Chapter 27 and 28 Flashcards
The three functions of money are
Medium of exchange
Store of value
Unit of account
Medium of exchange
use item to buy goods and services; an object that is generally accepted in return for goods and services.
Store of value
use item to transfer purchasing power to the future; any commodity or token that can be held and exchanged later for goods and services.
Unit of account
use item to denote prices and debts
an agreed-upon measure for stating the prices of goods and services.
Money in the world today is called
fiat money.
Fiat Money
objects that are money because the law decrees or orders them to be money.
The objects that we use as money today are
Currency; Deposits at banks and other financial institutions
The notes (dollar bills) and coins that we use in the United States today are known as _
currency
Notes are money because
the government declares them to be with the words printed on every dollar bill.
The words printed on every dollar bill:
This note is legal tender for all debts, public and private
Deposits at ___ are also money.
banks, credit unions, savings banks, and savings and loan associations
Deposits are money because they
can be converted into currency on demand and are used directly to make payments.
Quantity of money demanded is
the amount of money that households and firms choose to hold.
Benefit of Holding Money
The benefit of holding money is the ability to make payments; the more money you hold, the easier it is for you to make payments.
The opportunity cost of holding money is
the interest forgone on an alternative asset.
the opportunity cost of holding money is the nominal interest because
it is the sum of the real interest rate on an alternative asset plus the expected inflation rate, which is the rate at which money loses buying power.
We hold money for two reasons
Transaction Demand, Asset Demand
Transaction Demand
Holding money in our bank account so we can buy stuff.
Asset Demand
Liquidity preference in which money is kept as a store of value for later use.
A change in the nominal interest rate brings a
change in the quantity of money demanded.
A change in any other influence on money holdings changes __
the demand for money.
The three main influences are
The price level; Real GDP; Financial technology
The price level
need more money to pay for goods and services
Real GDP
increases in expenditures and incomes
Financial technology
credit cards
An x percent rise in the price level brings ___ because ______
An x percent rise in the price level brings an x percent increase in the quantity of money that people plan to hold because the number of dollars we need to make payments is proportional to the price level.
The demand for money increases as __ because ___
The demand for money increases as real GDP increases because expenditures and incomes increase when real GDP increases.
Daily interest on ____ transfers between ___ have increased the marginal benefit of money and increased the demand for money.
Daily interest on checking deposits, automatic transfers between checking and savings accounts, automatic teller machines, debit cards, and smart cards have increased the marginal benefit of money and increased the demand for money.
__ have made it easier to buy goods and services on credit and have decreased the demand for money.
Credit cards
The supply of money is the relationship between the
quantity of money supplied and the nominal interest rate.
The quantity of money supplied is determined by the
actions of the banking system and the Fed.
On any given day, the quantity of money is
fixed independent of the interest rate.
The nominal interest rate adjusts to make
the quantity of money demanded equal the quantity of money supplied.
On a given day, the price level, real GDP, and state of financial technology is
fixed, so the demand for money is given.
The Federal Reserve System
the central bank of the United States.
A central bank
A public authority that provides banking services to banks and regulates financial institutions and markets.
The Fed’s main task is to
regulate the interest rate and quantity of money to achieve low and predictable inflation and sustained economic growth.
The Chairman of the Board of Governors
The chairman is the Fed’s chief executive, public face, and center of power and responsibility. The current chairman is Jerome Powell.
The key elements in the structure of the Federal Reserve are
The Chairman of the Board of Governors
The Board of Governors
The Regional Federal Reserve Banks
The Federal Open Market Committee
The Board of Governors
Seven members, appointed by the President of the United States and confirmed by the Senate.
Each for a 14-year term.
The President appoints one of the board members as Chairman for a term of 4 years, which is renewable.
The Regional Federal Reserve Banks
There are 12 Federal Reserve banks, one for each of 12 Federal Reserve districts.
Each Federal Reserve Bank has nine directors, three of whom are appointed by the Board of Governors and six of whom are elected by the commercial banks in the Federal Reserve district.
The Federal Reserve Bank of New York implements some of the Fed’s most important policy decisions.
The Federal Open Market Committee
(FOMC) is the Fed’s main policy-making committee.
The FOMC consists of
The chairman and other six members of the Board of Governors.
The president of the Federal Reserve Bank of New York.
Four presidents of the other regional Federal Reserve banks (on a yearly rotating basis).
The FOMC meets approximately every six weeks.
