The monetary system Flashcards
Define medium of exchange
An item that buyers give to sellers when they want to purchase goods and services. It is anything that is readily acceptable as payment
Define unit of account
The yardstick people use to post prices and record debts
Define store of value
An item that people can use to transfer purchasing power from the present to the future
Define liquidity
The ease with which an asset can be exchanged into the economy’s medium of exchange
Define commodity money
This is a form of commodity with intrinsic value such as gold or cigarettes
Define fiat money
This does not have intrinsic value
Give 3 examples of fiat money
Coins, currency, current account deposits
Why is fiat money used?
Because of government decree
Define currency
The paper bills and coins in the hands of the public
Define demand deposits
Balances in bank accounts that depositors can access on demand by writing a cheque or using a debit card
Define central bank
An institution designed to oversee the banking system and regulate the quantity of money in the economy
When is a central bank required?
Whenever an economy relies on fiat money
Define money supply
The quantity of money available in the economy
What happens when too much money is printed?
Prices tend to rise
Why is the regulation of money supply a crucially important task?
Because if too much money is printed, prices will rise
Define monetary policy
The set of actions taken by the central bank in order to affect the money supply
What is the European Central Bank?
This is the overall central bank of the 19 countries comprising the European Monetary Union
Why did the ECB come into being?
11 countries wanted to use the same currency and be part of the European Monetary Union
What is the main aim of the ECB?
Promote price stability throughout the euro area
What is an important feature of the ECB and the Eurosystem?
Independence
What is the Bank of England?
The central bank of the UK
What is the primary duty of the Bank of England?
To deliver price stability
What is different about the Bank of England compared to the ECB?
The Bank of England does not have the freedom to define for itself what is meant by price stability, this is done by the UK government
What is the Federal Reserve (Fed)?
The central bank of the USA
Who runs the Fed?
A Board of Governors, which has 7 members
Who appoints the 7 members of the Fed?
The US president
What two things can banks influence?
The quantity of demand deposits in the economy and the money supply
Define reserves
Deposits that banks have received but have not loaned out
What happens in a fractional-reserve banking system?
Banks hold a fraction of the money deposited as reserves and lend out the rest
Define reserve ratio?
This is the fraction of the deposits that banks hold as reserves
What happens to the money supply when a bank makes a loan from its reserves?
The money supply increases
What is the money supply affected by?
The amount deposited in the banks and the amount that banks loan
What are deposits into a bank recorded as?
Both assets and liabilities
What becomes an asset to a bank?
Loans
What does a T account show?
A banks deposits, loans and reserves
What can you work out from a T account?
The reserve ratio
How can you work out the reserve ratio from a T account?
Divide reserves by the total assets
What happens to the money that one bank loans?
The money is deposited into another bank which creates more deposits and reserves that are lent out
Define money mulitplier
The amount of money the banking system generates with each unit of reserves
How can you work out the money supply from the T accounts of multiple banks?
Add up each banks total assets
What are 3 main tools that a central bank has?
Open-market operations
Changing the market reserve requirement
Changing the refinancing rate
How does a central bank conduct open-market operations?
It does this buy buying government bonds from, or sells government bonds to the public
What happens when the central bank buys government bonds?
The money supply increases
What happens when the central bank sells government bonds?
The money supply decreases
What is the refinancing rate?
This is the interest rate the ECB lends on a short-term basis to the euro area banking sector
What happens to the money supply if the refinancing rate decreases?
The money supply increases
What happens to the money supply if the refinancing rate increases?
The money supply decreases
What is the refinancing rate called in the USA?
The discount rate
What is the refinancing rate called in the UK?
The repo rate
What are reserve requirements?
These are regulations on the minimum amount of reserves that banks must hold against deposits
What does increasing the reserve requirement do to the money supply?
It decreases the money supply
What does decreasing the reserve requirement do to the money supply?
It increases the money supply
How often are reserve requirements changed?
Very rarely
Which bank no longer sets reserve requirements?
The Bank of England
What are two problems for central banks because of fractional-reserve banking?
The central bank does not control the amount of money that households choose to hold as deposits in banks
The central bank does not control the amount of money bankers choose to lend
What does securitization do?
It takes loans off the balance sheet so that the banks does not have to set aside reserves to cover these loans, increasing the bank’s scope for increasing lending
Why did banks stop lending causing the 2008 credit crunch?
Mortgages were failing
