ap macro unit 4

functions of money

medium of exchange, unit of account, store of value

M1 definition of money

includes currency held by the public plus checkable deposits in commercial banks and thrift institutions

M2 definition of money

includes M1 plus savings deposits, time deposits less than $100k, and money market mutual funds (MMMF)

M3 definition of money

money market mutual funds over $100k (ex. retirement funds)

thrift institutions

banks that are specialized to give you help (credit unions, smaller banks, etc.)

commercial banks

bigger and almost a one stop shop (wells fargo, truist, etc.)

near-monies

certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits

where is the money of value found

the government's ability to manage it

transaction demand (Dt)

use money as a medium of exchange

asset demand (Da)

use money as a store of value

how do we find interest rates on a money market demand graph

where the supply and demand for money intersect

federal reserve system

they run the banking system, print money, and store money for banks

board of governors

the central authority of the US money and banking system, nominated by POTUS and approved by Senate, 7 members

FOMC (federal open market committee)

sets monetary policy and controls nation's money supply and influences interest rates; made up of board of governors, the president of the NY fed, and 4 of the remaining presidents of the fed

banker's bank

where banks keep their money; fed accepts the deposits of and make loans to banks and thrifts

fed functions

issuing currency, setting reserve requirements, acting as a fiscal agent, supervising banks, and controlling the money supply

what is the reserve ratio

the fraction of deposits that banks hold as reserves; commercial bank's required reserves / commercial banks checkable-deposit liabilities

banks create money when they

make loans

banks destroy money when they

fail to reissue loans that are paid off

what are excess reserves

bank reserves in excess of required reserves; actual reserves - required reserves

liabilities

debt with monetary value; an amount owed by a firm or an individual

the amount by which a bank's actual reserves exceed its required reserves is called what

excess reserves

two basic functions of a bank

accept deposits and make loans

required reserves

reserves that a bank is legally required to hold, based on its checking account deposits

federal funds rate

the interest rate collected by banks on overnight loans

the monetary multiplier

the multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans

money multiplier formula

1 / required reserve ratio

tools of monetary policy

open market operations, the reserve ratio, and the discount rate

what is the most important tool for influencing the supply of money

open market operations

open market operations

the fed's buying and selling government bonds to/from commercial banks and the general public

why does the fed manipulate the reserve ratio

influence the ability of commercial banks to lend

raising the reserve ratio

banks lose excess reserves diminishing their ability to create money by lending

lowering the reserve ratio

transforms required reserves into excess reserves and enhances the ability of banks to create new money by lending

what are the 2 ways changes in the reserve ratio affect the money-creating ability

amount of excess reserves and the size of the monetary multiplier

discount rate

the interest rate the fed charges commercial banks on the loans they make to them

decrease in the discount rate

encourages commercial banks to obtain additional reserves; when commercial banks lend new reserves, money supply increases

increase in the discount rate

discourages commercial banks to obtain additional reserves; fed raises discount rate when it wants to restrict money supply

easy money policy

designed to increase the supply of money

how is the easy money policy done

buying government securities, lower the reserve ratio, and lower the discount rate

tight money policy

designed to decrease the supply of money

how is the tight money policy done

selling government securities, raise the reserve ratio, and raise the discount rate

market for money cause and effect chain

the supply of money affects interest rates > interest rates affect investment > investment affects aggregate demand > aggregate demand affects equilibrium GDP and price level

strengths of monetary policy

speed and flexibility, isolated from political considerations

shortcomings of monetary policy

less control, changes in velocity (money), and cyclical assymetry

cyclical assymetry

fed can tighten the money easily and contract the economy but cannot expand the economy easily or efficiently

net exports effect

where we take our money can determine how far it goes

net exports effect when higher interest rates

higher valued currency so we lose X

net exports effect when lower interest rates

lower valued currency so we gain X

loanable funds market

supply and demand for loans

supply for loans

the higher the interest rate, the more funds people are willing to make available for loans

determinants of supply for loans

less savings = left
more savings = right

demand for loans

higher interest rates means businesses are less likely to borrow money

determinants of demand for loans

returns on investments and excessive spending by government beyond taxable revenue

if businesses think they're not going to receive returns what happens to the demand for loans

leftward shift

if local governments keep borrowing money from the government in the form of loans what will happen to the demand for loans

rightward shift

crowding out affect in relation to the demand for loans

higher interest rates means that businesses cannot pay for the interest rates

range of interest rates is influenced by what

risk, maturity, loan size, and taxability

what is the equilibrium interest rate determined by

the demand and supply of loanable funds

time-value of money

the idea that $1 can be converted into more than $1 of future value through compound interest and therefore that $1 to be received sometime in the future has less than $1 of present value

interest rates on investment loans affect

the total level of investment (= the levels of total spending and total output), allocate money and real capital to specific industries and firms, level and composition of R&D spending

usury laws that establish an interest-rate ceiling below the market interest rate may

deny credit to low-income people, subsidize high-income borrowers and penalize lenders, diminish the efficiency with which loanable funds are allocated to investment and R&D projects

3 sources of economic profit

the bearing of uninsurable risk, the uncertainty of innovation, and monopoly power

profit and profit expectations affects

levels of investment, total spending, and domestic output