Week 6 Flowchart Flashcards
Money
The set of assets in an economy that people regularly use to buy goods and services from other people. Money includes cash, deposits and other types of assets, but not credit card (or cheques). In fact, if people use cheques instead of cash, money supply will increase as people no longer carry extra cash.
The 3 functions of money
Medium of exchange
Unit of account
Store of value
Medium of exchange
An item that buyers give to sellers when they want to purchase goods and services. Money is the most liquid asset available
Unit of account
The yardstick people use to post prices and record debts.
Store of value
An item that people can use to transfer purchasing power from the present to the future.
Money is not the best store of value (shares, bonds, real estate…). Value of money deteriorates when there are inflationary expectations.
Liquidity
The ease with which an asset can be converted into the economy’s medium of exchange.
Kinds of money
When money takes the form of a commodity with intrinsic value, it is called commodity money (e.g. gold.)
Flat money: Money without intrinsic value that is used as money because of government decree.
Monetary policy in Australia today
The RBA uses the cash rate to influence the level of economic activity rather than attempting to control the money supply. The RBA uses open-market operations to guarantee that its target rate is the equilibrium interest rate in the short-term money.
Cash rate
The interest that financial institutions can earn on overnight loans of their currency or reserves.
Open-market operations
The purchase and sale of Australian government securities by the RBA
Problems in controlling the money supply
Can not control the amount that bankers chose to lend.
Trade-off between inflation and unemployment in short-run
Bank runs
Can not control the amount of money that households choose to hold as deposits in banks.
Bank runs
Large numbers of depositors all try to withdraw their deposits at the same time
Banks and the money supply
100 per cent reserve banking
Fractional-reserve banking
100 per cent reserve banking
Reserves: Deposits that banks have received but have not lent out
In banks hold all deposits in reserve, banks don’t influence the supply of money.
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Fractional-reserve banking
A banking system in which banks hold only a fraction of deposits as reserves. Lend out a majority of their deposits thereby creating money.
Reserve ratio
Money multiplier
Reserve ratio
The fraction of deposits that banks hold as reserves.
The money multiplier
The amount of money the banking system generates with each dollar of reserves.
Fractional reserve ratio example
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When banks hold only a fraction of deposits in reserve, banks create money. While new money has been created so has debt. There is no new wealth created by the process. The process of money creation does not continue forever. It stops when the actual reserve-deposit ratio is equal to the desired reserve-deposit ratio.
Money in the Australian economy
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Money supply
The quantity of money available in the economy.
Currency
Current deposits
Currency
The plastic notes and metal coins in the hands of the public.
Current deposits
Balances in bank accounts that depositors can access on demand by using a debit card or writing a cheque.
Central Bank (or The Reserve Bank of Australia)
An institution designed to oversee the banking system and regulate the quantity of money in the economy.
Roles of the RBA
Monitor individual banks and ensure their stability
Act as a lender of last resort
Determine monetary policy