exam 3 Flashcards
commodity money
currency that has value in and of itself ie gold coins
fiat money
currency with no inherent value, value is attributed ie debit card
medium of exchange
currency’s ability to be used to buy and sell goods and services
unit of account
money is a measurement of value
store of value
money can be saved and used in the future
nominal value
value printed on money
real value
what money can buy
real sector
produces goods and services
financial sector
creation, exchange, and valuation of financial assets such as money, stocks, bonds
- makes it possible to hold wealth in assets and obtain financing like loans
double conciousness of wants
for bartering to work, both parties must want what the other has at the same time
requirements of an effective currency
durable, portable, divisible, widely accepted, value is easily determined
liquidity
how fast, easily, and reliably can asset can be converted to cash
money 1 (M1)
(liquid) currency + demand deposits (checking accounts), other checkable deposits
money 2 (M2)
(less liquid) M1 + small value time deposits + savings deposits + money market deposits + money market mutual funds
financial intermediary
aquires funds from savers and lends to borrowers, reduces information costs, reduces transaction costs, banks can tolerate a small number of failed loans
bond
buyer promises to pay the bondholder interest payments + predetermined value of a bond at its maturity date
stocks
exchanges money for partial ownership of a company
liability
what banks owe to their customers
assets
deposits into a bank
- money is destroyed wen loans are paid
- its profitable to give out as many loans as possible, but it must be limited to customers who can actually pay them
The Federal Reserve
central bank of the US
- use money supply to influence interest rates
board of governors
Seven members appointed by the president and confirmed by the Senate
for a single 14-year term
Federal Open Market Committee
Composed of the Board of Governors and five of the 12 regional bank
presidents (with the New York Fed president as a permanent member)
Meets 8 times a year
decides on monetary policy
Functions of Regional Fed Banks
Provide a nationwide payments
system including clearing checks and Fedwire and FedNow funds transfer system
Distribute coins and currency
Regulate and supervise member banks
Serve as the banker for the U.S.Treasury
twin goals (dual mandate) of the Fed
economic growth with low unemployment and stable prices with moderate long-term interest rates.
how the Fed influences interest rates
FOMC sets federal funds range -> policy implementation ->
affects market interest rates and overall financial conditions
influences consumer and producer spending ->
progress toward dual mandate
reserve balance accounts
checking accounts banks hold within the Fed
federal funds transaction
transfer of funds from banks reserve account at the Fed to another
federal funds rate
interests on loans between banks in the Fed, Fed sets a range and can manipulate it, but cannot set it
affects all other interest rates
interest on reserve balances (IORB)
interest accrued on banks reserve balance, set by the Fed
“floor” of interest rates
discount rate
interest rate set by the fed to banks borrowing from the Fed
“ceiling” of interest rates
how the fed influences AD-AS
Fed affects the interest rate, and thus investment
expansionary monetary policy
reduces interest rates, which leads to greater
aggregate demand and investment, shifting
the AD curve to the right
contractionary monetary policy
raises interest rates, which leads to lower aggregate demand and less investment, shifting the AD curve to the left
transparency and the Fed
In 1994, the Fed began releasing a statement whenever it changed interest rates
policy is less effective when people are uncertain about what the Fed does
monetary policy lags
information, decision, recognition, and implementation like fiscal policy
- Fed avoids legislative delays
- monetary policy takes ~12-18 months to be effective
pro rules
discretion leads to arbitrary decisions and may cause instability with lags
pro discretion
economy is too complex for set rules, discretion is useful in extreme economic shocks
inflation rule
setting target inflation rate (2%)
monetary growth rule
increasing money supply by set percentage each year consistent with dual mandate
taylor rule
Federal funds target rate = 2 + current inflation rate + ½(inflation gap) + ½(output gap)
inflation
general increase in price level
deflation
general decrease in price level
consumer price index (CPI)
measures a weighted average of consumer prices
CPI core excludes volatile prices of food and energy
Personal Consumption Expenditure Price Index (PCE)
The weights in the index can change when consumers substitute from some goods and services to other and it is more
comprehensive, so it is used by the Fed.
PCE core excludes volatile prices of food and energy
causes of inflation
demand factors: consumer confidence, income, and wealth
supply shocks: price fluctuations on items
monetization of debt: the central bank buying government debt to make
it easier for the government to sell the
debt
hyperinflation
inflation ~over 50% a month
typically caused by excessive government spending over tax revenues and the printing of money to finance deficits
phillips curve
if policymakers use expansionary policy to reduce unemployment below the natural rate, they must be willing to accept higher inflation
*not always the case
FDIC insurance
- Established by 1933 Banking Act
- insures deposits in savings accounts up 250k
certificate of deposit
time deposit
- penalty charge if funds are withdrawn before period, but interest rates are higher than savings
savings account
pro: highly liquid, low risk because funds are insured
con: low or no interest rate
401k
retirement accounts available through large companies, allows you to save money pre-tax + additional funds from employer
pensions
employer continues to make paychecks after retirement
IRA (individual retirement account)
traditional (PRETAX (TAX-
DEFERRED) CONTRIBUTIONS
THAT CAN BE
INVESTED. TAXES
PAID UPON
WITHDRAWAL) or Roth (AFTER-TAX
CONTRIBUTIONS.
NO PENALTY
FOR EARLY
WITHDRAWAL.
NO TAXES ON
EARNINGS.
long term, tax advantaged savings account
social security
funded by payroll tax
- minimum age to collect is 62, but payments increase if one waits until 67
- benefits are calculated by one’s lifetime contributions
