Week 6

Question 1

Money

Answer 1

Money is the set of assets in an economy that people regularly use to buy goods and services from other people.

Question 2

What are the main functions of money

Answer 2

medium of exchange (means of payment)

unit of account

store of value

Question 3

Medium of exchange

Answer 3

An item that buyers give to sellers when they want to purchase goods and services.
A medium of exchange is anything that is readily acceptable as payment.

Question 4

Unit of account

Answer 4

A unit of account is the yardstick people use to post prices and record debts.

Question 5

Store of value

Answer 5

A store of value is an item that people can use to transfer purchasing power from the present to the future.

Question 6

Commodity money

Answer 6

Commodity money takes the form of a commodity with intrinsic value.
Examples: gold, silver, cigarettes.

Question 7

Fiat money

Answer 7

Fiat money is used as money because of government decree.
It does not have intrinsic value.
Examples: coins, currency, cheques, deposits
zero-coupon bond of infinite maturity

Question 8

Currency

Answer 8

Currency is the plastic notes and metal coins in the hands of the public.

Question 9

Current deposits

Answer 9

Current deposits are balances in bank accounts that depositors can access on demand by using a debit card or writing a cheque.

Question 10

Money supply

Answer 10

The money supply is the quantity of money available in the economy

Creation of money supply by the central bank AND the banking system

1. the RBA (monopolistically)
   - Open market operations
2. Money stock (M1-M3) through interactions between the CB, commercial banks and the public and the ‘multiplication’ process

Question 11

money in the Australian economy

Answer 11

Photo in favourites 21/8/18

Question 12

Can banks also affect money supply?

Answer 12

Influencing the quantity of demand deposits

Question 13

Reserves

Answer 13

Reserves are deposits that banks have received but have not loaned out.

Question 14

fractional-reserve

Answer 14

In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest

Question 15

Reserve ratio

Answer 15

Reserve ratio (R) is the fraction of deposits that banks hold as reserves

Question 16

Money multiplication

Answer 16

photos in favourites 21/8/18

Question 17

Money multiplier

Answer 17

The money multiplier is the amount of money the banking system generates with each dollar of reserves

The money multiplier is the reciprocal of the reserve ratio:
M = 1/R

Question 18

Capital

Answer 18

The capital is the owners’ equity (part of their funding raised by issuing shares)

Question 19

Leverage ratio

Answer 19

total assets/capital

Question 20

Is the Multiplier Model Correct?

Answer 20

No.

Question 21

Is the Multiplier Model useful?

Answer 21

Yes.

Question 22

Is the Multiplier Model Correct? No. Is it Useful? Yes.

Answer 22

Above it is assumed that the initial step in the process of changing money supply is on the banks liabilities side
i.e. there are some changes in deposits which will affect money supply.
But can this be the other way round?
Can this be that a bank decides to give a loan, creates electronic money out of nothing, and THEN creates a deposit to the loan’s recipient?
If so, can this be a problem? Why? When?

Question 23

RBA

Answer 23

The Reserve Bank of Australia (RBA) serves as the nation’s central bank since 1959.

It has two main functions:

The formulation and administration of monetary policy.

To maintain financial stability

Question 24

What is the Reserve Bank Board?

Answer 24

responsible for the Bank’s monetary and banking policy.

Question 25

What does the explicit inflation target do?

Answer 25

Accountability
The inflation target also anchors private sector inflation expectations.
Credibility

Question 26

The inflation forecast targeting regime

Answer 26

If inflation is forecast to be:
above the target, monetary policy has to be tightened to move inflation down
contractionary policy

below the target, monetary policy should be eased
expansionary policy

Question 27

Cash rate

Answer 27

The cash rate is the interest rate that financial institutions can earn on overnight loans of their currency or reserves (the short-term money market which financial institutions operate in).

Question 28

The inflation targeting regime

Answer 28

The RBA now targets the cash rate (as its instrument) as a means of influencing the inflation rate.
When the cash rate rises, interest rates in the retail market rise. Likewise when the cash rate falls, interest rates fall. As changes in the cash rate flow through to interest rates, generally economic activity is affected

Question 29

How does the Reserve Bank affect the cash rate?

Answer 29

open market operations

To increase the amount of cash in the economy, the RBA buys government securities from financial institutions.

To decrease the money supply, the RBA sells government securities to financial institutions.

Question 30

open market operations

Answer 30

purchasing or selling Australian government securities

Question 31

To increase the amount of cash in the economy, the RBA buys government securities from financial institutions.

Answer 31

Injecting cash into money markets

What then happens to the money supply?

Question 32

To decrease the money supply, the RBA sells government securities to financial institutions.

Answer 32

withdrawing cash from the system

Question 33

Problems in affecting the economy

Answer 33

The RBA has been able to control movements in the cash rate and thereby influence the cash market but its ability to control the money supply is not precise.
The RBA must wrestle with two problems that arise due to fractional-reserve banking
The RBA does not control the amount of money that households choose to hold as deposits in banks.
The RBA does not control the amount of money that bankers choose to lend.