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money

Terms in this set (60)

barter
traders must find partners with "mutual coincidences of wants" (this problem is solved with money)
I must find someone with the goods and services I want from someone who wants what I have to trade.
A barter economy
makes it hard for workers who specialize in their training and work because they have less variety in products in which to trade for the many items they seek.
The number of barter ratios becomes
(n(n-1))/2 where n = number of goods/services.
Money serves three functions.
1. Money serves as a medium of exchange
2. Money serves as a unit of account.
3. Money also serves as a store of value, or wealth.
1. Money serves as a medium of exchange bc
it makes trade much easier than it would be under a system of pure barter.
2. Money serves as a unit of account.
Money allows us to compare apples to oranges: we can add up the money values of a lot of disparate things and learn the value of an individual's or a business's assets and liabilities. As a unit of account, money also allows us to compare the cost of different ways of producing things.
3. Money also serves as a store of value, or wealth.
For a dairy farmer it would be far easier for her to sell the milk and store her wealth using money.
Fiat money differs from what people have traditionally used as money because
it isn't backed by anything. It is money because the government says it is. People will accept it in exchange for real goods and services, and you can use it to pay taxes.
A $25,000 price tag on a new car is an example of money as
a unit of account
If an economy tried to use bananas as money, which function would bananas likely have the most difficult time fulfilling?
a store of value
A Treasury Security is
an IOU, or debt obligation, of the federal government.
Governments operate under "budget deficits" whenever
they spend more than they collect in tax revenues in a given year.
A budget surplus is said to occur whenever
government spending is less than tax revenues in a given year.
A balanced budget occurs whenever
government spending equals tax revenue in a give year.
national debt
$18,152,456,926,656.13 as of May 10, 2015.
increases whenever the federal government operates under a budget deficit.
It reflects "deferred taxation" since it must be eventually paid off by future taxpayers.
The government becomes a borrower (i.e., they owe lenders/creditors)
when it operates under budget deficits.
Treasury securities come in three types:
Treasury bills
Treasury notes
and Treasury bonds
Treasury bills
maturity of one year or less
Treasury notes
maturity of 1 to 10 years
Treasury bonds
maturity over 10 years
Creditors
receive interest income over the maturity of the securities determined by market forces (i.e., supply and demand) at the time securities are issued by the U.S. Treasury.
The sum of all Treasury securities outstanding (i.e., have not yet been paid back) is
the value of the national debt.
Reserves of banks are
dollars that can neither be lent or invested.
Banks's must meet "reserve requirements" that mandate
that a specific percentage of deposits must be held as reserves (either held in its vault or at its Federal Reserve branch office).
Notice that "reserves" refer to _____, while a "reserve requirement" refers to the _______ that must be held in reserves.
dollars held, percentage of deposits
Suppose the money supply rises by $44 M when the Fed conducts an open market purchase of $11 M. What reserve requirement ratios is consistent with this result? (Express at a percentage between 0 and 100.)
25 (open market purchase/how much money supply rises)
Suppose the Fed wishes to decrease the money supply by $30 M. Which of the following open market operations would be consistent with this action assuming the reserve requirement is 5%?
Open market sale of $1.5 M
The Fed may also change the money supply through changing
reserve requirements. Increases in reserve requirements lower the money multiplier, thus lowering the money supply.
Money Multiplier
If the reserve requirement rises from 10% to 20%, the money multiplier falls from 10 (=1/.1) to 5 (=1/.2).
(1/.n)
Therefore, banks must hold back more of their deposits and this lowers their ability to create new loans.
The fed funds market is
the market in which private banks trade reserves on an overnight basis mostly for purposes of meeting their reserve requirements. (fed controls interest rates)
The "fed funds rate" is
the interest rate in this market in which banks "short" of reserves may borrow from banks that have too many reserves.
