Money and Banking Flashcards
What are the four functions of money?
- Medium of exchange - instead of a barter system you exchange money
- Store of value - the money will hold value into the future
- Unit of account - gives a value to trade-offs
- Standard of deferred payment - it will be accepted in the future to pay off purchases made today
What is a commodity-backed currency?
Currencies with values backed by gold, silver, or other commodity physically held at a bank
What is fiat money?
Fiat money has no intrinsic value. It is not backed by anything other than the universal faith and trust that the currency has value backed by legal decree from the government
What are the two definitions of money supply?
M1 - very liquid - cash, checks, cashiers checks, coins, and currency in circulation
M2 - not very liquid, you can withdraw them to spend but require effort to get - money in savings accounts, CD’s, money market funds
On a bank’s balance sheet, how does the T-account breakdown?
Left - Assets which is comprised of the current outstanding loans given, US government securities given, and the reserves on hand
Right - Liabilities and Net Worth
Liabilities = deposits made by customers
Net Worth = Assets - Liabilities
How does a bank go bankrupt?
Defaults on loans lowers the overall assets on the balance sheet leading to a negative net worth.
In other words, people don’t pay their loans and the bank has no way to repay the deposits made by its customers
What is the main driving factor of a bank going bankrupt, and what is a common term used to express this?
Asset-Liability Time Mismatch - a banks liabilities (customers deposits) can be withdrawn in the short term while the assets (loans to others) are repaid in the long run
commonly known as a bank run
What is the main goal behind bank diversity in markets, what impact does the diversity have on overall net worth, and what is the major dark cloud over the banking industry?
Banks will diversify their loans across all markets with varying repayment schedules to fight the asset-liability time mismatch.
The diversity in markets helps keep a positive net worth when specific industries face economic trouble and defaults.
The major dark cloud over the banking industry is a widespread macroeconomic recession
What is a money multiplier and what is the formula?
The money multiplier tells us how many times a loan will be multiplied and spent in the economy
money multiplier = 1 / reserve requirement
What is a reserve requirement?
The percentage of money required to be on hand at a bank compared to overall deposits
What is the two part structure to the federal reserve?
1 - Centralized - board of governors
2 - Decentralized - 12 reserve banks
What is the federal open market comity, who makes up the fmoc, and what is its main function?
It brings together the board of governors and the 12 reserve banks into a comity that meets 8 times a year
It is made up of 12 voting members; the entire 7 board of governors, and 5 annually rotating presidents from the 12 reserve banks
Their main function is to analyze economic conditions and vote on monetary policies based on these conditions
What is the board of governors, and who makes up the board of governors?
The board of governors oversees the entire federal reserve system.
It is made up of presidential electives who serve a 14-year term
What are the three tools of the central bank’s monetary policies?
Open market operations - buying/selling treasury bonds
Changing reserve requirements
Changing the discount rate
What is an open market operation?
When the central bank buys or sells US treasury bonds influencing the overall bank reserves at the current interest rate
How does changing the reserve requirements affect money supply?
If the fed raises reserve requirements then banks will have less money to lend out
If the fed lowers reserve requirements then banks will have more money to lend
What is the discount rate, and how does it affect the money supply and interest rates?
The discount rate is the interest rate that banks pay when they borrow money from the Federal Reserve
When the fed raises the discount rate, banks will reduce borrowing from the fed, reduce overall lending, leading to a decrease in the money supply and an increase in interest rates.
When the fed lowers the discount rate, banks will increase borrowing, increase overall lending, leading to an increase in money and a decrease in interest rates
What is a loose/expansionary monetary policy?
What is a tight/contractionary policy?
A policy that lowers interest rates and stimulates borrowing
A policy that raises rates and reduces borrowing
What happens to supply curves and demand curves of the financial market when there are changes in monetary policies?
With an expansionary policy the fed will lower the rate, causing a supply shift to the right, and a movement down along the demand curve to the higher quantity.
With a contractionary policy the fed will raise rates, causing a supply shift to the left, and a movement upwards along the demand curve to a lower quantity
What two factors of aggregate demand are affected with contractionary and expansionary monetary policies?
First, consumer spending will increase/decrease depending on the direction of interest rates
Second, business investments will follow the demand of consumer spending
If a country is producing over potential GDP and the market is seeing overwhelming inflationary pressures what type of monetary policy would be enacted, and what would happen to the AD curve, SRAS curve, and the overall price and money of the economy?
A contractionary monetary policy would be enacted. The fed would decrease the money supply in order to decrease consumer spending and make borrowing less attractive.
The SRAS curve would shift to the left and a movement up the AD curve to a higher equilibrium price and money supply
What is the velocity of money and what is the formula?
How quickly money circulates through an economy
Velocity = Nominal GDP / Money Supply
