week 3

Question 1

Hyperinflation

Answer 1

When inflation reaches an extraordinarily high level

Question 2

Least restrictive defination of money

Answer 2

any good that is intered for use in exchange

Question 3

Three functions of money

Answer 3

Medium of exchange, unit of account, store of value

Question 4

Medium of exchange

Answer 4

moeny can be used to buy and sell goods and services

Question 5

Unit of account

Answer 5

money provides the terms by which prices and debts are recorded

Question 6

Store of Value

Answer 6

money provides a means of transferring purchasing power from the present to the future

Question 7

Double Coincidence of Wants

Answer 7

The double coincidence of wants occurs in successful barter or direct exchanges
The preferences of both parties align and demand each others’ goods. Exchange is able to take place.

Question 8

Commonly Accepted Medium of Exchange (CAMOE)

Answer 8

Once a medium of exchange is widely accepted and used, it achieves CAMOE status.

Question 9

Commodity money

Answer 9

money that has value outside of its role as money.
Ex: Gold or Precious Metals
Ex: Cigarettes

Question 10

Fiat Currency

Answer 10

money that has no value outside of its role as money

Question 11

Money Supply

Answer 11

the quantity of money available in the economy

Question 12

Monetary Policy

Answer 12

policy that affects the money supply

Question 13

open market operation

Answer 13

the purchase and sale of government bonds

Question 14

Currency (C)

Answer 14

is defined as the amount of paper money and coins in circulation in the economy.

Question 15

M1

Answer 15

C + demand deposits at commercial banks + traveler’s checks + other checkable deposits

Question 16

M2

Answer 16

M1 + saving deposits + small-denomination time deposits + balances in retail money market funds

Question 17

Fractional reserve banking

Answer 17

some non-zero percentage of the deposit is lent out to others (not 100% reserves)

Question 18

Monetary base (B)

Answer 18

is the total amount of money held by the public as currency (𝐶) and by the banks as reserves (𝑅) such that 𝐵=𝐶+𝑅. The monetary base is directly controlled by the Federal Reserve.

Question 19

Reserve-deposit ration (rr)

Answer 19

is the fraction of deposits (𝐷) that banks hold in reserve (i.e., 𝑟𝑟=𝑅/𝐷). It is determined by business policies of banks and the laws regulating banks.
It follows from the last slide that 0≤𝑟𝑟≤1.

Question 20

currency-deposit ratio (cr)

Answer 20

is the amount of currency (𝐶) people hold as a fraction of their holdings of demand deposits (𝐷; i.e., 𝑐𝑟=𝐶/𝐷)

Question 21

The monetary base (B) is proportional to what

Answer 21

money supply (M) and grows by the same amount

Question 22

A decrease in Reserve-deposit ration (rr) causes a waht

Answer 22

a decrease in 𝑟𝑟 INCREASES 𝑚 and 𝑀.As the reserve-deposit ratio (𝑟𝑟) decreases, the more loans banks make, and the more money banks create from every dollar of reserves.

Question 23

A decrease in the currency-deposit ration (cr) causes what

Answer 23

a decrease in 𝑐𝑟 INCREASES 𝑚 and 𝑀. As the currency-deposit ratio (𝑐𝑟) decreases, the fewer dollars of the monetary base the public holds as currency, the more base dollars banks hold as reserves and the more money banks can create.

Question 24

Tightening or contractionary monetary policy

Answer 24

Increases the policy rate federal fund rate and IOR. Increase market interest rate and reduces the money supply

Question 25

Easing or expansionary Monetary Policy

Answer 25

Lowers the policy rate (Federal fund rate) and IOR. Lowers market interest rates and increases the money supply.

Question 26

Whats on the feds balance sheet?

Answer 26

Assets: securities and loans to financial institutions
Liabilities: currency in circulation and reserves

Question 27

The Federal Reserve can influence the money supply by

Answer 27

Influencing the monetary base and influencing the reserve deposit ratio

Question 28

Open Market operations

Answer 28

Buying bonds -> selling currency -> b increases -> increases money supply

Selling bonds -> buying currency -> b decreases -> money supply decreases

Question 29

Discount Rate

Answer 29

Interest rate the Fed charges on loans. If this rate falls it’s cheaper for banks to borrow from the Fed so B (monetary base) increases

Question 30

Reserve Requirements

Answer 30

Banks have to have a minimum reserve amount. An increase in requirements to increase rr but is less effective when banks hold excess reserves

Question 31

Interest on reserves

Answer 31

Paid to banks for holding reserves. If this rate rises its more beneficial for banks to hold reserves to rr increases

Question 32

Why can’t the Fed influence the currency-deposit ratio (cr)?

Answer 32

Its up to consumers and is personal preference.

Question 33

Illiquid

Answer 33

Assets>Liabilities, but does not have liquid assets (cash) on hand at a specific time
Illiquid banks can be saved.

Question 34

Insolvent

Answer 34

Assets<Liabilities. “Underwater”
Most often happens when loans are defaulted on.
If saved through a bailout, an insolvent bank cannot pay back the loan.

Question 35

Sunspot Theory

Answer 35

Depositors run because the others run. Self-fulfilling expectations

Question 36

Bad News Theory

Answer 36

Depositors run on a banks that are insolvent
Depositors watch bank activity to make sure their deposits are safe. If they think the bank is in a risky position (Too many bad loans, not enough reserves), they run.

Question 37

Costs of Bank Runs

Answer 37

1. Depositors lose deposits
2. Shareholders lose out
   -After the run, banks liquidate assets quickly to try and stay liquid.
   -Assets are sold at low prices to move them quickly. “Fire sale losses”.
3. To Borrowers
   -Interrupts bank-borrower relationship
4. For banking panics
   -Money supply contracts
   -Can cause recession in its own right

Question 38

Benefits of Bank Runs

Answer 38

1. Runs on insolvent banks stop a “wealth destroying machine”
2. The threat of runs encourages banks to run a sound operation

Question 39

What is FDIC and what are the pros and costs of it.

Answer 39

The Federal Deposit Insurance Corporation (FDIC) protects deposits up to $250,000 when a bank fails.

It is intended to preserve public confidence in the banking system.

Therefore, mitigates large swings of the currency-deposit ratio (𝑐𝑟), and allow the Fed to have more control over the money supply.

Costs: Bail out incolvent savings and loans institutions. And a moral hazard and the likelihood of being bailed out for risky behavior increases the cost of engagin in risky behavior decreases

Question 40

Implications of the Floor System vs the Corridor System

Answer 40

• much higher level of reserves in the system
• swells the size of the central banks balance sheet to undesirable proportions
• loss of monetary policy control