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AP Macroeconomics Unit 3 Vocabulary
Terms in this set (75)
It is any asset that can easily be used to purchase goods and services, and consists of cash itself and other assets that are liquid.
Double coincidence of wants
(You have to want what I have and vice versa. We could have to spend time searching for others to trade with.) The requirements of a barter exchange that each trader has want the other wants and wants what the other has. Because everyone does not necessarily want everything, the lack of double coincidence of wants is a major obstacle in barter exchanges, especially for complex, modern economies like that fond in the United States. While double coincidence of wants is also essential for exchanges involving money, it is such an inherent trait of money that it is not a problem. By its very nature as a generally accepted medium of exchange, everyone WANTS money.
The money supply
is the total value of financial assets in the economy that are considered money.
Medium of Exchange
It must be able to be used to buy goods and services.
Measure of Value (Unit of account)
meaning that money is a measure used to set prices and make economic calculations. It must be capable of being a measurement as to the relative worth of a good or service.
Store of Value
You can hold it without worrying about it spoiling.
is a good used a medium of exchange that has intrinsic value in other use.
Commodity backed money
is a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods.
is a medium of exchange whose value derives entirely from its official status as a means of payment.
overall measures of the money supply, which are known as M1 & M2.
Currency + Traveler's checks + Checkable Deposits (checking account). This is the narrowest definition also the most liquid.
Currency in circulation
Coins and Paper Money in the hand of the public. Coins are token money because the value of the metal is not worth what the actual coins represents. Paper money is actually Federal Reserve Notes.
Checking accounts are a way of transferring money from one account to another. They can be easily converted into liquid cash.
M1 + savings accounts + small time deposits + money market deposit accounts + money market mutual funds
This is the middle most to be liquid.
are financial assets that are not directly useable as a medium of exchange but can be readily converted into cash or checkable deposits.
money that can only be gotten when they mature.
M1 + M2+ large time deposits (most least liquid) This is too broad that is why economists rarely use it.
Equation of Exchange
M= supply of money
V= velocity of money
P= price level
Q= physical volume of G&S produced
MV is the amount spent by consumers. This is the same as the total C + I + G + Xn.
PQ is the amount received by sellers. This is the same as nominal GDP.
Velocity of money
how much the money goes through the system and how fast it is going on.
The money demand curve
shows the relationship between the quantity of money demanded and the interest rate.
Dt: transaction demand
we need money to make day to day purchases (transactions). The larger the nominal GDP (total value of G & S in the economy) the larger the Dt. For simplification purposes we must assume that Dt is independent of interest rates. Therefore the Dt is a vertical line
Da: asset demand
When money is not being held it can be put into interest earning accounts. The money that is held is Da. Notice the Da is inversely related to interest rates. When the interest rates increase the opportunity cost of holding money is too great so people will put their money in investments. i is nominal not real
The money supply curve
When you add in the vertical money supply curve to the Dm you can get equilibrium. (Sm is vertical because the supply should be constant at interest rates). It depicts how the quantity of money supplied by the FED varies with the interest rate.
The money market
The money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities.
Determinants of the Demand for Money
1. Changes in Price Level. If things become more expensive, people demand more money. In fact, if price level increases by 10% the Dm will shift to 10% to the right. This makes sense because people need that much more money to buy products.
2. Changes in GDP: Since people hold money to purchase goods, when GDP increases the Dm increases.
3. Increase in income of population. People spend more money when they have more money. As incomes increase the demand for money increases because people want to hold more money.
4. Changes in technology (ATM's decreased demand for money) and changes in institutions (changes in regulations ex. Checking from having interest to none then back to having interest...)
- More money in wallet shifts demand to the right
- Less money in wallet shifts demand to the left
Money base (Monetary base)
In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is defined as the portion of the commercial banks' reserves that are maintained in accounts with their central bank plus the total currency circulating in the public (which includes the currency, also known as vault cash, that is physically held in the banks' vault). The monetary base should not be confused with the money supply which consists of the total currency circulating in the public plus the non-bank deposits with commercial banks.
an institution that oversees and regulates the banking system, and controls the monetary base. Due to the importance of controlling the money supply our banking system is regulated. You cannot just go out and create a bank.
The Federal Reserve
The Federal Reserve was created by the U.S. Congress in 1913. Before that, the U.S. lacked any formal organization for studying and implementing monetary policy. Consequently markets were often unstable and the public had very little faith in the banking system. The Fed is an independent entity, but is subject to oversight from Congress. Basically, this means that decisions do not have to be ratified by the President or anyone else in the government, but Congress periodically reviews the Fed's activities.
