Money and Banking Flashcards
what is the price level
the overall rate of prices in an economy, measured by GDP deflator or consumer price index
what is consumer price index
measuring of the prices that matter to consumers eg groceries, education, household goods
doesnt include tech goods, pharmaceutical goods produced in a country unlikee GDP
what is inflation
the steady rise of prices over time
what does nominal mean
the total value of transactions
what does real mean
total value of transactions, controlling changes in price
how to calculate GDP deflator
nominal GDP / real GDP * 100
in the base year what will the GDP deflator always be
100
what is wealth
any value that is stored up
example of stock wealth
loans, site of land, share in a firm
example of flow wealth
interest payments, rent, income
what are the 2 types of financial systems
financial market
financial intermediaries
what do financial systems do
match one persons savings with another persons investment
example of financial market
stock and bond market
direct interaction between savers and borrowers
example of financial intermediaries
banks
indirect interaction between savers and borrowers
4 main forms of financial wealth
property and real estate
equities
bonds
cash
what is an equity
partial ownership in a public firm
what is the most liquid form of wealth
cash
some unusual forms of wealth that are difficult to measyre
art
cars
natural materials
define money
the assets in an economy that people regularly use to buy goods and services
3 functions of money
medium of exchange
unit of account
store of value
what does it mean to be a medium of exchange
turn your stock of wealth into everyday good and services
what does it mean to be a unit of account
measureable
what does it mean to be a store of value
purchasing power from present to future exists, ie £1 of money is worth £1 in futre
why might bitCoin not be considered money
it isn’t a medium of exchange
too volatile to be a store of value
what is fractional reserve banking
banks hold a fraction of the deposits and lend out the rest
what are liabilities in banks
depsoits, what the bank owes people
what are assets in banks
loans, what the people owe the bank
what is a reserve rati
the fraction of deposits that the bank holds as reserves
formula for money multiplier
1/r
who controls the reserve ratio
the central bank
control of supply of money
what is a credit risk
the probability that the borrower will fail to pay some of the interest or principle
what is sovereign debt
when governments borrow money to finance public spendinf
what does it mean when a form of wealth has intrinsic value
the item would have value even if not used as money eg gold, jewellery
what is fiat money
money that doesn;t have intrinsic value and is only used as money because the government says sp
what is money stock
the quantity of money circulating in the economy
what are central banks
institutions designed to regulate the quantity of money in the economy
what is monetary policy
set of actions taken by the central bank to affect the money supply
if the interest rate is higher, do people want to save or spend their money
save
increase opportunity cost in holding money
Demand of money depends on what
interest rates
what is the relationship between interest rates and demand for money
negative relationship
as interest rates go up, demand for money falls as people don’t want to hold as much money
what is the central bank in America called
Federal reserve
what is the central bank in europe called
European central bank
what are the three main tools that central banks use to affect money supply
- changing reserve ratio
- changing the refinancing rate
- open market operations
when there is a higher reserve ratio, is more or less money created
less
what is the refinancing rate
the rate at which the central bank lends to the private banks
does a higher refinancing rate increase or decrease money supply
decrease as it is harder to borrow money
how can the central bank take money out of circulation
selling government bonds in exchange for cash
how can the central bank put more money into circulation
buying government bonds in exchange for cash
two main roles of central bank
- price stability (keeping inflation low)
2. smoothing cycles
what percentage do central banks like to keep inflation at
2%
can interest rate affect GDP
yes
how does interest rate affect GDP
GDP = C(r) + I(r) + G(r) + NX(r)
r reflects cost of borrowing, borrowing is cheaper when r is low and more expensive when r is high
when interest rates fall does aggregate demand increse or decrease
increase
what is the dual mandate of the FED
price stability & full employment
why might a dual mandate be diffciult
increasing output and lowering unemployment means there must be a rise in prices
but a rise in prices goes against the price stability mandadte
the reverse is also truewha
what is helicopter money
unlimited money supply continues to be dropped into the economy
why are interest rates cut during a crisis
encourages borrowing and investing
will shift AD curve out
in aim to bring back to long run gowth
what is a zero lower bound
when the CB are limited in reducing the interest rate because they cannot have a negative interest rate
what is the money multiplier
how much money the banking system can create with each euro of reserves
where is ECB HQ
Frankfurt, Germany
if the CB wanted to increase the money supply, how would they change reserve requirements
decrease reserve requirement
if the CB wanted to decrease the money supply, how would they change reserve requirements
increase reserve requirement
what is the discount rate./ policy rate
the rate at which the CB lends to the private banks
if the CB wanted to decrease the money supply, how would they change discount rates
increase discount rate
if the CB wanted to increase the money supply, how would they change discount rates
decrease discount rates making it eaier to borrow
in an expansionary period, why is there a low interest rate
cheaper to borrow ==
more investment
more consumption
does monetary policy work in the long run
no, monetary policy only deals with the short run
what happens to AD when bubbles pop
shifts to the left
what is a deficit
Spending more money than generated in revenue
what is debt
accumulation of defecits
what can help slow down debt
surplus
should debt be looked at on its own or as a percentage of GDP
as a percentage of GDP, making it easier to compare countries
what does the ECB say the debt percentage of GDP is too high
60%
how can debt be decreased using fiscal policy
increase taxes use government revenue to reduce deficit (eg USCI) cut government spending bailout options
when is debt sustainable
if the growth rate of the economy is greater than the interest rate
what is the emergency European Stability Mechanism
the EU restructures loans at a much lower interest rate
Describe a change in the tax system that might increase private saving.
To encourage people to invest in a pension early by offering a certain growth percentage on pension savings through the government would mean the government would have to spend less on state pensions
is supply of money elastic
no inelastic
how many member states in ECB
27
Why is it important for central banks to maintain price stability
economy works best when prices are stable
if prices are constantly falling and rising, peeople will wait for prices to fall before they buy goods and services