The Fed controls the "Fed Funds Rate" by
changing supply of reserves of private banks through open market operations
The supply exhibits a positive slope because
banks find it more attractive to lend other banks their "excess" reserves as they receive higher rates of return on such overnight lending
Reserve supply rises when
the Fed conducts open market purchases since this action injects more reserves into the banking system. RIGHT shift
Open market sales
decrease reserves in the banking system LEFT shift of supply
The demand for reserves by private banks is
downward sloping reflecting the law of demand. That is, as the fed funds rate falls, banks find it more attractive to borrow from other banks.
Intersection of supply and demand curves
That intersection defines the equilibrium fed funds rate ffe and quantity of reserves Qe in the banking industry.
Overnight loans from one commercial bank to another for reserve purposes entail an interest rate called the
federal funds rate
To raise the fed funds rate, the Fed sells Treasury securities (i.e., open market sales) thus decreasing reserve supply to shift
left
Reducing the fed funds rate requires the Fed to conduct open market purchases of Treasury securities. This action increases reserve supply to shift
right
open market sales
raise the fed funds rate
Suppose the Fed conducts open market sales of $100M. Under which reserve requirement will it change the fed funds rate the most, and in which direction?
Raise the fed funds rate under a 10% reserve requirement
(want low reserve requirement so can lend out more money. also want to raise fund rate)
The ratio 1/P equals (P=price index)
the quantity of goods/services that can be bought with $1.
-a rising price level P lowers the value of money.
Money supply is vertical, or perfectly inelastic, because
the Fed determines the money supply. The Fed conducts open market operations to achieve whatever money supply it wants. Money supply increases (decreases) with open market purchases (sales).
money demand is
negatively sloped
stated by economist Milton Friedman and
"inflation is always and everywhere a monetary phenomenon"
inflation is best described as
resulting from too many dollars chasing too few goods.
see a high and rising inflation rate over time
The Fed conducts a large volume of open market purchases
"Quantitative Easing" (QE) by the Federal Reserve represents
programs of purchasing government and mortgage debt that go far beyond conventional monetary policy associated with open market operations. These are unconventional in the sense that they are geared toward lowering interest rates in loan markets other than overnight loans between banks in what we have called the "federal funds" market.
"excess reserves" of banks
are reserves that banks can lend out, but still hold them as reserves on their balance sheets.
have gone from 0 to nearly 16 trillion.
QE is a policy whereby the Fed
buys government bonds and mortgage bonds with electronic cash that did not exist before.
It is supposed to stimulate the economy by encouraging banks to make more loans
Today, has resulted in lower interest rates
The Fisher equation states that
nominal rates of interest equal real rates of interest plus (expected) inflation.
The velocity of money refers to
the speed at which the typical dollar bill travels around the economy from wallet to wallet.
velocity of money formula
quantity equation
V = (P × Q) / M. OR* M × V = P × Q
If P is the price level (the GDP deflator), Q the quantity of output (real GDP), and M the quantity of money (nominal GDP)
when the central bank increases the money supply rapidly, the result is
a high rate of inflation.
Inflation Causes a
Redistribution of Resources from creditors to debtors
Inflation Is an Indicator of
Economic Health
Low inflation tends to create economic environments that are conducive to economic growth. Citizens are more confident about making longer-term economic commitments regarding saving and investing when they have little worry about what the inflation rate will be in the future.
Menu Costs of Inflation
When inflation is low, businesses don't have to change prices very often. Economists call the real costs of changing prices "_______."
Shoeleather Costs of Inflation
When inflation is low, it isn't very costly to hold your wealth as money or as non-interest bearing (or very low-interest) bank deposits
If the inflation rate were much higher and if prices were rising rapidly, I wouldn't carry cash and gift cards as often. I would want to hold more assets with higher interest rates. This would mean more trips to the bank and to the ATM.
Inflation Causes
Tax Distortions
Inflation means that "bracket creep"—where inflation pushes people into higher tax brackets even though their real incomes haven't changed—is an important problem
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