Macro Unit 3 Flashcards
Money
the set of assets in the economy that people use to buy goods and services
3 functions of money
- used as a medium of exchange
- used as a unit of account
- used as a store of value
Medium of exchange
an item buyers give to sellers when they want to purchase goods and services
Unit of account
the yardstick people use to post prices and record debts
Store of value
an item that people can use to transfer purchasing power from the present to the future
Liquidity
the ease of an asset to be converted into the economy’s medium of exchange
Intrinsic value
something that has worth even when not used as moeny
Commdity money
money with intrinsic value (ex. gold)
Fiat money
money without intrinsic value that is used as money because of a government decree (ex. the U.S. dollar)
Demand deposits (checkable deposits)
balances in bank accounts that depositors can access by writing a check ir using a debt card
Largest portion of U.S. money supply
Most liquid money is kept in demand deposits
M1 vs. M2 money
M1: most money supply, most liquid. Increases over time because the inflation goes up
M2: grows form investments
Federal Reserve
central bank of the U.S.
Money supply
quantity of money available in the economy
Monetary policy
the setting of the money supply by policymakers in the central bank
Assets
items of value in your control (money you actually have, ex. stocks, bonds, loans)
Equity
used to account for the capital of a firm
Liabilities
money/debts owed
Reserves
deposits that banks have received but not loaned out
Reserve ratio
the percent of deposits a bank must keep as reserves
Fractional Reserve Banking
a banking system where the bank holds only a fraction of deposits as reserves
depositing by consumers and lending by the bank makes new money
Money multiplier
the amount of money the banking system generates with each dollar of reserves
the reciprocal of the reserve ratio
Excess reserves
any extra money that a bank can lend out, but has decided to keep for the time being
excess reserves REDUCE the money multiplier
Open market operations
the purchase and sale of U.S. government bonds by the Fed.
How does the Fed increase money supply?
the Fed tells bond traders at the NY Fed to buy bonds from the public in bond markets. The money the Fed pays for the bonds increases the number of dollars in circulation
How does the Fed decrease money supply?
The Fed sells government bonds to the public in the nation’s bond markets. The public buys the bonds with currency and bank deposits, reducing the amount of money in circulation
Interest rates
The fee paid to borrow money OR the compensation received for lending money
Why are loans needed?
To invest in things
Investment is the portion most affected in GDP
Bond
A certificate that represents a loan from a lender to a borrower
Lender
Buys bonds and collects interest
Borrower
Sells bond and collects interest
Why do governments and companies issue bonds?
To raise money or cover debts
Savings bond
Sold at a discount, yields a return through maturity
Treasury bill
sold at a discount, yields a return through maturity. Take longer to mature, but is cheaper to buy, so it will yield more
Relationship between bond prices and interest rates
Bond prices and interest rates are inversely related
Rule of 70
Money will double every 70/x years, where x=interest rate
The Fed
Central job of the U.S.
Main jobs are to supervise and ensure health of commercial banks and is the lender of last resort
Federal Open Market Committee (FOMC)
Enacts monetary policy (the changes in money supply used to manage demand)
Contractionary vs expansionary money supply
Contractionary reduces the money supply
Expansionary increases the money supply
3 ways the Fed controls money supply
- Reserve requirements
- Discount rate
- Open market operations
Reserve requirements
Changes bank’s reserve requirement minimum
Changes the money multiplier
If reserve requirement decreases,money supply increases
If reserve requirement increases, money supply decreases
Discount rate
Rate at which the Fed lends money to banks. Banks use the discount rate to get short term liquidity. Fed raises or lowers interest rates
When the discount rate goes up, money supply goes down
When the discount rate goes down, money supply goes up
Open market operations
Buying and selling U.S. bonds by the Fed
Sets the federal funds rate (short term interest rate for overnight loans)
Feds purchase of bonds is set by supply and demand for interbank loans
When bonds are sold, money supply decreases
When bonds are bought, money supply increases
