topic 4 Flashcards
What is money?
stock of assets readily used to make transactions
4 functions of money?
medium of exchange
unit of account
store of value
standard of deferred payment
What is fiat money?
currency a government has declared as legal tender, but is not backed by a physical commodity (eg. gold)
What is commodity money?
money whose value comes from a commodity by which it is made
2 official measures of money supply?
M0 - narrow money
M4 - broad money (money supply)
What is M0?
Narrow money - level of notes and coins in circulation and banks operational balances at the bank of england
What is M4?
broad money = the money supply
M0 + bank accounts
Money supply = ?
currency + demand deposits
What are reserves?
Portion of deposits that banks have not lent
What is a 100-percent-reserve banking system?
A system in which banks hold all deposits as reserves
What is fractional reserve banking?
A system in which banks hold a fraction of their deposits as reserves
See notes
Scenario 1,2&3
Equation to calculate total money supply?
Total money supply = original money x 1/rr
Where rr = ratio of reserves to deposits (ie. if banks hold 20% of reserves then rr=0.2)
3 parts of model of money supply?
Monetary base
Reserve deposit ratio
Currency deposit ratio
Equation for monetary base and what it depends on?
B=C+R
where B=monetary base, C= currency, R=reserves
controlled by central bank
Equation for reserve deposit ratio and what it depends on?
rr=R/D
D=deposits
depends on banks regulations and policies
Equation for currency deposit ratio and what it depends on?
cr=C/D
depends on household’s preferences
See solving for money supply in notes
Now
What is the money multiplier?
the increase in money supply resulting from a one pound increase in the monetary base
3 equations for money multiplier?
1) m=(cr+1)/(cr+rr)
2) M=mB
3) (change in M)=m x (change in B)
How can central banks change the monetary base? (and explanations) (2)
1) Open market operations = buying and selling government securities in the Open Market in order to expand or contract the amount of money in the banking system
2) The discount rate = the interest rate the Fed charges on loans to banks
How can central banks change the reserve deposit ratio? (2) (and explanations)
1) Reserve requirements = minimum reserve-deposit ratio set by the Fed
2) Interest rate on reserves = the interest the Fed pays on bank’s deposits with them
What happens if households change the currency-deposit ratio?
it causes changes in m and M
What happens if banks change their reserve amounts?
it causes changes in rr, m and M
