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Macro Economics > Topic 5 - Money, Banking and the Financial System > Flashcards

Topic 5 - Money, Banking and the Financial System Flashcards

1
Q

5.01 - What is money?

A

Money is anything that performs the function of money. It is what it does.

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2
Q

5.02 - What are the three functions of money?

A

1) medium of exchange - used to buy & sell
2) unit of account - used to measure relative worth
3) store of value - store wealth (liquid and convenient)

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3
Q

5.03 - What are the two official measures of money in Australia?

A

M3 & Broad Money

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4
Q

5.04 - what is M3 the sum of?

A
  • Currency (coins and notes)
  • Current deposits (in banks on which cheques can be drawn)
  • Other deposits (non current accounts such as savings (ADIs))
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5
Q

5.05 - What is Broad money?

A

It is M3 plus the non-deposit borrowings from the private non-financial sector by all financial institutions (AFI) less holdings of currency and bank deposits by registered financial corps (RFCs) and cash management trusts.

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6
Q

5.06 - What is currency?

A

Is the coin and note components of money supply.

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7
Q

5.07 - What are the two forms of money supply in Australia?

A

Token money - coins in supply

Currency - Coin and notes

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8
Q

5.08 - What is token money?

A

It is a term that refers to money for which the intrinsic value of the commodity used to hold the monetary unit is less than the recorded value of the money.

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9
Q

5.09 - What are current deposits?

A

They are deposits in banks on which cheques can be drawn.

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10
Q

5.10 - What are three important functions of a cheque?

A
  • they enable ownership to be transferred
  • they are acceptable as a medium of exchange
  • they can be readily converted into currency.
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11
Q

5.11 - What are non-current deposits (or other ADI deposits)?

A

They are certain highly liquid financial assets that can be readily converted into currency or current deposits or transferred as payment for goods and services.

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12
Q

5.12 - What is included as a non-current deposit?

A
  • savings and term deposits (non-cheque book accounts)
  • credit unions & building societies (CUBs)
  • specialist credit card institutions (SCCIs)
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13
Q

5.13 - What is a new technology that has increased the importance of non-current deposits?

A

EFTPOS

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14
Q

5.14 - Which is the preferred measure of money, M3 or Broad Money and why?

A

M3 because it is directly and immediately useable as a medium of exchange

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15
Q

5.15 - Why are some currency and deposits excluded from M3?

A

Because thy are owned by the government and this avoids overstating the money supply and because money in the possession of households and businesses is more relevant to the level of spending in the economy.

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16
Q

5.16 - Some components of M3 and / or broad money are described as less ‘money-like’ than other forms? What is this and why?

A

Term deposits etc because they are less liquid and cannot be used immediately.

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17
Q

5.17 - What are credit cards?

A

They are not money, they are simply a convenient method of receiving a short term loan and facilitate the synchronisation of receipts and expenditures reducing the demand for cash.

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18
Q

5.18 - What is the monetary base? and what is its other name?

A

The monetary base (or high-powered money) refers to the net monetary liabilities of the government to the non-bank public and banks in the form of:

  • currency held by the public
  • currency held by the banks
  • band’s demand deposits with the RBA
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19
Q

5.19 - How is Australia’s money supply backed?

A

By the amount of G&S that money will purchase - not linked to precious metals. Australia’s notes and deposits have no intrinsic value.

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20
Q

5.20 - Why is money valuable?

A
  • It is accepted as money
  • It is legal tender
  • It has relative scarcity
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21
Q

5.21 - what is the real value or purchasing power of money?

A

Is the amount of goods and services a unit of money will buy.

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22
Q

5.22 - What sort of relationship exists between the general price level and the value of the dollar?

A

A reciprocal relationship.

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23
Q

5.23 - What are the Government’s tools in managing its responsibility to stabilise the value of money?

A
  • Appropriate fiscal policy

* intelligent management of monetary conditions

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24
Q

5.24 - The demand for money is the demand for real money balance. What are the two reasons why people demand money?

A
  • Transaction demand (Dt) - as a medium of exchange

* Asset demand (Da) - as a financial asset and store of wealth.

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25
Q

5.25 - How does Dt vary and because of this how is the demand curve drawn?

