IB Economics Macro Section 3.5

central bank

independent national authority that controls the monetary system

money supply

total amount of money in circulation

perfectly inelastic

because the money supply is fixed at any particular point in time, the supply of money is considered to be:

recessionary gap

If the economy functions at a level LOWER than the
full employment level, the economy experiences this.

interest rate

what it costs to borrow money

low interest rate

this will induce firms to invest and consumers to spend more

high interest rate

this will induce firms and consumers to save

lender of last resort

banks act as this in a financial crisis, when consumers may lose faith in their bank and the banks need financial support

bond

a financial security that represents a promise to repay a fixed amount of funds

reserve requirement

the proportion of deposits that a commercial bank must keep in its vaults in reserve

aggregate demand

the total value of goods and services demanded by different groups at a given price level in an economy.

purchasing power

the number of goods and services an individual can buy

inflation targeting

the central bank using monetary policy to keep inflation close to an agreed target (~2%)

low unemployment

a priority of monetary policy; the opposite of high unemployment

fluctuations

the central bank is responsible for smoothing out in the business cycle

external balance

this is achieved when the revenue from a country's exports is equal to the payments made for imports.

trade deficit

this occurs when visible imports outweigh visible exports.

commercial banks

privately owned banks that accept deposits and make loans and provide other services for the public

credit creation

the bank must keep a small percentage of deposited funds as cash. the rest they can lend out, and in doing so they pursue:

deposit

the amount of money individuals put into the bank for safekeeping, and/or to earn interest.

money multiplier

the amount of money the banking system generates with each dollar of reserves; reciprocal of the reserve requirement

total deposits

initial deposit x money multiplier

total credit creation

initial credit creation x money multiplier

open market operations

the central bank buying and selling bonds to regulate the money supply

expansionary monetary policy

monetary policy that increases aggregate demand

contractionary monetary policy

monetary policy that reduces aggregate demand

minimum lending rate

The rate at which the central bank charges commercial banks to borrow money. also known as the discount rate

quantitative easing

when the Fed buys longer-term government bonds or other securities. expansionary.

quantitative tightening

when the Fed sells longer-term government bonds or other securities. contractionary.

expansionary

the following monetary policies are _. decreasing MRR, buying bonds, and decreasing the discount rate.

contractionary

the following monetary policies are _. increasing MRR, selling bonds, and increasing the discount rate.

demand for money

the willingness and the ability of economic agents (consumers, firms, etc.) to use money at a given interest rate and at a specific point in time

transactions motive

the need to hold money for spending

precautionary motive

holding money for unexpected expenses and impulse buying

speculative motive

holding cash to avoid holding financial assets whose prices are falling

buys bonds

if the central bank , it pays investors in cash. It is this payment in cash that increases the money supply

nominal interest rate

the interest rate quoted by commercial banks (real interest rate + inflation premium)

real interest rate

the interest rate with inflation taken into account