week 3 Flashcards
Hyperinflation
When inflation reaches an extraordinarily high level
Least restrictive defination of money
any good that is intered for use in exchange
Three functions of money
Medium of exchange, unit of account, store of value
Medium of exchange
moeny can be used to buy and sell goods and services
Unit of account
money provides the terms by which prices and debts are recorded
Store of Value
money provides a means of transferring purchasing power from the present to the future
Double Coincidence of Wants
The double coincidence of wants occurs in successful barter or direct exchanges
The preferences of both parties align and demand each othersβ goods. Exchange is able to take place.
Commonly Accepted Medium of Exchange (CAMOE)
Once a medium of exchange is widely accepted and used, it achieves CAMOE status.
Commodity money
money that has value outside of its role as money.
Ex: Gold or Precious Metals
Ex: Cigarettes
Fiat Currency
money that has no value outside of its role as money
Money Supply
the quantity of money available in the economy
Monetary Policy
policy that affects the money supply
open market operation
the purchase and sale of government bonds
Currency (C)
is defined as the amount of paper money and coins in circulation in the economy.
M1
C + demand deposits at commercial banks + travelerβs checks + other checkable deposits
M2
M1 + saving deposits + small-denomination time deposits + balances in retail money market funds
Fractional reserve banking
some non-zero percentage of the deposit is lent out to others (not 100% reserves)
Monetary base (B)
is the total amount of money held by the public as currency (πΆ) and by the banks as reserves (π ) such that π΅=πΆ+π . The monetary base is directly controlled by the Federal Reserve.
Reserve-deposit ration (rr)
is the fraction of deposits (π·) that banks hold in reserve (i.e., ππ=π
/π·). It is determined by business policies of banks and the laws regulating banks.
It follows from the last slide that 0β€ππβ€1.
currency-deposit ratio (cr)
is the amount of currency (πΆ) people hold as a fraction of their holdings of demand deposits (π·; i.e., ππ=πΆ/π·)
The monetary base (B) is proportional to what
money supply (M) and grows by the same amount
A decrease in Reserve-deposit ration (rr) causes a waht
a decrease in ππ INCREASES π and π.As the reserve-deposit ratio (ππ) decreases, the more loans banks make, and the more money banks create from every dollar of reserves.
A decrease in the currency-deposit ration (cr) causes what
a decrease in ππ INCREASES π and π. As the currency-deposit ratio (ππ) 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.
Tightening or contractionary monetary policy
Increases the policy rate federal fund rate and IOR. Increase market interest rate and reduces the money supply
Easing or expansionary Monetary Policy
Lowers the policy rate (Federal fund rate) and IOR. Lowers market interest rates and increases the money supply.
Whats on the feds balance sheet?
Assets: securities and loans to financial institutions
Liabilities: currency in circulation and reserves
The Federal Reserve can influence the money supply by
Influencing the monetary base and influencing the reserve deposit ratio
Open Market operations
Buying bonds -> selling currency -> b increases -> increases money supply
Selling bonds -> buying currency -> b decreases -> money supply decreases
Discount Rate
Interest rate the Fed charges on loans. If this rate falls itβs cheaper for banks to borrow from the Fed so B (monetary base) increases
Reserve Requirements
Banks have to have a minimum reserve amount. An increase in requirements to increase rr but is less effective when banks hold excess reserves
Interest on reserves
Paid to banks for holding reserves. If this rate rises its more beneficial for banks to hold reserves to rr increases
Why canβt the Fed influence the currency-deposit ratio (cr)?
Its up to consumers and is personal preference.
Illiquid
Assets>Liabilities, but does not have liquid assets (cash) on hand at a specific time
Illiquid banks can be saved.
Insolvent
Assets<Liabilities. βUnderwaterβ
Most often happens when loans are defaulted on.
If saved through a bailout, an insolvent bank cannot pay back the loan.
Sunspot Theory
Depositors run because the others run. Self-fulfilling expectations
Bad News Theory
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.
Costs of Bank Runs
- Depositors lose deposits
- 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. βFire sale lossesβ. - To Borrowers
-Interrupts bank-borrower relationship - For banking panics
-Money supply contracts
-Can cause recession in its own right
Benefits of Bank Runs
- Runs on insolvent banks stop a βwealth destroying machineβ
- The threat of runs encourages banks to run a sound operation
What is FDIC and what are the pros and costs of it.
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 (ππ), 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
Implications of the Floor System vs the Corridor System
- 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