A

It varies directly with nominal GDP, reflecting both the number and average value of transactions conducted throughout the economy. So the level of demand depends on money GDP (not interest rates). The money demand curve is vertical.

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26
Q

5.26 - How does Da vary and because of this how is the demand curve drawn?

A

It varies inversely with the interest rate on bonds, which represents the opportunity cost of holding money in terms of the interest forgone. The asset demand has a down sloping money demand curve.

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27
Q

5.27 - What is Dm?

A

Total demand for money - that is transactions demand and assets demand are added horizontally. Changes in interest rates lead to movement along the curve. Anything that changes money GDP leads to a shift in the money demand curve.

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28
Q

5.28 - How is the money market represented?

A

Total demand for money (Dm) combined with the total money supply.

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29
Q

5.29 - Where the total supply for money is vertical or upsloping, what can we tell?

A

Where the equilibrium interest rates are - they are determined at the point where the total demand for money equates to the supply of money. (ie)

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30
Q

5.30 - What does the interest rate represent?

A

The opportunity cost of holding money balances.

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31
Q

5.31 - What is the Australian financial system comprised of?

A
  • The Reserve Bank of Australia
  • The banks
  • Financial Intermediaries
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32
Q

5.32 - What legislation sets out the Reserve Bank of Australia’s responsibilities?

A

REserve Bank Act 1959

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33
Q

5.33 - What are the main functions of the Reserve Bank of Australia under the Reserve Bank Act 1959?

A
  • control of note issue
  • act as banker to the banks
  • Act as banker to the government
  • Manage the international means of payment (foreign exchange)
  • direct monetary management of the interests of the economy (monetary policy)
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34
Q

5.34 - How does the RBA act as banker to the banks?

A
  • through exchange settlement accounts and non-callable deposits.
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35
Q

5.35 - What are exchange settlement accounts?

A

These are accounts kept by the banks ( and ADIs) with the RBA to settle debts owing to other banks which arise as a result of the exchange of cheques and to provide funds on which to draw additional notes and coin.

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36
Q

5.36 - What functions do the banks have?

A
  • accept money deposits
  • make loans
  • provide cheque paying and other account transfer facilities
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37
Q

5.37 - What is the outcome of banks lending?

A

By lending, the banks create deposits and therefore are money-creating institutions.

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38
Q

5.38 - What are the NBFIs? and what is the largest in this group?

A

They are the non-bank financial institutions and the larges is superannuation funds.

39
Q

5.39 - What is the balance sheet?

A

It is a statement of assets and claims that summarises the financial position of a firm at a point in time.

40
Q

5.40 - What is the equation for a balance sheet?

A

Assets = liabilities + net worth

41
Q

5.41 - What are the first three transactions in the formation of a bank?

A

1) The birth of a bank - shares are sold
2) Becoming a going concern - acquire property & equipment
3) Accepting deposits

42
Q

5.42 - What are the names given to the cash held by a bank?

A

Vault cash or till money

43
Q

5.43 - What are the two functions of a bank?

A

Accept deposits and make loans

44
Q

5.44 - What are the final four transactions in the formation of a bank

A

4) Setting aside the required reserves
5) A cheque is drawn against the bank
6) Granting a loan
7) Buying government bonds

45
Q

5.45 - What is the required reserve ratio?

A

It is the ratio of reserves to deposits required to meet official liquidity requirements and additional requirements determined by normal banking practice.

46
Q

5.46 - How do we calculate the reserve ratio?

A

Reserve ratio = banks required reserves / banks deposit liabilities

47
Q

5.47 - What is the conflict of the banks?

A

They are motivated by profits, so loans and bonds are very attractive, but a bank must also be cautious and seek safety to ensure liquidity.

48
Q

5.48 - How much can the banking system as a whole lend by? and why?

A

A multiple of its excess reserves because it cannot lose reserves - even though individual banks can lose reserves to other banks in the system.

49
Q

5.49 - What is the multiple by which the banking system can lend to? and what is it known as?

A

The reciprocal of the target or required reserve ratio. This is known as the money multiplier.

50
Q

5.50 - What is another name for the money multiplier? and what does the money multiplier show?

A

The deposit, credit or monetary multiplier is the reciprocal of the required reserve ratio, showing the maximum number of new dollars of deposits that can be created for a single dollar of excess reserves.

