Money and Banking Flashcards
Money
The set of assets in an economy that people regularly use to buy goods and services from other people.
Double Coincidence of Wants
Limitations on economies as a result of transaction costs in a barter economy. Ex: Musician will play for free if it covers living expenses without needing money to “pay for rent”
Commodity Money*
Money that takes the form of a commodity with intrinsic value. Gold, silver, cattle, sheep, horses, assets
Fiat Money
Money without intrinsic value that is used as money because of a government decree
Medium of exchange
an item that buyers give to seller when tye want to purchase goods and services [typically something everybody accepts for exchange for all items; easily accessible
Unit of Account
The common way (common denominator) in which market values are measured in an economy.
Store of Value
An item that people can use to transfer purchasing power form the present to the future [something that holds its value]
Money Revisited
Severs society in three functions: medium of exchange, unit of account, store of value
Types of Money
Currency, Demand Deposits, Savings Deposits, Money Market Funds, Certificate of Deposit
Currency
The coins and paper bills in the hands of the public
Demand Deposits
Deposits in banks that are available by making a cash withdrawal or writing a check
Savings Deposits
Bank accounts where you can’t withdraw money by writing a check, but can withdraw the money at a bank - or can transfer it easily to a checking account
Money Market Funds
Where the deposits of many investors are pooled together and invested in a safe way like short-term government bonds
Certificate of Deposit (CD) - or Time Deposit
Mechanism for the saver to deposit funds at a bank and promise to leave them at the bank for a time, in exchange for a higher rate of interest.
Measuring Money
M0 - High powered money, M1, M2
M0
High powered money - Currency and bank reserves (cash held by banks; deposits held by commercial banks with central bank)
M1
A definition of the quantity of money (money “out there”) includes: currency, traveler’s checks, demand deposits, and other checking accounts
M2
Definition of the quantity of money that includes M1, but also savings deposits, money market funds, certificates of deposit
Financial Intermediary - Bank
An institution that operate between a saver with financial assets to invest and an entity who will receive those assets and pay a rate of return
Bank - Financial Intermediary Revenue and Expenses
Revenue: Interest payments, other fees and charges
Expenses: Interest payments to depositors; loans that are not repaid; operating costs- taxes, employees, equipment
Assets
Items of value by a firm or an individual
Liabilities
Amounts/Debts owned by a firm or an individual
Bond
Financial contract through which a borrower (corp, city, stage, fed) agrees to repay the amount that was borrowed and also a rate of interest over a period of time in the future
Reserves
Funds that a bank keeps on hand and that are not loaned out or invested in bonds
Net Worth
Total assets minus liabilities (bankruptcy if < 0)
Fractional-Reserve Banking
Banking system in which banks hold on a fraction of deposits as reserves
Reserve Ration
Fraction of deposits that banks hold as reserves
Reserve Ratio
Government policy through the reserve requirement
Bank policy when the bank decides to hold excess reserves above and beyond the reserve requirement
Money Multiplier
Amount of money the banking system generate with each dollar or reserves
Quantity of Money
Let R be the reserve rate in an economy
- Money Multiplier is the reciprocal of the reserve ration, 1/R
- Total quantity of money is the original quantity of reserves times 1/R
Quantity of Money Equation
Q(M) = Q(R) x 1/R
Bank Capital
Resource a bank’s owners have put into the institution
Leverage and Leverage Ratio
Leverage is the use of borrowed money to supplement existing funds for purposes of investment. The leverage ratio is the ratio of assets to bank capital
What are the three functions served by money?
Medium of exchange, unit of account, store of value
What distinguishes money form other assets in the economy?
The liquidity of money
What are demand deposits and why should they be included in the money supply?
Deposits in banks that are available by making a cash withdrawal or writing a check. Useable cash as well as money that the bank can loan out to borrowers.
How do banks create money?
Money multiplier effect and financial intermediary
Why don’t banks hold 100 percent reserves?
??? Money multiplier and can loan out deposits to earn interest and distribute that interest back to the depositors
What is the formula for money multiplier?
QMoney = QReserves x 1/Ratio
Role of the Federal Reserve
1Regulate banks and ensure the health of the banking system
2Control the quantity of money
Options to Control the Quantity of Money
1Open market operations
2Reserve requirements
3Lending to banks
4Quantitative easing
Open Market Operations
Increase or decrease quantity of money - Tool used most often
Increase money supply
Bond traders at New York Fed buy bonds from the public
Dollars the Fed pays increase the number of $ in the economy
Held as currency, bank deposits. Increases bank reserves and increases lending
Decrease money supply
Public pays in dollars, reducing hte number of $ in circulation
As people withdraw deposits from banks to pay for bonds, banks find themselves with lower reserves reducing their lending.
Reserve requirements
Affect the reserve ratio and thus the money multiplier
Rarely used as it disrupts the business for banking. With higher reserve requirements, banks will curtail lending until they have built up higher reserves
Lending to banks
Increase banks’ reserves by lending reserves to banks
Borrow at the discount rate
Fed can change the money supply by altering this discount rate
Quantitative Easing
Fed makes discount rate loans broadly available to many financial firms, not just to banks
Firms/banks bid for loans anonymously
Fed bouth financial securities directly MBS
Problems in Controlling Money supply
Fed does not cotrol the amount of money households choose to hold as bank deposits - More deposits, more money the banking sector can create (money multiplier)
- Less Money, lower reserves and less they will lend
Fed does not control the amount bankers choose to lend
Money Demand
An increase in Y causes an increase in money demand, other things equal. The money demand curve is downward sloping
How is a central bank different from a typical commercial bank?
Central bank does not receive interest, but sets the Fed bank rate
Explain how to use an open market operation, reserve requirements, and the discount rate to expand the money supply
Open Market Operation: Adjust monetary supply and allow market to react
Reserve Requirements: Adjust reserve requirements to alter money multiplier/change lending habits
Discount Rate: Adjust to alter reserves and money supply
Why can’t the Fed control the money supply perfectly?
Can’t control how the banks lend
Can’t control how the …..
Explain how the money supply affects the interest rate
Increase money supply and interest rate decreases - supply and demand
