Lecture Note #6 Flashcards
Why do banks have excess liquidity?
1) the benefit of having more liquidity to face depositors’ demand and avoiding default overshadows the opportunity cost
2) Liquid securities (as opposed to cash) and remunerated(pay) reserves do not carry such cost
What is the equation for Quantity Theory of Money (QTM)?
M x V = P x Y
What does (P x Y) mean in the QTM equation?
nominal GDP
What does (M x V) mean in the QTM equation?
volume of monetary transactions
What does the demand for money include?
cash
What are other financial assets (OFA)?
bank deposits, bonds, stock, foreign currency
What is monetary base?
a broad measure, influencing the amount of money banks can lend out through the multiplier effect
What is currency in circulation?
is the subset of the monetary base that is actively used in day-to-day transactions by the public
What is a currency mismatch?
in some countries, banks lend in foreign currency and accept deposits in local currency, a currency risk emerges in the event of depreciation
What is the difference between inflationary tax and standard tax?
Inflationary tax is caused by inflation, which is made through monetary policy. Monetary policy is then controlled by the federal reserve.
Standard tax is a tax rate that is passed by Congress.
What are six properties money should have?
1) Durability
2) Portability
3) Divisibility
4) Uniformity
5) Acceptability
6) Limited Supply
What are beliefs held by economists concerning cryptocurrencies?
it is an unstable and risky form of currency so it will not substitute standard currencies any time soon
What is true about the number of central banks over the past 200 years?
The number of central banks have risen
When considering how a central bank works, what are the assets and liabilties?
Assets:
1) international reserves
2) credit to the treasury
3) securities
4) credit to the financial system
Liabilities:
1) monetary base
2) central bank securities
What is needed to calculate the opportunity cost of holding cash?
1) nominal interest rate
2) interest rate on cash (is always zero)
What is the formula needed to calculate the opportunity cost(OC) of holding cash?
OC = nominal interest rate - interest rate on cash
What does income elasticity measure?
how much nominal money balances increase if nominal GDP increases by 1%
Can V and Y be removed from the QTM equation (M x V = P x Y)?
No because V and Y cannot be fixed or constant
What do central bankers do when the policy rate gets close to zero?
They start to implement unconventional methods like Quantitive Easing (QE) to inject money into the economy directly
What makes up US commercial banks (percentage wise)?
Cash: 14%
Securities: 23%
Loans: 53%
Other assets: 10%
According to QTM, why is it theoretically possible to have inflation even if the supply of money and the real GDP stay constant?
Reason being is that velocity of money could increase which would boost prices even if M and Y or constant.
What are sterilization operations used for when considering deficits?
used to counteract money printing due to capital inflows to countries with fixed or manage exchange rate regimes
How is the fiscal federal deficit financed?
buy and sell government securities and others
What makes foreign investors extremely confident about the stability of the US dollar?
owed to the safety and stability of the currency issued by the largest economy in the world (US)
How can seniorage be calculated?
Seniorage = Inflationary Tax + Change in Real Money Demand
What is the relationship between money growth and inflation in the short term?
Weak short-term correlation
What is the relationship of money growth and inflation in the long-term?
Strong long-term correlation
Who and why are bank reserves retained?
Held by banks to face depositor’s demand for cash
Who and why are international reserves retained?
Held by central banks to manage the exchange rate when deemed necessary
