Monetary System Flashcards
Define Money
Set of Assets in an Economy, used Regularly to buy G+S
- It is a Liquid Asset
What are the 3 main Functions of Money?
- Medium of Exchange
- Unit of Account
- Store of Value
Define Medium of Exchange
Item Buyers give to Sellers in exchange for G+S
Define Unit of Account
Measure of Economic Value
- Represents Value of G+S
- Records Debts
Define Store of Value
Can retain its Purchasing Power
Define Liquidity
Ease an Asset can be Converted into the Economy’s Medium of Exchange
What is the most Liquid Asset?
Money = Medium of Exchange
What is the general relationship between Liquidity + Return
Higher Liquidity –> Lower Return
What are the 2 main Kinds of Money?
Commodity Money + Fiat Money
What is Commodity Money?
Money in the form of a Commodity with Intrinsic Value
- e.g. Gold, Paper Money convertible to Gold on Demand
- Cigarettes + Phone cards in Prison
What is Fiat Money?
Money with NO Intrinsic Value
- Requires people’s Trust- Loses Value without it
- If Trusted– No Gov. necessary- e.g. Bitcoin
What is Money Stock?
Quantity of Money circulating the Economy
- Includes: Paper Bills + Coins in hands of Public + Demand Deposits
Define Demand Deposits?
Balances in Bank accounts Depositors can access on Demand
What are the 2 main measures of Money Stock?
M1 + M2
What is M1?
- Currency in Circulation
- Demand Deposits
- Other checkable deposits
What is M2?
- M1
- Savings Deposits (Short term)
- Money Market Mutual Funds
- Other categories
What do Central Banks regulate?
Fiat Currencies
- e.g. BoE, Fed. Res., ECB
Define Central Bank
Legal Entity with Authority to:
- Oversee Banking System
- Regulate Money Supply
What happens if too much money is printed?
Price Levels RISE–> Inflation
What do I.R / Money Supply affect?
Economic Activity + Unemployment
Why is Monetary Policy Important?
There is a TRADE OFF between Economic Activity / Unemployment + Inflation
How does a Fall in I.R affect the Economy?
Inflation- bad
Increased Production–> Lower Unemployment in SR
What is QE?
Quantitative Easing
Unconventional Monetary Policy
Jan 2010- MPC authorised purchase of £200 bn worth of Assets
–> Decreases I.R–> Increased C + I –> Increased AD
=> BUT Increased Inflation
How do Banks influence the Money Supply?
Reserves
What are Reserves?
Deposits Banks have received but NOT Loaned out
What is 100% Reserve Banking?
ALL Deposits held as Reserves
What is Fractional-Reserve Banking?
Banks holds a Fraction of Deposits as Reserves
–> Loan out remainder + earn Return on their Assets
What is the Reserve Ratio?
Fraction of Deposits Banks MUST hold as Reserves
– In case Depositors want to Withdraw their Cash
What is the Reserve Requirement
Minimum amount of Reserves Banks MUST hold in C.B
What are Excess Reserves?
Reserves Banks hold above the Legal Minimum
What is the Money Multiplier?
Amount of Money Banking System generates from Reserves
1 / rr
How does the Reserve Ratio affect the Money Multiplier?
Increased rr –> Lower m
Given the Money Multiplier, how do you find the Final level of Money?
Initial Deposit x 1/rr
= Initial Deposit x m
New Money Created = Final level of Money - Initial Deposit
What are the 3 main tools C.B uses for Monetary Control?
- Open Market Operations
- Refinancing Rate
- Reserve Requirement
What are Open Market Operations?
Purchase + Sale of Gov. Bonds by the C.B
How does the C.B Increase M.S using OMOs?
C.B buys Gov. Bonds from Public–> Increased Money in hands of Public
How does the C.B Decrease M.S using OMOs?
C.B sells Gov. Bonds to Public–> Decreased Money in hands of Public
What is the Refinancing Rate?
I.R at which C.B lends to Commercial Banks on a Short-Term basis
- C.B controls I.R in Money Market–> Affects Retail I.R
How does the C.B Increase M.S using Ref. Rate?
Decrease Ref. Rate–> Increased Borrowing
How does the C.B Decrease M.S using Ref. Rate?
Increase Ref. Rate–> Decreased Borrowing
What is the Reserve Requirement?
Regulations on Min amount of Reserves banks MUST hold against Deposits
How does C.B Decrease M.S using Reserve Requirement?
Increase Reserve Requirement–> Lower Multiplier–> Lower M.S
How does C.B Increase M.S using Reserve Requirement?
Decrease Reserve Requirement–> Higher Multiplier–> Higher M.S
What are the main problems with Monetary Policy?
- C.Bs control of M.S NOT Precise- Fractional Reserve Banking affects Money Multiplier
- C.Bs do NOT choose how much Households deposit in Banks
- Unable to control how much Banks lend than keep as Reserves
