WEEK 8 Flashcards
money
any asset that can be easily used to produce g+s
currency in circulation
cash held by the public
checkable bank deposits
bank accounts on which people can write checks
money supply
total value of financial assets in the economy that are considered money
what can money function as?
- medium of exchange
- store of value
- unit of account
medium of exchange
asset that individuals acquire for the purpose of trading rather than for own consumption
store of value
- money is a means of holding purchasing power over time
- enables people save money earned today and use it to buy g+s they want tomorrow
unit of account
money provides yardstick for measuring and comparing values of a wide variety of g+s
commodity money
good used as a medium of exchange that has intrinsic value in other uses
commodity-backed money
medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promic that it can be converted into valuable goods
fiat money
money whose value derives entirely from its official status as a means of payment
monetary aggregate
overall measure of money supply
what are the two types of monetary aggregate?
- M1 - only most liquid forms of money (e.g. currency in circulation, checkable bank deposits, traveller’s checks)
- M2 - near moneys + M1 (e.g. money market funds, time deposits, savings deposit
near moneys
financial assets that can’t be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits
banks
financial intermediaries that use liquid assets (in the form of bank deposits) to finance illiquid investments of borrowers
T-account
tool for analysing a business’s financial position by showing business’s assets and liabilities
assets
loans + reserves
liabilities
deposits
bank reserves
currency that banks hold in their vaults plus their deposits in a central bank
reserve ratio
fraction of bank deposits that a bank holds as reserves
what is the primary purpose of financial markets and institutions?
- act as bridge between lenders and borrowers
- also able to create money by accepting deposits and making loans
fractional reserve bank system
when deposit money in bank account, bank required to hold part of it in its vault as cash
bank run
phenomenon in which many of a bank’s depositors try to withdraw their funds because fear bank failure
types of bank regulation
- deposit insurance
- capital requirements
- reserve requirements
- discount window
what is the incentive issue with deposit insurance?
banks take more risks because insured
- $X deposited into account
- What is the effect on the T-account before and after bank makes loan with the money?
- What is the effect on the money supply?
- Increase in money supply
- If loan out all of left over money, money in circulation is now X + 0.9X
- M1 =
deposit insurance
insurance deposits up to certain amount
capital requirements
requirement that owners of banks hold substantially more assets than value of bank deposits
reserve requirements
rules set by a Central Bank that determine minimum reserve ratio for a bank
discount window
arrangement in which a Central Bank stands ready to lend money to banks in trouble
$X withdrawn from account
What is the effect on the T-account before and after bank makes loan with the money?
monetary base
sum of currency in circulation and bank reserves
what does the money supply depend on?
- ratio of reserves to bank deposits (decrease in reserve ratio leads to increase in money supply)
- fraction of money supply that individuals choose to hold as currency
money multiplier
ratio of money supply to monetary base
what does a bank do if it can’t meet a Central Bank’s reserve requirement?
London Interbank market allows banks that fall short of reserve requirement to borrow funds from banks with excess reserves
Libor rate
measures the cost of funds to large global banks operating in the London financial markets or with London-based counterparts
discount rate
- (aka base rate, repo rate) interest rate a bank charges on loans to banks
- normally set about federal funds rate to discourage banks from turning to Central Bank
how do Central Banks alter money supply?
- change reserve requirements (decrease in reserve requirements increases money supply)
- change discount rate (decrease in discount rate increases money supply)
- open market operations
open market operations
- becuase government bonds can be stored indefinitely it is easy to buy/sell on open market
- Central Bank uses this commodity to buy in order to increase reserves
why does the Central Bank not buy bonds directly from the government?
- if it buys government debt directly from the government, it is lending directly to the government
- essentially printing money to finance government budget deficit
- Central Bank’s decisions are independent of government
if the central bank wants to…
- increase money supply
- decrease money supply?
- increase money supply
- to pay for T-bills, CB electronlically increases reserves of seller
- with more reserves, bank increases loans
- increases money supply as money creation process ripples through economy
- decrease money supply
- Fed sells T-bills
- decreases reserves of the buyer
- with fewer reserves, bank decreases loans
- decreases money supply as money creation process ripples in reverse through economy
how do stocks impact M1/M2?
don’t belong to M1 or M2 so don’t affect either
what is the effect of depositing the money from the sale of stocks into a savings account?
increases M2 because savings is a part of M2 but not M1, M1 stays the same
what is the effect of moving money from savings to checking account?
- does not affect M2 because savings and checking accounts are both part of M2
- savings account not a part of M1 so M1 increases
what is the effect of depositing cash into a checking account?
does not affect M1/M2 because it involves transferring money from one component of M1 to another component of M1
what is the effect of depositing cash into a savings account?
- does not affect M2 because both savings account and cash are a part of M2
- M1 decreases because savings are not a part of M1
