Money market Flashcards
What are the 3 functions of money?
Unit of account - represents real value of economic items
Medium of exchange ( no need to barter nor double coincidence)
Store of value - holding wealth and transferring to purchasing power in future.
Narrow vs Broad money?
Narrow money - cash (notes and coins)
Broad - less liquid assets e.g deposits, short term debts, shares.
What is a bond? What relationship does it have with interest rates?
Pay a fixed amount in a definite future date. Negative relation with interest rate. AS price of bond increases, interest rate falls.
What is the formula for bond price?
Bond price = face value (total value repaid by borrower at end of period / 1 + interest rate.
What is money demand? What is it determined by?
The choice of holding money relative to other assets. Determined by the price level, real income (higher income= more cash needed so can buy more), decreasing level of interest rate
What shifts the money demand?
Changes in price level and income
How is the money supply determined and how is it shifted?
Central Bank controls the money supply and any changes to the supply side will shift it.
Where is the interest rate determined?
When the money market is in equilibrium - where money demand = money supply
What are a commercial banks assets and liabilities?
Assets - loans, reserves and other assets.
Liabilites - deposits, equity capital
What are the central banks assets and liabilites?
Assets - domestic and foreign assets
Liabilities - commercial bank reserves, money in circulation, equity capital
What is open market operations?
CB change money supply by buying/selling bonds in the market.
How would the CB conduct expansionary open market operations?
CB buys bonds from commercial banks or financial institutions to increase their liquidity by providing them with more funds and this increases the demand for bonds which decreases the interest rate.
What is the money multiplier?
For an extra unit of deposit, a fixed fraction has to be freezed of the reserve, the rest is used for lending which becomes loans for further deposits. Money multiplier = 1/ Required reserve ratio
Why does the money multiplier vary?
banks may hold more fixed assets if perceive higher risk, extra cash may be withdrawn from banks which decreases reserve ratio, banks may offer increased credit to match demand, customers may not take up all credit on offer.
What is the liquidity trap? What will happen to money demand?
Economy’s interest rate cant be reduced any further as at the lower zero bound. People will choose to hold cash as wont receive interest on saving - this increases money demand
