Chapter 6 Concepts and Terms Flashcards
money
anything that is generally acceptable in making exchanges
barter
trading without the use of widely accepted means of exchange
double coincidence of wants
what must exist to exchange through means of barter
functions of money
- Medium of exchange—it is generally acceptable and convenient for exchange. 2. Unit of account—each unit of it is “worth” the same amount. 3. Store of value—it retains value over time.
commodity money
when money has other uses such as when the money of a society is sugar, iron, copper, cod - etc.
fiat money
when money has no other uses in society
liquidity
the ease with which an asset can be converted to spendable form
M1
M1 is the sum of: - Paper currency held outside banks, - Checking account balances, - Travelers’ Checks M1 is about $2.9 trillion
monetary policy
the Fed uses the money supply to attempt to affect the economy
Federal Open Market Committee
Conducts monetary policy. It is composed of: • The Board of Governors (which has seven members) • The President of the New York Federal Reserve Bank • The Presidents of the other eleven district banks, four of whom vote at each meeting on a rotating basis the Fed chairman’s recommendations are nearly always adopted unanimously because voting against the chairman is looked down upon
three tools of monetary policy
- open market operations - the required reserve ratio - the discount rate
Open Market Operations
buying and selling US government bonds from individuals and businesses who previously bought them from the US government. When the Fed buys bonds, bonds flow into the Fed and money flows into the economy, increasing the money supply, and vice versa,
The Required Reserve Ratio
the Fed sets the required reserve ratio, which is the percentage of deposits that banks cannot lend out, but must hold as reserves, • A bank’s reserves consist of its vault cash plus the bank’s account with the Fed, • Excess reserves are reserves that banks hold in excess of those the Fed requires, • At any point in time, a bank can lend out its excess reserves, • The current required reserve ratio is 10%, • With a lower required reserve ratio, banks can lend more, and vice versa, • This creates new money—remember, money inside bank vaults or at the Fed is not part of the money supply, while money in household and business accounts is part of the money supply,
The Discount Rate
the Fed was created to be a lender of last resort. That is, they are the final stop that a bank makes for an emergency loan before it fails. When a bank borrows from the Fed, it pays an interest rate called the discount rate which the Fed sets by command.
Federal Funds Rate
a free market rate at which banks lend to other banks. If the Fed puts money into the banking system, it is easier to borrow, so the Federal Funds Rate falls. If the press reports, “The Fed met today and lowered interest rates by a point,” they mean, “The Federal Open Market Committee met today and decided to increase the money supply until the free market Federal Funds Rate falls by a point.”
value of the dollar in the domestic economy
depends on how many and which goods and services it will buy
Consumer Price Index (CPI)
each month the Bureau of Labor Statistics (BLS) measures prices of 200 goods that a typical consumer buys, from a fancy parakeet, to a rental payment on a home, to a fifteen-minute visit with a family doctor. The measurement is a weighted average of the prices—weighted by the amounts of the goods that consumers purchase
PCE price index
(personal consumption expenditures index), which excludes food and fuel, which make up 20% of household purchases.
How to calculate the price index?
PI = (cost of market basket in focal period) / (cost of market basket in base period) x 100 Your answer to the next-to-last question in Thinking Exercise 6.2 is a price index number—if you multiply it by 100. This is the most straightforward interpretation of a price index. It answers this question: So if the price index is 300, then if $100 bought $100 worth of stuff in the base period, today it would cost $300 to buy the same stuff.
Inflation is the percentage change in the price index, usually over a year’s time. To find the inflation from year 1 to year 2, use
Inflation[Y1toY2] = (CPI[Y2] / CPI[Y1]) - 1
Determining how well off you are now compared to previously:
Equivalent Income[New] = CPI[New]/CPI[Old] x Income[Old] Equivalent Income[New] = 337.6/168.8 x $50,000 Equivalent Income[New] = 2 x $50,000