Board of Governors
seven members appointed by the President and confirmed by the senate. They are in term for 14 years. A new one is appointed every two years. They control the operation of the money and banking system of the nation.
Federal Open Market Committee
part of the Board of Governors. It is made up of seven members of the Board plus five of the presidents of the Federal Reserve Banks. The president of the FED of New York is always on the committee. They are in charge of the purchase and sale of government bonds in the open market. This is an important monetary control.
Federal Advisory Council
also part of the Board of Governors. It has 12 commercial bankers. They are each selected by one of the local Federal Reserve Banks. They are advisory to the Board. They hold no power.
These banks are like being partly government owned and part privately owned. Member banks are required to buy stock in the Fed. Reserve banks. This gives them part ownership. Even though the banks own the Fed Reserve Banks they have no control over them. The Fed. Reserve Banks have no profit motive. Their only role is to provide for the well being of the economy.
state banks (operated under a state charter) and national banks (operate under charter from the Federal government
They are not regulated directly by the Fed. Yet they still must maintain a reserve with the Fed and they can still get loans from the Fed.
A statement of assets and claims (liabilities) summarizing the financial position of a firm or bank at some point in time.
A T-account is an informal term for a set of financial records that use double-entry bookkeeping. The term T-account describes the appearance of the bookkeeping entries. If a large letter T were drawn on the page, the account title would appear just above the T, debits would be listed under the top line of the T on the left side and the credits would be listed under the top line of the T on the right side, with the middle line separating the debits from the credits.
the claims of the owners against the firm's assets
claims of the non-owners
net worth + liabilities
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit.. Assets are bought to increase the value of a firm or benefit the firm's operations. You can think of an asset as something that can generate cash flow, regardless of whether it's a company's manufacturing equipment or an individual's rental apartment.
Fractional reserve system of banking
Only a fraction of the receipts were covered with gold. The goldsmiths created money. Today the same thing occurs. Banks make loans based on an amount that the Federal Reserve requires them to keep in reserve.
We now have money in the form of deposits. In order to avoid the nam panics we are required to keep a legal reserve. These are also known as bank reserves or the currency that a bank holds in its vault plus their deposits at the Federal Reserve.
An amount of funds equal to a specified percentage of its own deposit liabilities which a member bank must keep on deposit with the Federal Reserve Bank in its district or as vault cash.
this is the specified percentage of its demand liabilities, which the commercial bank must keep as reserves.
-Reserve ratio= banks required reserves/ banks demand-deposit liabilities
Excess reserves are capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities. These required reserve ratios set the minimum liquid deposits (such as cash) that must be in reserve at a bank; more is considered excess.
The money multiplier is the amount of money that banks generate with each dollar of reserves. Reserves is the amount of deposits that the Federal Reserve requires banks to hold and not lend. Banking reserves is the ratio of reserves to the total amount of deposits.
borrower may request part of payment in cash. Currency in circulation is outside the banking system and cannot be held by banks as reserves from which to make loans. The greater the amount of cash leakage, the smaller is the actual deposit expansion multiplier.
Real World Money Multipliers
Because of leakages, actual deposit multipliers are smaller than the maximum possible. The reserve requirements on transactions deposits is currently around 10 percent implying a potential deposit expansion multiplier of about 10.
Goal is to assist the economy in achieving a full-employment, non inflationary level of total output. This means using the money supply to stabilize aggregate output, employment and price level.
Open market operations
This is the buying and selling of securities. This is the most important control of the FED. When the FED buys securities from banks it directly increases the reserves of the commercial banks. If they buy from individuals, the individuals end up putting the money in their banks which increases the bank reserves.
The federal funds rate
This is the rate of which finds are borrowed and lent in the federal finds market where banks that run short on the reserve requirement can borrow finds from other banks with excess reserves.
are a fixed maturity investment that pays a fixed dividend each period. The investor will then get back his original investment unless the company goes out of business.
The Reserve Requirement
The FED influences the banks ability to lend through the reserve ratio. If the FED increases the reserve requirement they take away part of the banks excess reserves. This takes away the banks ability to create money. In some cases banks have to cut down on checking accounts in order to meet the reserve requirement. Banks may also call in outstanding loans. Banks may also sell securities and put the money into reserves.
The Discount rate
The FED loans money to banks if they re in need of money. The rate of interest that they charge is the discount rate.
