Chapter 21

Question 1

Money

Answer 1

the set of assets in the economy that people regularly use to buy goods and services from each other

Question 2

Medium of exchange

Answer 2

an item that buyers give to sellers when they purchase goods and services

Question 3

Unit of account

Answer 3

the yardstick people use to post prices and record debts.

Question 4

Store of value

Answer 4

an item that people can use to transfer purchasing power from the present to the future (nonmonetary assets, stocks, bonds)

Question 5

Liquidity

Answer 5

the ease with which an asset can be converted into the economy’s medium of exchange

Question 6

Commodity money

Answer 6

money that takes the form of a commodity with intrinsic value

Question 7

Fiat money

Answer 7

money without intrinsic value that is used as money by government decree

Question 8

Currency

Answer 8

the paper bills and coins in the hands of the public

Question 9

Demand deposits

Answer 9

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

Question 10

Two measures of the money stock for the U.S. economy

Answer 10

1. M1

2. M2

Question 11

M1

Answer 11

• currency
• demand deposits
• traveler’s checks
• other checkable deposits

Question 12

M2

Answer 12

• savings deposits
• small time deposits
• money market mutual funds
• a few minor categories
• everything in MI

Question 13

Federal reserve

Answer 13

the fed. the central bank of the united states

Question 14

Central bank

Answer 14

An institution designed to oversee the banking system and regulate the quantity of money (other major central banks: bank of england, bank of japan, and the european central bank)

Question 15

When was the federal reserve created?

Answer 15

The fed was created in 1913 after a series of bank failures in 1907 convinced Congress that the U.S. needed a central bank to ensure the health of the nation’s banking system

Question 16

Breakdown of the Fed

Answer 16

The Fed is run by its board of governors, which has 7 members appointed by the president and confirmed by the senate. The governors have 14 year terms. The most important member is the chair.

Question 17

The Federal Reserve system

Answer 17

consists of the federal reserve board in D.C. and 12 regional federal reserve banks located in major cities across the country.

Question 18

The Fed has two jobs

Answer 18

1. To regulate banks and ensure the health of the banking system
   (when financially troubled banks find themselves short of cash, the Fed acts as a lender of last resort, a lender to those who cannot borrow anywhere else)
2. To control the quantity of money that is made available in the economy, the money supply. Decisions by policymakers concerning the money supply constitute monetary policy.

Question 19

Money supply

Answer 19

quantity of money available in the economy

Question 20

Monetary policy

Answer 20

the setting of the money supply by policymakers in the central bank

Question 21

Monetary policy is made by

Answer 21

the Federal Open Market Committee (FOMC)

Question 22

Monetary policy is made by

Answer 22

the Federal Open Market Committee (FOMC), who meet ever 6 weeks in D.C.

Question 23

The Fed’s primary tool

Answer 23

the open-market operation

Question 24

The open-market operation

Answer 24

the purchase and sale of U.S. government bonds

Question 25

The Fed’s policy decisions are key determinants of

Answer 25

inflation in the long run and employment and production in the short run

Question 26

Reserves

Answer 26

deposits that banks have received but have not loaned out

Question 27

Fractional reserve banking

Answer 27

a banking system in which banks hold only a fraction of deposits as reserves

Question 28

Reserve ratio

Answer 28

the fraction of total deposits that a bank holds

Question 29

Reserve requirement

Answer 29

the Fed sets a minimum amount of reserves that banks must hold

Question 30

Excess reserves

Answer 30

Banks may hold reserves above the legal minimum

Question 31

Money multiplier

Answer 31

the amount of money the banking system generates with each dollar of reserves

Question 32

Leverage

Answer 32

the use of borrowed money to supplement existing funds for investment purposes

Question 33

The leverage ratio

Answer 33

the ratio of the bank’s total assets to bank capital

Question 34

Insolvent

Answer 34

unable to pay off its debt holders and depositors in full

Question 35

Capital requirement

Answer 35

a government regulation specifying a minimum amount of bank capital

Question 36

Credit crunch

Answer 36

when banks reduce lending

Question 37

The Fed has 2 main tools in its monetary toolbox

Answer 37

1. those that influence the quality of reserves

2. those that influence the reserve ratio and in turn the money multiplier

Question 38

The Fed has 2 main tools in its monetary toolbox

Answer 38

1. those that influence the quantity of reserves

2. those that influence the reserve ratio and in turn the money multiplier

Question 39

How does the Fed alter the quantity of reserves?

Answer 39

by buying or selling bonds in open-market operations or by making loans to banks

Question 40

Open-market operations

Answer 40

the purchase and sale of U.S. government bonds by the Fed

Question 41

Banks borrow from the Fed’s discount window and pay an interest rate on that loan called a

Answer 41

discount rate

Question 42

2007-2010 the “term auction facility”

Answer 42

the fed set a quantity of funds it wanted to lend to banks and eligible banks then bid to borrow those funds. The loans went to highest bidders. Unlike the discount window, where the Fed sets the price of a loan and the banks determine the quantity of borrowing, at the term auction facility, the Fed set the quantity of borrowing and bidding among banks determined price. The more funds the fed available, the greater the quantity of reserves and the larger the money supply.

Question 43

Reserve requirements

Answer 43

the regulations that set the minimum amount of reserves that banks must hold against their deposits. reserve requirements influence how much money the banking system can create with each dollar of reserves. An increase in reserve requirements means that banks must hold more reserves and therefore can loan out less of each dollar that is deposited. As a result, an increase in reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply. Conversely, a decrease in reserve requirements lowers the reserve ratio, raises the money multiplier, and increases the money supply.

Question 44

The Fed’s tools

Answer 44

1. open-market operations
2. bank lending
3. reserve requirements

Question 45

The Fed’s problems

Answer 45

1. the Fed does not control the amount of money that households choose to hold as deposits in banks
2. the Fed does not control the amount that bankers choose to lend. (when money is deposited in a bank, it creates more money only when the bank loans it out

Question 46

The federal funds rate

Answer 46

the short-term interest rate that banks charge one another for loans. loans are typically short-term, overnight. The price of the loan is the federal funds rate.

Question 47

Discount rate vs. federal funds rate

Answer 47

the discount rate is the interest rate banks pay to borrow directly from the federal reserve through the discount window

borrowing reserves from another bank in the federal funds market is an alt. to borrowing reserves from the Fed., and a bank short of reserves will typically do whichever is cheaper.

both move closely together.