Money Flashcards
What is the definition of money?
= The set of assets in an economy that people regularly use to buy goods + services from other people
- Only includes the few types of wealth regularly accepted by sellers in exchange for goods and services
What are the 3 functions of money?
- Medium of exchange
- A unit of account
- A store of value
What is liquidity?
= The ease with which an asset can be converted into the economy’s medium of exchange
- Money is the most liquid asset available but is an imperfect store of value as if prices rise then value decreases
- Stocks and bonds are relatively liquid
What are the types of money?
- Commodity money
= a commodity with intrinsic value eg. gold - Fiat money
= No intrinsic value but established as money by gov’t decree depending on expectation and social convention
- Eg. paper notes
How is money in the economy measured?
Money stock = Qt of money circulating in the economy
- Currency is the paper notes and metal coins in circulation
- M0 = Currency in circulation + balances in B of E
- M1 (EU) = Currency in circulation + overnight deposits
What is the role of central banks?
= Regulate the money supply using ‘monetary policy’
- SR trade-off between inflation and unemployment
- Keep inflation at a stable rate
What are open-market operations?
= The purchase and sale of non-monetary assets to and from the banking sector
- Increase/decrease supply by creating currency and using it to buy/sell bonds from public
- Money supply effects price stability
The Bank of England
= Central bank of the Uk
- Has independence in setting interest rates which are announced monthly
- Freedom to use monetary policy to maintain price stability but the definition of what this is set by the gov’t
The European central bank and the Eurosystem
= Central to the EU monetary union for those which use the Euro
- Sets monetary policy with assistance from national banks in each country
- Does not take instruction from any gov’ts
- Decides desired inflation rates twice a month (2%)
Explain money creation with financial reserve banking
- The banking systems holds only a fraction of deposits as reserves (reserve ratio) this is determined through gov’t regulation and bank policy
- When banks make loans money supply increases but they do not create wealth as borrowers are still in debt
- Loans make the money supply more liquid and are and asset to the bank
Explain the money multiplier
= Amount generated with each euro of reserves
- If reserve ratio was 1/20 (5%) then banking system would have 20x more deposits than reserves and MM = 20 euros
- The higher the reserve ratio the smaller the money multiplier
What is a repurchase agreement (repo)?
= Special form of open-market operations which involves the CB buying bonds from commercial banks with an agreement to sell them back later
- The CB has effectively made a loan and taken the bonds as a form of security
- The difference between the price the bank sells them at and how much it buys them back for is the repo rate
- Commonly used when banks do not have sufficient reserves
What is the ‘money market’?
= The market for short-term (<2 wks) bank reserves
- CB monitors the liquidity of the economy as it significantly affects interests rates and will issue ‘repo’s’ if there is a shortage
- To ‘mop up liquidity’ CB will increase repo rate to discourage banks from doing so much lending
Explain quantitive easing
= Tactic by CB to boost the economy
- Will buy assets from commercial banks with electronic money which did not previously exist
- Increases banking reserves which stimulate’s lending and increases the MM
- CB has accumulated a large number of assets
What are the problems associated with controlling the money supply?
- CB cannot control how much households choose to deposit or how much banks choose to lend
- A loss of confidence in the economy leads to increased withdrawals and banks may not have enough reserves
- Caution by banks about economic conditions can cause it to hold excess reserves thus reducing the money in the economy