Easy Money Policies
(or accommodative monetary policy) is a monetary policy that increases the money supply usually by lowering interest rates. It occurs when a country's central bank decides to allow new cash flows into the banking system.If the economy is faced with unemployment and deflation the FED can increase the supply of money.
Expansionary monetary policy
Expansionary monetary policy is when a central bank uses its tools to stimulate the economy. That increases the money supply, lowers interest rates, and increases aggregate demand. That boosts growth as measured by Gross Domestic Product (GDP). It usually diminishes the value of the currency, thereby decreasing the exchange rate. It is the opposite of contractionary monetary policy.
Contractionary monetary policy
Contractionary monetary policy is when the Federal Reserve uses the Federal funds rate and its other tools to slow economic growth. The Fed's goal is to do this without pushing the economy into a recession. Therefore, the Fed would only implement contractionary policy to fulfill its primary mandate of preventing inflation. Contractionary monetary policy probably wouldn't be used unless the core inflation rate is more than the Federal Reserve's 2% target inflation rate. Core inflation is the year-over-year price increases for everything measured by the Consumer Price Index except volatile food and oil prices.
Target federal funds rate
The government sets a target on what they want t to be at. (basically a goal)
The Taylor rule for monetary policy
says that the federal funds rate should be set on the basis of inflation and the output gap. Otherwise the FED has a dual mandate to keep both the interest and the unemployment rate low.
Value of a dollar
1/ price level (index based on set year) (in the long run...)
The Fisher effect
When the FED increases the rate of money growth, the result is both a higher inflation rate and a higher nominal interest rate. This one for one adjustment of the nominal interest rate to the inflation rate is called the Fisher Effect. It does not hold true in the short run because unanticipated inflation catches lenders and borrowers by surprise. However, in the long run the adjustment is made.
This changes in the money supply have no real effect on the economy in the long-run because real wages adjust with price increases in the long-run. So, monetary policy is powerful in impacting the economy in the short-run but not in the long-run.
The Crowding out effect
One problem we encounter in fiscal policy is the crowding out effect. If the economy is in a recession and the government decides to expand what happens. AD increases this will in turn increase output. The problem is that it will also increase the interest rates because there is an increase in demand for money. This increase in interest rates will then drive out investment spending.
of this is that the increase in government spending increases aggregate demand which increases equilibrium incomes. This increase in incomes will increase the demand for money which will increase interest rates.]
Strengths of the monetary policy
1. Speed and flexibility over the fiscal policy. It could be done on a daily basis if need be.
2. Isolation from political pressure
Shortcomings and problems of monetary policy
1. Cyclical Asymmetry:
EZ money does not mean that banks will loan or that people will borrow. People may use the excess money to pay off loans.
2. Changes in V. Velocity can sometimes go the opposite direction. If m increases, V may actually decrease. This will of course affect total spending. If I decreases people will hold m for asset demand. This affects V.
3. Money demand is interest elastic. (It depends on the elasticity of the Dm curve)
4. Investment is interest elastic. (It depends on the elasticity of the I curve)
5. Inflow of international capital from the increase in interest rates leads to an expansion of AD.
The Short-run Phillips Curve
The faster AD grows the faster inflation will grow. As output increases unemployment decreases. A slower growth in AD causes a slower growth in inflation and a slower growth in unemployment. If you put inflation and unemployment together you find that high inflation goes hand in hand with low unemployment and vice versa. The greater the shift in AD the greater the change in inflation, output and therefore unemployment.
The long-run Phillips Curve
The net result is that prices go up but GDP (unemployment) stay the same. The economy will naturally gravitate to the natural rate of unemployment. This is what makes the Phillips curve vertical in the long run.
The non accelerating inflation rate of unemployment (NAIRU)
is the unemployment rate at which inflation does not change overtime.
is the process of bringing down inflation that is embedded in expectations.
is the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation.
the idea that the interest rate cannot go below zero, which limits the effects of monetary policy because banks will not lend out money at zero interest rates so they just sit on their money.
This is a situation where conventional monetary policy is ineffective because of zero bound.
is a macroeconomic theory which argues that economic growth can be most effectively created by investing in capital, and by lowering barriers on the production of goods and services.
The Laffer Curve
shows the relationship between tax rates and tax revenue collected by governments. The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.
Recommended textbook explanations
Principles of Economics
N. Gregory Mankiw
Economics: Concepts and Choices
Economics New Ways of Thinking, Applying the Principles Workbook
Economics: Principles & Practices
Gary E. Clayton
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