Money, inflation and the Monetary system

Question 1

What is money?

Answer 1

the set of assets in an economy that people regularly use to buy goods and services

Question 2

Money does not equal

Answer 2

wealth

Question 3

What is liquidity?

Answer 3

the ease at which as asset can be converted into the economy’s medium of exchange

Question 4

What is the most liquid asset? Why is this?

Answer 4

money

because it is the economy’s medium of exchange

Question 5

What are the four functions of money?

Answer 5

1. medium of exchange
2. a unit of account/measure of value (ie. prices as expressed as money)
3. store of value
4. standard of deferred payment

Question 6

What are three types of money?

Answer 6

Commodity money
commodity-backed paper money
fiat money

Question 7

What is commodity money?

Answer 7

takes the firm of a commodity with intrinsic value eg. gold

Question 8

What is commodity-back paper money?

Answer 8

paper money that exchanges for a fixed quantity of a commodity of intrinsic value eg. every US dollar is backed by an amount of gold

Question 9

What is fiat money?

Answer 9

money without intrinsic value that is used as a money because of government decree eg. no intrinsic value in the NZ paper so $100 is $100 worth of value

Question 10

Who determines the money supply in the economy?

Answer 10

the banking system

Question 11

What four things does the RBNZ aggregate?

Answer 11

1. notes and coins held by the public (the monetary base)
2. M1 - notes and coins plus transaction account balances - chequable, EFTPOS or sweep account deposits - the most liquid part of the money supply
3. M2 - all call deposits (includes M1)
4. M3 - all funding ie. deposits (M1 and M2 plus stuff in a term deposit) money here is more of a store of value than a medium of exchange

Question 12

What is the fraction of deposits held by commercial banks called and what is the purpose of this?

Answer 12

Commercial banks only hold a fraction of deposits as reserves. Not all depositors (the general public) will withdraw their money at the same time, so banks only keep a fraction of deposits in reserve and lend out the rest. The fraction of deposits held by commercial banks is the reserve ratio

Question 13

What is a commercial bank’s optimal reserve ratio determined by?

Answer 13

• the OCR
• market interest rate
• other things

Question 14

By choosing their optimal reserve ratio, commercial banks have an impact on a economy’s…

Answer 14

money supply

Question 15

What is settlement cash?

Answer 15

This is money held by banks in settlement cash accounts which the trading banks can deal with each others transactions at the end of each trading day

Question 16

Where do trading banks hold a settlement cash account?

Answer 16

with the reserve bank