Monetary System Flashcards
Good characteristics of money
Durable Portable Divisible Recognisable Hard to counterfeit
Types of money
1) commodity money with intrinsic value- gold
2) fiat money used because gov decree but no intrinsic value- coins
Demand deposits
Balances in bank accounts that depositors can access on demand
Narrow money M1
All physical money and demand deposits and other liquid assets held by the central gov
Role of central banks
Institution designed to oversee banking system and regulate the Q of money in economy
Economy reliant on fiat money needs agency to regulate system
Regulates and controls prices
Money supply
Quantity of money available in economy
SR trade off between inflation and unemployment
Reserves ratio
Fraction of deposits banks hold as reserves and don’t lend out
Functions of money
Medium of exchange
Store of value
–transfer purchasing power present–>future
Unit of account
ECB and Eurosystem
12 countries in EMU
Primary objective to promote price stability
Sub-prime mortgage crisis
Building CDO
Mortgage lender sell mortgages to investment bank
I Bank turns debt into ASSET BACKED SECURITY (ABS)
Then sell BOND on money markets to banks/financial institutions/larger savers
Banks and money supply
Reserves= deposits banks have received but not loaned out
Reserve ratio- fraction deposits banks hold
Fractional reserve banking
Banking system which banks hold fraction of deposits as reserves
What happens what bank makes loan from reserves
Money supply increases
What is money supply affected by
Amount deposited in banks
Amount banks loan
Money multiplier
1 / reserves ratio
Central banks tools of monetary controls
1) open market operations
2) refinancing rate
3) reserve requirements
Open market operations
Increase money supply - create currency and buy bonds from public
Refinancing rate
IR at which European Central Bank lends on ST basis to euro area
Repo rate
IR at which BofE lends on ST basis to UK banking sector
Discount rate
IR at which Federal reserve lends on ST basis to US banking sector
Reserve requirements
Regulations on min amount of reserves that banks must hold against deposits
- increase in reserve requirements = banks must hold more reserves and therefore can lend out less of each euro deposited
- increase reserve ratio, decrease money multiplier and decrease monetary policy
Problems in controlling money supply
Central bank doesn’t control amount of money that households choose to hold as deposits in banks
Toxic debt
Mortgage backed securities and other debt (bonds) that aren’t able to be repaid in many cases because the value of the assets against which they’re secured have decreased significantly