51
Q

5.51 - What is the formula for the money multiplier?

A

money multiplier = 1/reserve ratio or m=1/R

52
Q

5.52 - What is the formula for maximum current deposit expansion?

A

maximum current deposit expansion (D) = excess reserves (E) x money multiplier (m)

53
Q

5.53 - What is the multiple-deposit contraction?

A

This is where the multiple credit expansion process is reversed and leads to a multiple reduction in the level of deposits and hence the supply of money if reserves are withdrawn.

54
Q

5.54 - What are the complications to the quantitative preciseness of the money multiplier and the reserves?

A
  • Current Australian system - the required reserve ratio is not precisely set and differs for each bank
  • Possible leakages
  • Willingness to borrow
55
Q

5.55 - What is the reserve ratio based on?

A

The level of prime assets that are to be held by the banks against their liabilities. The Prime Asset Ratio (PAR)

56
Q

5.56 - How is the PAR for each bank set?

A

By way of negotiation between APRA and each bank, and considers the bank’s total liabilities and requires this portion to be held in a highly liquid form.

57
Q

5.57 - Banks must have a liquidity policy statement. What factors are considered in a liquidity policy?

A
  • the size and nature of the banks operations
  • the banks standing in markets
  • liability diversification in particular the bank’s contingency plans for sourcing funds during crises.
58
Q

5.58 - What is capital adequacy refer to?

A

The ability to make claims against shareholders sufficient to cover losses should the bank be liquidated.

59
Q

5.59 - What is the current level of capital adequacy?

A

Maintain financial capital requirement equivalent to 8% of their risk weighted assets.

60
Q

5.60 - What are the possible leakages for a bank other than those to excess reserves?

A
  • currency drains - loan may be made in cash and remain in circulation
  • transfer of deposits to non-bank financial institutions
  • excess reserves - individual banks may choose to have larger reserves than required.
61
Q

5.61 - What is the complication in relation to willingness to borrow?

A

For the full multiplier effect to take place:

  • borrowers must be willing and able to utilise the loans
  • borrowing is likely to be low during a recession.
62
Q

5.62 - How do the banks contribute to the state of the economy?

A

By holding back credit or by lending, they contract or stimulate economic growth through enabling business investment.

63
Q

5.63 - What is monetary policy?

A

Monetary policy represents actions by the RBA that influence interest rates and creditability to assist in stabilising real GDP, employment and the price level.

64
Q

5.64 - What is the fundamental objectives of monetary policy?

A

To assist the economy to achieve a full employment and non-inflationary level of total output.

65
Q

5.65 - What is the cause-effect chain between monetary policy and economic activity?

A
  • RBA sets cash rate on ESAs
  • money supply impacts short-term interest rates
  • interest rates affect investment
  • investment is a component of aggregate demand
  • equilibrium GDP is changed
66
Q

5.66 - What are the two types of monetary policy that are caused by the RBA’s actions?

A

Easy money policy - RBA reduces cash rate - lower cost of & increase availability of bank credit - expand spending & GDP
Tight money policy - RBA increases cash rate - higher cost of & decrease availability of bank credit - contract spending & GDP

67
Q

5.67 - What are the major assets of the RBA?

A
  • Gold and foreign exchange
  • Government securities
  • Treasury notes
68
Q

5.68 - What are the major liabilities of the RBA?

A
  • Notes on issue
  • Non-callaable deposits
  • Exchange settlement accounts
69
Q

5.69 - What is an exchange settlement account?

A

It is an account kept by banks with the RBA to settle debts owing to other banks which arise as a result of the exchange of cheques and to provide funds on which to draw additional coins and notes.

70
Q

5.70 - What else does the cause-effect chain of monetary policy cover?

A
  • the impact of flow of funds to and from Govt accounts

* the need for Banks to maintain a positive balance in their ESA with the RBA

71
Q

5.71 - What may a bank do to ensure their ESA stays positive?

A
  • borrow funds from other banks
  • trade in government securities
  • trade in repurchase agreements (repos)
72
Q

5.72 - What are repos?

A

Repurchase agreements are agreements that detail the price, timing and conditions under which the banks and the RBA may exchange government securities.

