answer 12

• Creates a common language and unit of measurement
• Enables people to make accurate comparisons between items
• Creates a consistent method of record keeping

Question 13

A means for holding wealth

Answer 13

Store of Value

Question 14

The money supply measure composed of currency and checkable deposits

Answer 14

M1

Question 15

Are deposits in bank accounts from which depositors may make withdrawals by writing checks

Answer 15

Checkable Deposits

Question 16

The money supply measure that includes everything in M1 plus savings deposits, money market mutual funds, and small-denomination time deposits (CDs)

Answer 16

M2

Question 17

Access checking and/or savings accounts

Answer 17

Debit Cards

Question 18

Technically not a part of the money supply

Answer 18

Credit Cards

Question 19

Banks have two important roles in the economy

Answer 19

(1) They are critical participants in the loanable funds market
(2) Play a role in determining the money supply

Question 20

Interest Rates on Bank Deposits and Loans

Answer 20

• Banks charge more interest for loans than they pay for deposits
• The difference pays the bank’s expenses and produces profits

Question 21

The items a firm owns

Answer 21

Assets

Question 22

The financial obligations a firm owes to other

Answer 22

Liabilities

Question 23

The difference between a firm’s assets and its liabilities

Answer 23

Owner’s Equity

Question 24

The portion of bank deposits that are set aside and not loaned out. No “lock box” mayonnaise jars!

Answer 24

Reserves

Question 25

When banks hold only a fraction of deposits on reserve

Answer 25

Fractional Reserve Banking

Question 26

Banks hold deposits for two reasons:

Answer 26

(1) To accommodate withdrawals by depositors

(2) Because they are legally bound to hold a fraction of their deposit on reserve

Question 27

The portion of deposits that banks are required to keep on reserve

Answer 27

Required Reserve Ratio (rr)

Question 28

Required Reserves =

Answer 28

rr x deposits

Question 29

Are any bank reserves held in excess of those required

Answer 29

Excess Reserves

Question 30

Total Reserves =

Answer 30

= Required Reserves + Excess Reserves

Question 31

Money Creation

Answer 31

Banks do not mint money but through their daily activities they do help to create new money

Question 32

Two simplifying (but unrealistic) assumptions of Money Creation:

Answer 32

(1) All currency is deposited in a bank

(2) Banks hold no excess reserves

Question 33

The rate at which banks multiply money when all currency is deposited into banks and they hold no excess reserves

Answer 33

Simple Money Multiplier

Question 34

Central bank of United States

Answer 34

Federal Reserve

Question 35

Three Responsibilities of the Fed:

Answer 35

(1) Monetary Policy
(2) Central Banking
(3) Bank Regulation

Question 36

Roles of the Fed:

Answer 36

• The Fed acts as a “bank for banks”
• The Fed also acts as a lender of last resort
• The Fed also serves as a regulator of individual banks

Question 37

The Fed has several tools it can use to alter the money supply:

Answer 37

(1) Open market operations
(2) Quantitative easing
(3) Reserve requirements
(4) Discount rates

Question 38

The purchase or sale of bonds by a central ban

Answer 38

Open Market Operations

Question 39

Buys securities →

Answer 39

Increase money supply

Question 40

Sells securities →

Answer 40

Decrease the money supply

Question 41

When performing open market operations, the Fed typically buys and sells short-term Treasury securities for two reasons:

Answer 41

• The Fed’s goal is to get the funds directly into the market
• The market for Treasury securities is big enough to where the Fed can buy and sell without difficulty

Question 42

The targeted use of open market operations in which the central bank buys securities specifically targeting certain markets

Answer 42

Quantitative Easing

Question 43

During the Great Recession:

Answer 43

• In late 2008, Fed injected almost $2 trillion worth of new funds
• Included $1.25 trillion in mortgage backed securities
• Bought long-term Treasury securities in addition to targeting short-term ones

Question 44

Reserve Requirements

Answer 44

• The Fed can change the money multiplier by changing the reserve requirement
• Imprecise and unpredictable

Question 45

Discount Rate

Answer 45

• Fed would increase the discount rate to discourage borrowing by banks and decrease money supply (or vice versa)
• Used actively until Great Depression era
• No longer considered useful

Question 46

Excess Reserves, 1990-2018

Answer 46

It is no coincidence that the excess reserves climbed immediately after the Fed began paying interest on reserves