Chapter 6 Notes

Question 1

What is money?

Answer 1

Anything that is generally acceptable in making exchanges

Question 2

What does “a double coincidence of wants” mean?

Answer 2

With barter, one must find someone who both has what he wants and wants what he has

Question 3

How does money evolve from barter?

Answer 3

In a barter system, eventually some goods become more acceptable in making exchanges.

Question 4

What is the wellspring of all US dollars?

Answer 4

The Federal Reserve

Question 5

What is liquidity?

Answer 5

The ease by which an asset can be converted to a spendable form

Question 6

What are the parts of M1?

Answer 6

Currency held outside banks. Checking account balances. Travelers checks.

Question 7

How big is M1?

Answer 7

$2.5 trillion

Question 8

Why was the Fed created?

Answer 8

To be a lender of last resort to prevent banking crises

Question 9

True, false, explain: The Fed’s early record was not good.

Answer 9

True. They caused a huge deflation that economists believe is the cause of the Great Depression.

Question 10

True, false, explain: If congress wanted to end the Fed, they could refuse to fund it.

Answer 10

False. The Fed finances itself.

Question 11

True, false, explain: The president runs the Fed.

Answer 11

False. The Board of 7 governors are appointed by the president to 14 year terms. The Chair is appointed for a 4 year term. All confirmed by the Senate.

Question 12

Who is on the Federal Open Market Committee?

Answer 12

The 7 governors. The NY Fed president. The 11 other district bank presidents, 4 of whom who vote at meetings on a rotating basis.

Question 13

What are the three tools of monetary policy?

Answer 13

Open Market Operations, The Required Reserve Ratio. The Discount Rate.

Question 14

What are Open Market Operations?

Answer 14

Buying and selling US government bonds to affect the money supply.

Question 15

How could an open market transaction lower the money supply?

Answer 15

If the FOMC sells bonds, bonds flow into the economy and money flows out of the economy, into the Fed.

Question 16

What is the required reserve ratio?

Answer 16

The percentage of deposits that a bank cannot lend but must hold as reserves

Question 17

In which two forms can a bank hold reserves?

Answer 17

As vault cash and in their account with the Fed

Question 18

If the Fed lowers the required reserve ratio, what will happen to the money supply? Why?

Answer 18

The money supply will increase because the bank can lend more, which moves money from their reserves, which are not part of the money supply, into currency and individual accounts, which are part of the money supply.

Question 19

What is the discount rate?

Answer 19

The interest rate at which a bank can borrow from the Fed.

Question 20

What is the Federal Funds Rate?

Answer 20

A free market rate at which banks lend to each other

Question 21

The news media says, “The Fed lowered interest rates by 1% today.” What does that really mean?

Answer 21

The FOMC plans to increase the money supply until the Federal Funds Rate falls by 1%

Question 22

Which of its three tools of monetary policy does the Fed prefer? Why?

Answer 22

Open Market Operations–the required reserve ratio is dangerous and the discount rate is weak.

Question 23

What is the definition of the money multiplier?

Answer 23

1/required reserve ratio

Question 24

If the Fed injects $1M into the banking system, how much money is created if the required reserve ratio is 10%?

Answer 24

$1M * (1/.1) * = $1M * 10 = $10M

Question 25

How can one measure the value of the dollar in the domestic economy?

Answer 25

By the amount of goods that it will buy

Question 26

What is the formula for a price index?

Answer 26

PI = (cost of market basket in the period of interest)/(cost of the market basket in the base period) * 100

Question 27

The price index for a particular year is 200. What is the most straightforward interpretation of that number?

Answer 27

If $100 bought $100 worth of stuff in the base year, it now takes $200 to buy that same stuff

Question 28

What is the definition of the inflation rate?

Answer 28

The percent change in the price index, usually over one year

Question 29

True, False, explain: If we compare Mr. Bender’s paycheck in one year with his paycheck in another year, we can tell when he was materially better off.

Answer 29

False. Prices likely changed, so we need to compare real income in the two years.

Question 30

If Mr. Bender earned $30,000 when the price index was 150 and now the price index is 450, how much would Mr. Bender need to earn now to be just as well off?

Answer 30

New income required = $30,000 * (450/150) = $30,000 * 3 = $90,000

Question 31

If Mr. Bender earned $30,000 when the price index was 150, what was his real income?

Answer 31

Real income = Nominal Income/CPI = $30,000 * (100/150) = $20,000