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econ ch 16

Terms in this set (27)

money
the set of assets in the economy that people regularly use to buy goods and services from each other
liquidity
the ease with which an asset can be converted into the economys medium of exchange-money is the most liquid asset available
currency
paper bills and coins in the hands of the public-most widely accepted medium of exchange in the US economy
demand deposits
balances in bank accounts that depositors can access on demand by writing a check
reserves
deposits that banks have received but have not loaned out-if banks hold all deposits in reserve, banks do not influence supply of money
3 functions of money
Medium of exchange: an item that buyers give to sellers when they purchase goods and services
Unit of Account: the yardstick people use to post prices and record debts-when we want to measure and record economic value, we use money as a unit of account
Store of Value: an item that people can use to transfer purchasing power from the present to the future
wealth
term used to refer to the total of all stores of value, including both monetary and nonmonetary assets
when prices rise, the value of money...
falls
when goods and services become more expensive, each dollar in your pocket can buy....
less
Types of Money
Commodity Money: when money takes the form of a commodity with intrinsic value (intrinsic value means that the item wold have value even if it were not used as money, ex: gold)
Fiat Money: money without intrinsic value that is used as money because of government decree, ex: dollar)
What is M1 and M2?
The two most widely followed measure of the money stock are M1 and M2-the money stock for the US economy includes not just currency but also deposits in banks and other financial institutions that can be readily accessed and used to buy goods and services
What are M1 and M2 composed of?
M1: Demand deposits, travelers checks, other checkable deposits, currency
M2: everything in M1, savings deposits, small time deposits, money market mutual funds, a few minor categories
Structure of the Federal Reserves System
Fed: central bank for US, responsible for regulating the system of fiat money
7 members with 14 yr terms, given long terms to give them independence from short-term political pressures
central bank
an institution designed to oversee the banking system and regulate the quantity of money in the economy
two related jobs to the Fed
to regulate banks and ensure health of banking system and to control quantity of money that is made available to economy
Money Supply: quantity of money available in economy
Monetary Policy: setting of the money supply by policymakers in central bank-in the US it is made by FOMC, which meets about every 6 weeks, made up of 12 members, only five get to vote
How does the Fed influence the quantity of reserves?
Open-market operations and discount rate (fed lending to banks)
Open Market Operations
If the FOMC increases the money supply, the Fed creates dollars and uses them to buy government bonds from the public in the nations bond markets (after this purchase the dollars are in the hands of the public)--an open market purchase of bonds by the Fed increases money supply; to increase the money supply, the Fed instructs its bond traders at the New York Fed to buy bonds from the public in the nations bond markets--each new dollar held as currency increases the money supply by exactly $1, each new dollar deposited in a bank increases the money supply by more than a dollar because it increases reserves and thereby, the amount of money that the banking system can create
Discount rate (Fed lending to banks)
The interest rate on the loans that the Fed makes to the banks. Banks borrow the Fed's discount window and pay an interest rate on that loan (the discount rate); when the Fed makes such a loan to a bank, the banking system has more reserves than it otherwise would, and these additional reserves allow the banking system to create more money (an increase in the discount rate reduces the quantity of reserves in the banking system, which reduces the money supply; a lower discount rate encourages banks to borrow from the Fed, increasing the quantity of reserves and the money supply)
How does the Fed influence the reserve ratio?
Reserve requirements and paying interest on reserves
Reserve requirements
regulations on the minimum amount of reserves the banks must hold against deposits (an increase in reserve req. means that banks must hold more reserves and can loan out less of each dollar that is deposited-this raises the reserve ratio, lowers the money multiplier, and decreases the money supply
Paying interest on reserves
when a bank holds reserves on deposits at the Fed, the Fed now pays the bank interest on those deposits (higher the interest rate on reserves, the more reserves banks will choose to hold; tends to increase the reserve ratio, lower the money multiplier, and lower the money supply
Types of Banking systems
Reserve banking, Fractional-reserve banking
reserve banking
banks take in deposits but not loan out
fractional-reserve banking
a banking system in which banks hold only a fraction of deposits as reserve
reserve ratio
the fraction of deposits that banks hold as reserves The Fed sets a minimum amount of reserves that banks must hold (reserve requirement), and banks may hold reserves above the legal minimum (excess reserves) so they can be more confident that they will not run short of cash When banks hold only a fraction of deposits in reserve, the banking system creates money—the economy is more liquid in the sense that there is more of the medium of exchange, but the economy is no wealthier than before The Fed does not control the amount of money that the households choose to hold as deposits in the banks, the Fed does not control the amount that bankers choose to led
how does a bank create money? (money multiplier)
for each time that money is deposited and a bank loan is made, more money is created
keep adding up the loans from each bank=total money supply
money multiplier
the amount of money the banking system generates with each dollar of reserves—the money multiplier is the reciprocal of the reserve ratio If R is the ratio of reserves to deposits at each bank (reserve ratio), then the ratio of deposits to reserves in the banking system (the money multiplier) must be 1/R The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier (in reserve banking, the reserve ratio is 1, the money multiplier is 1, and banks do not make loans or create money)
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