Macro: Chapter 4: Financial Markets Flashcards
4 Main functions of money
Medium of exchange
Unit of account
Store of value
Standard of deferred payment
M1
Sum of currency (coins and bills) and cheque deposits (bank deposits)
Speculative demand for money
An individual’s demand for money that is based on the uncertainty about future interest rates (and future expected returns on bonds).
An economy in a liquidity trap
Where the interest rate is equal or very close to zero.
Demand for Money
Md = RY x L(i)
Is equal to the nominal income RY times a function of the interest rate i, L(i).
Equilibrium in financial markets requires
Money supply = Money demand
M = RY L(i)
Liquidity
A measure of how easily an asset can be exchanged for money.
How do central banks increase the amount of money in the economy?
They buy bonds and pay for them by creating money.
- Increases the price of bonds.
- Decreases the interest rate.
How do central banks decrease the amount of money in the economy?
They sell bonds and remove from circulation the money received.
- Decreases the price of bonds
- Increases the interest rate
Expansionary open market operation
One that increases the supply of money.
Financial intermediaries
Institutions that receive funds from people and firms, and use these funds to buy financial assets or to make loans to other people and firms.
3 Reasons for banks holding reserves
- Bank must keep cash on hand for deposits
- For if the amount owed by one bank to another isn’t equal.
- Reserve requirements, as set out by the SARB.
Demand and supply for central bank money.
Demand for central bank money = demand for currency y people + demand for reserves by banks.
Supply of central bank money is under the direct control of the central bank.
Equilibrium interest rate
Such that the demand and supply for central bank money are equal.
Demand for currency (CUd)
CUd = cMd,
where c is the proportion of people’s money in currency.
