Chapter 6 Notes Flashcards
What is money?
Anything that is generally acceptable in making exchanges
What does “a double coincidence of wants” mean?
With barter, one must find someone who both has what he wants and wants what he has
How does money evolve from barter?
In a barter system, eventually some goods become more acceptable in making exchanges.
What is the wellspring of all US dollars?
The Federal Reserve
What is liquidity?
The ease by which an asset can be converted to a spendable form
What are the parts of M1?
Currency held outside banks. Checking account balances. Travelers checks.
How big is M1?
$2.5 trillion
Why was the Fed created?
To be a lender of last resort to prevent banking crises
True, false, explain: The Fed’s early record was not good.
True. They caused a huge deflation that economists believe is the cause of the Great Depression.
True, false, explain: If congress wanted to end the Fed, they could refuse to fund it.
False. The Fed finances itself.
True, false, explain: The president runs the Fed.
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.
Who is on the Federal Open Market Committee?
The 7 governors. The NY Fed president. The 11 other district bank presidents, 4 of whom who vote at meetings on a rotating basis.
What are the three tools of monetary policy?
Open Market Operations, The Required Reserve Ratio. The Discount Rate.
What are Open Market Operations?
Buying and selling US government bonds to affect the money supply.
How could an open market transaction lower the money supply?
If the FOMC sells bonds, bonds flow into the economy and money flows out of the economy, into the Fed.
What is the required reserve ratio?
The percentage of deposits that a bank cannot lend but must hold as reserves
In which two forms can a bank hold reserves?
As vault cash and in their account with the Fed
If the Fed lowers the required reserve ratio, what will happen to the money supply? Why?
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.
What is the discount rate?
The interest rate at which a bank can borrow from the Fed.
What is the Federal Funds Rate?
A free market rate at which banks lend to each other
The news media says, “The Fed lowered interest rates by 1% today.” What does that really mean?
The FOMC plans to increase the money supply until the Federal Funds Rate falls by 1%
Which of its three tools of monetary policy does the Fed prefer? Why?
Open Market Operations–the required reserve ratio is dangerous and the discount rate is weak.
What is the definition of the money multiplier?
1/required reserve ratio
If the Fed injects $1M into the banking system, how much money is created if the required reserve ratio is 10%?
$1M * (1/.1) * = $1M * 10 = $10M
How can one measure the value of the dollar in the domestic economy?
By the amount of goods that it will buy
What is the formula for a price index?
PI = (cost of market basket in the period of interest)/(cost of the market basket in the base period) * 100
The price index for a particular year is 200. What is the most straightforward interpretation of that number?
If $100 bought $100 worth of stuff in the base year, it now takes $200 to buy that same stuff
What is the definition of the inflation rate?
The percent change in the price index, usually over one year
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.
False. Prices likely changed, so we need to compare real income in the two years.
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?
New income required = $30,000 * (450/150) = $30,000 * 3 = $90,000
If Mr. Bender earned $30,000 when the price index was 150, what was his real income?
Real income = Nominal Income/CPI = $30,000 * (100/150) = $20,000
