Chapter 4 Flashcards
Financial markets
banks, money market funds, mutual funds, investment funds, and hedge funds
play an essential role in the economy
Functions of money
medium of exchange (spend time in barter economy)
unit of account (defines obligations, calculates GDP)
store of value (transfer purchasing power)
standard of deferred payment (paying debt)
Money
you can use for transactions, pays no interest.
Types of money
Currency (coins and bills)
chequable deposits (deposits in form of cheques)
Bonds
pay a positive interest rate but they cannot be used for transactions.
Motives for holding money
Transactions motive (rises with income)
Precautionary motive (unforeseen events; stronger as income rises)
Speculative (or asset) motive (less risky than bonds)
The holding of money and bonds depends on what?
Your level of transaction
Interest rate on bonds
Money market funds
pool together the funds of many people, then used to buy bonds
pay an interest rate close to, but slightly below, the interest rate on the bonds
Income
what you earn from working, plus what you receive in interest and dividends.
Saving
part of after-tax income that you do not spend
Wealth
the value of what you have accumulated over time
financial wealth
the value of all your financial assets minus all your financial liabilities
stock variable
Investment
the purchase of new capital goods, from machines to plants to office buildings
financial investment
the purchase of shares or other financial assets
Demand for money
increases in proportion to nominal income, and
depends negatively on the interest rate.
Determining interest rate
money supply: an increase in nominal income leads to an increase in the interest rate
An increase in the supply of money by the central bank leads to a decrease in the interest rate
open-market operations
Central banks typically change the supply of money by buying or selling bonds in the bond market
expansionary open-market operation
the central bank expands the supply of money by buying bonds.
Contractionary open market operation
the central bank contracts the supply of money by selling bonds
Central bank balance sheet
Asset: bonds
Liabilities: Money
treasury bills (T-bills)
bonds issued by the government promising payment in a year or less
The higher the price of the bond, the lower the interest rate.
The higher the interest rate, the lower the price today.
Financial intermediaries
institutions that receive funds from people and firms, and use these funds to buy financial assets or to make loans to other people and firms.
repurchase market
an actual market for bank reserves
repurchase rate (repo rate)
the interest rate determined in the repurchase market.
main indicator of SA’s monetary policy
Liquidity trap
when the interest rate is down to zero, monetary policy cannot decrease it further.