The FED uses three main policy tools
Required reserve ratios
Discount rate
Open market operations
Required reserve ratios
Banks hold reserves.
Banks and thrifts are required to hold a minimum percentage of deposits as reserves, a required reserve ratio.
Banks hold reserves
Currency in the institutions’ vaults and ATMs
Deposits held with other banks or with the Fed
Discount rate
The interest rate at which the Fed stands ready to lend reserves to commercial banks.
A change in the discount rate begins with
a proposal to the FOMC by at least one of the 12 Federal Reserve banks
If the FOMC agrees that a change is required, it proposes the change to
The Board of Governors for its approval.
open market operation
The purchase or sale of government securities—U.S. Treasury bills and bonds—by the New York Fed in the open market.
When the New York Fed conducts an open market operation, the New York Fed
does not transact with the federal government.
The Fed’s normal policy tools work by
changing either the demand for or the supply of monetary base, which in turn changes the interest rate.
By increasing the required reserve ratio,
the Fed can force banks to hold a larger quantity of monetary base.
By raising the discount rate,
the Fed can make it more costly for the banks to borrow reserves—borrow monetary base.
By selling securities in the open market,
the Fed can decrease the monetary base.
By decreasing the required reserve ratio,
the Fed can permit the banks to hold a smaller quantity of monetary base.
By lowering the discount rate,
the Fed can make it less costly for the banks to borrow monetary base.
By buying securities in the open market,
the Fed can increase the monetary base.
If the Fed increases the quantity of money and the supply of money curve shifts to MS1,
the interest rate falls to 4 percent a year.
If the Fed decreases the quantity of money and the supply of money curve shifts to MS2,
the interest rate rises to 6 percent a year.
Following the collapse of Lehman Brothers, the Fed (working closely with the U.S. Treasury Department) took a number of major policy moves that created new policy tools:
Quantitative easing
Credit easing
Operation Twist
Quantitative Easing
When the Fed creates bank reserves by conducting a large-scale open market purchase at a low or possibly zero federal funds rate
Quantitative Easing differs from ____ and it might require the Fed to ____
a normal open market purchase in its scale; buy any of a number of private securities rather than government securities.
When the Fed buys private securities or makes loans to financial institutions to stimulate their lending,
the action is called credit easing.
When the Fed buys long-term government securities and sells short-term government securities, _____, aiming to _____
the action is called operation twist; to lower long-term interest rates and stimulate borrowing and investment.
The long run
refers to the economy at full employment or when we smooth out the effects of the business cycle.
In the short run
the interest rate adjusts to make the quantity of money demanded equal the quantity of money supplied.
In the long run,
the price level does the adjusting.
The lower the “price” of money,
the greater is the quantity of money that people are willing to hold.
The “price” of money is the
value of money.
The value of money
the quantity of goods and services that a unit of money will buy.
Value of Money
It is the inverse of the price level, P, which equals the GDP price index divided by 100.
Value of money = 1/P.
The long-run demand for money is determined by
potential GDP and the equilibrium interest rate.
The MS curve shows
the quantity of money supplied
The price level adjusts to make the value of money equal _ and achieve __
1 and achieve long-run money market equilibrium.
Inflation is costly for four reasons
Tax costs
Shoe-leather costs
Confusion costs
Uncertainty costs
The income tax on nominal interest income drives a wedge between
the before-tax interest rate paid by borrowers and the after-tax interest rate received by lenders.
The fall in the after-tax interest rate weakens the
incentive to save and lend.
The rise in the before-tax interest rate weakens the
incentive to borrow and invest.
Inflation increases the ___, and because income taxes are paid on ___, the true income tax rate rises with _____.
nominal interest rate; nominal interest income; inflation.
When money loses value at a rapid anticipated rate,
it does not function well as a store of value and people try to avoid holding it.
When money loses costsvalue at a rapid anticipated rate, people spend their incomes _____, and firms pay out incomes—wages and dividends—_____
as soon as they receive them; as soon as they receive revenue from their sales.
Borrowers and lenders, workers and employers, all make agreements in terms of __
Money
Inflation makes the value of __ change, so it changes ___.
money; so it changes the units on our measuring rod.
__ is our measuring rod of value.
Money
Uncertainty Costs
A high inflation rate brings increased uncertainty about the long-term inflation rate; Increased uncertainty also misallocates resources; Instead of concentrating on the activities at which they have a comparative advantage, people find it more profitable to search for ways of avoiding the losses that inflation inflicts; Gains and losses occur because of unpredictable changes in the value of money.
