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Econ Final Exam
Terms in this set (43)
What are the functions of money?
medium of exchange, unit of account, store of value, standard of deferred payment
a medium of exchange which has a significant nonmonetary use (wheat, cigarettes, etc.)
medium of exchange with no significant nonmonetary use
What are the characteristics of good money?
durable, divisible, portable, acceptable
M1 money supply
monies that function primarily as a medium of exchange (includes currency and coin in circulation, checkable deposits, checking deposits, and traveler's checks)
M2 money supply
monies that function primarily as a store of value (includes all of M1 plus savings deposits, small time deposits, money market mutual funds, and other items)
Fractional Reserve Banking System
a system under which banks must hold on to a fraction of their deposits and may lend out the rest
an item of value which someone owes to you
an item of value which you owe to someone else
Assets - Liabilities
Assets of a bank
reserves (vault cash, deposits at fed), loans to borrowers, and government securities
Liabilities of a bank
demand deposits, savings deposits, time deposits, loans from other banks
What can banks do to meet the reserve requirement?
do "nothing" (wait for deposits, wait for someone to pay off loan), sell government securities, borrow from another commercial bank or the federal reserve system
Change in Money Supply
(Amount of First Loan) x (1/RR)
the amount of money the banking system generates with each dollar of reserves (calculated by 1/RR)
How is money created in a fractional reserve banking system?
money is purchasing power, and when a bank makes a loan it is making more purchasing power, so the act of making a loan is the act of creating money
What are the roles of the central bank?
controls size of money supply, regulates banks and financial institutions, & acts as a fiscal agent for the federal government, serves as a banker's bank
What is the role of the federal open market committee?
they make key decisions about interest rates and the growth of the United States money supply (consists of all 7 members of the board of governors and 5 district bank presidents)
What are some monetary tools that can be used to adjust size of money supply?
Reserve requirements, discount rate, open market operations
rate at which a bank can borrow from the Fed itself
Open markets operations
consists of the Fed buying and selling government securities from financial institutions and the general support (can be used to adjust the level of excess reserves and therefore the amount of lending that can take place)
What are the 3 financial markets?
money market, bond market, foreign exchange market
the quantity of money available in the economy (curve is vertical, changes in interest rates do not affect money supply)
the amount that households and firms want to hold in currency and deposits (transactions demand and asset demand)
stems from money being medium of exchange (does not depend on interest rate, curve is vertical, NGDP shifts curve
stems from money's function as a store of value (does depend on interest rate, has negative slope)
How does the Fed conduct an expansionary monetary policy?
buys bonds, lowers discount rate, lowers reserve requirement
What is the result of expansionary monetary policy?
money supply curve shifts out, lowers interest rates, bond prices increase, value of the dollar decreases
How does the Fed conduct a contractionary monetary policy?
sells bonds, raise discount rate, raises reserve requirement
What is the result of contractionary monetary policy?
money supply curve shifts back, higher interest rates, lower bond prices, lower value of the dollar
policy lag due to not noticing a problem exists when it is happening (happens because data is retrospective)
policy lag due to the time it takes to figure out what policy to implement
policy lag due to the time it takes for a policy to kick in
a situation in which conventional monetary policy is ineffective due to low interest rates combined with consumers who prefer to save rather than invest
Velocity of money
the # of times the average dollar is used in economy during a year (prices x output / size of money supply)
Equation of exchange
M x V = P x Y
consists of changes in the money supply and interest rates
consists of changes in taxes and spending, responsibility of executive and legislative branches
Automatic Fiscal Stabilizers
stabilizers take away income as economy heats up and inject income as it slows down (no action needed from president or congress)
ex: progressive taxes, unemployment benefits, means-tested welfare benefits
Discretionary Fiscal Policy
refers to changes in taxing and spending intended to influence performance of the economy
Expansionary fiscal policy
cut taxes, raise transfer payments, increase government spending - closes recessionary gap
Contractionary fiscal policies
raise taxes, lower transfer payments, decrease government spending - closes inflationary gap
when government engages in additional borrowing, households expect higher future taxes to repay debt, so they increase their savings rate
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