73
Q

5.73 - Balances in an ESA will will shift, why?

A

they shift reflecting on a number of supply and demand factors including inflows and outflows of funds associated with Commonwealth Welfare payments and tax collections.

74
Q

5.74 - What is the yield curve?

A

It is a summary of the interest rates that apply at a given point in time to interest-bearing securities of similar credit quality, but different terms of maturity.

75
Q

5.75 - What does the yield curve provide us?

A

With a maturity profile of interest rates in the economy and the link between the cash rate and other short term rates.

76
Q

5.76 - What are the two major (and one not so major) tool of monetary policy used by the RBA to determine the cash rate?

A
  • Open market operations (OMOs)
  • Foreign exchange swaps and intervention in the foreign exchange market.
  • its rediscount rate on government securities
77
Q

5.77 - What are OMOs?

A

They are the buying and selling of government securities by the RBA in the cash or short term money market.

78
Q

5.78 - What is the goal, the RBA seeks to achieve in using expansionary or contractionary monetary policy?

A

To ensure that the demand for and supply of ESA funds are in equilibrium at the governments target cash rate.

79
Q

5.79 - What is the objective of the open-market operations? and what does this involve?

A

To ensure that the demand and supply of ESA funds are such that they are in balance at the target cash rate.
It involves the purchase or sale of government securities either directly or under repos.

80
Q

5.80 - How does the sale/purchase of government securities (directly or repos) affect the cash rate?

A
  • Sales lead to a reduction in the supply of ESA funds to the banks
  • Purchases lead to an increase in the supply to the banks
81
Q

5.81 - How can the public get an indication of the RBA’s monetary policy?

A
  • Sustained increases in cash rate target level - indicate a tightening of monetary policy
  • Sustained decreases in cash rate target level - indicate an easing of monetary policy
82
Q

5.82 - What is the process for OMOs buying securities?

A
  • Banks sell some of their securities
  • RBA pays for securities by increasing the banks ESAs (which form part of the PAR requirement
  • Banks reserves increase - causing the monetary base and banks lending ability to increase.
83
Q

5.83 - What is the target cash rate?

A

It is the target of monetary policy and the RBA acts as a monopoly supplier of the ESA funds to ensure the target cash rate is in line with its monetary policy.

84
Q

5.84 - How does the RBA use foreign exchange swaps in monetary policy?

A

They enter into a swap that involves selling foreign currency for Australian dollars, this supplements or substitutes for its OMOs

85
Q

5.85 - What is the rediscount rate?

A

It is the rate at which the RBA buys or sells short-term securities under a repurchase agreement.

86
Q

5.86 - What are the two complications associated with the operation of monetary policy?

A
  • Policy effectiveness

* feedback effect

87
Q

5.87 - What does policy effectiveness refer to?

A

The implication of the shapes of the money demand curve and the investment demand curve and the potential for shifts in these curves (around an initial equilibrium interest-rate-money or interest-rate-investment position)

88
Q

5.88 - How is an in-elastic money demand curve represented? and what does it affect?

A

It is a relatively steep curve and shows the greater the increase in the cost of investment funds.

89
Q

5.89 - What is the feedback effect?

A

It is a feedback from monetary policy to the demand for investment funds which occurs because of the changes in GDP on company profits also affect their investment plans.

90
Q

5.90 - what other additional complications can affect monetary policy in an open economy?

A
  • External shocks

* net export effect

91
Q

5.91 - What is the net export effect?

A

It is the exchange-rate induced change in aggregate demand associated with changes in the interest rate. eg An increase in interest rates appreciate the currency, resulting in lower net exports.

92
Q

5.92 - What are the shortcomings of monetary policy?

A
  • Cyclical asymmetry
  • the potential for conflict with Treasury goals
  • The potential ineffectiveness of monetary policy against cost-push inflation
  • Questions about its actual impact on investment.
93
Q

5.93 - What does cyclical asymmetry imply?

A

That although a tight monetary policy will reduce activity, a lack of confidence in the private sector may reduce the effectiveness of easy monetary policy.

94
Q

5.94 - What are the strengths of monetary policy?

A
  • The speed and flexibility with which it may be implemented compared with fiscal policy.
  • Its political acceptability because of its broad impact.

Macro Economics (7 decks)

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