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ECON1021 - Macro > Topic 6 - Money and Banking > Flashcards

Topic 6 - Money and Banking Flashcards

1
Q

What limits the store of value property of money

A
  • Inflation, if inflation is high, then money is worth considerably less
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2
Q

What is money

A
  • Primary means of payment
  • Means of exchange
  • Store of value
  • Unit of account
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3
Q

What does it mean for money to be a “unit of account”

A
  • Money is in the same units as the goods and services we buy, so there is no exchange rate or price risk
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4
Q

What does UK money consist of

A
  • Currency, notes and coins
  • Deposits, in banks and building societies
  • Deposits are money, that can be easily converted into currency and can settle debts
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5
Q

What is not classed as money

A
  • Cheques and Credit cards
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6
Q

What is the official measure of UK money supply and how is it calculated

A
  • M4 = C + D
  • Where C is currency held by the public and D is deposits of customers in UK banks
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7
Q

What is money mostly made up of

A
  • Deposits
  • BoE cannot directly control this!
  • Deposits depend on the banks willingness to loan, and the demand of consumers/firms for loans
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8
Q

How would a family needing a £1million loan for a mortgage increase M4

A
  • The bank credits £1million to the customers account to then be payed over a time period
  • This money is then deposited in a bank
  • Therefore M4 increases
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9
Q

How can M4 fall

A
  • As bank loans are repaid, deposits decrease
  • If more loans are repaid than originated, M4 falls
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10
Q

What does the money market consist of

A
  • Demand for money by households and firms
  • Supply of money by BoE and commercial banks
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11
Q

What does money creation achieve

A
  • Money creation makes financial capital more plentiful
  • More purchasing power and increased supply of loanable funds
  • This means the price of money will fall, therefore excessive money creation can lead to financial crisis
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12
Q

What are banks and why are they crucial

A
  • Banks are monetary financial institutions
  • They loan to households and firms, Take in deposits and Electronic payments
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13
Q

What makes banks risky

A
  • Banks are said to “borrow short, lend long”
  • In short, meaning that banks take on deposits and pay interest and lend to indivduals and firms, earning interest
  • “Maturity Mismatch”
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14
Q

How is bank profit calculated

A
  • Profit = rl * L - rd * D
  • Where rl is loan interest and rd is deposit interest
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15
Q

What is the profit margin on a new loan

A
  • Profit margin = rl - rd
  • Banks must earn more on loans than paid on deposits
  • rl > rd => Profit > 0
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16
Q

What are the challenges for banks trying to make profit

A
  • Not all bank loans will be repaid
  • There are costs on top of interest paid on deposits
17
Q

Why do banks hold liquid cash

A
  • Liquid assets like long term loans cannot be used to meet demand for cash
  • So liquid cash must be hold to meet demand
18
Q

What are the two types of liquid assets banks hold

A
  • Cash and Bonds, usually short-term gov bonds (gilts)
  • Reserves, commercial bank deposits at BoE
19
Q

What does a balance sheet show

A
  • Assets, Liability and Capital
20
Q

What two problems can arise if banks are run poorly

A
  • Bank Runs
  • Insolvency
21
Q

What causes a bank run

A
  • Belief or evidence shows bank is in financial difficulty
  • Many customers withdraw deposits as they want their money now
  • Deposits are invested elsewhere, if bank does not have enough reserves they cannot pay all withdrawals
  • illiquidity will force the bank to close
  • Bank runs exhaust liquid assets
22
Q

How is bank net worth calculated and what else is it referred to as

A
  • Net worth = Assets - Liabilites
  • Known as “Bank Capital”
23
Q

When is a bank insolvent

A
  • If Net worth is negative
24
Q

How is the leverage ration calculated

A
  • Leverage = Total Assets / Net Worth
  • More loans creates higher leverage as assets increase
  • Insolvency problems are usually a result of high leverage
  • Net worth is needed to absorb losses on loans
25
Q

In short, what do banks need to survive

A
  • Sufficient liquid assets and capital
26
Q

What is a central bank

A
  • A public authority that:
  • Provides banking services to central banks
  • Conducts monetary policy
  • Regulates the financial system
  • Lender of last resort
27
Q

What is the UK’s central bank

A
  • The Bank of England
  • Founded 1694, Nationalised 1946, Independant since 1997
28
Q

How does the BoE influence the economy

A
  • Interest Rate paid on banks reserves
  • Changes in its balance sheet
29
Q

What is the monetary base and how is it calculated

A
  • Monetary base (MB) is equal to BoE’s liabilities
  • MB = C(tot) + r
  • Where C(tot) is currency in circulation and r is reserves of banks at BoE
  • Includes currency with public and banks
30
Q

What is Monetary base useful for

A
  • Monetary base is the central banks money
  • Allows banks to pay eachother
  • Helps banks meet withdrawals
  • Primarily reserves
  • This is one way the CB can influence the economy
31
Q

How can the BoE influence money supply

A
  • Through open-market operations (OMPs)
  • BoE buys / sells government bonds and transacts with commercial banks
  • BoE could buy £10,000 worth of bonds from a bank, this gives the bank £10,000 of reserves in order to create loans with, increasing deposits and money supply
32
Q

What do open-market operations rely on

A
  • Banks having “excess reserves”
33
Q

Why are OMPs used alongside interest rate cuts

A
  • Prevents excess demand for reserves
  • Gets other short-term interest rates to fall
34
Q

What is the timeline for OMP’s and interest rate cuts

A
  • BoE announces cut in Bank Rate
  • Banks demand more reserves
  • OMPs increase the supply of reserves
  • Banks make more money available
  • Lending and economic activity increase
35
Q

What does M4 exclude

A
  • Notes + coins held by banks
  • Deposits of the UK government
36
Q

How is the money multiplyer calculated

A
  • mm = M4 / MB
  • Ratio of “broad money” to Central Bank money
  • Indicator of private money creation
37
Q

How can the central bank influence money creation without using OMPs and interest rates

A
  • Through regulation of financial institutions
38
Q

What is Macro-Prudential regulation of capital

A
  • Requires banks to ensure that bank capital (equity) remains above a minimum threshold
  • Capital affects commercial banks’ loss-absorbing capacity
  • In the UK, MAcro-pru regulation is done by the BoE

ECON1021 - Macro (8 decks)

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