Key Concepts in Monetary Policy and Banking Systems

Asset demand

The demand for money as a store of value (people hold cash instead of other assets).

Assets

Everything of value owned by an individual or institution (cash, loans, bonds, etc.).

Balance sheet

A financial statement showing a bank's assets, liabilities, and net worth.

Bank run

When many depositors withdraw money at once due to fears of bank failure.

Board of Governors

The seven-member board that oversees the Federal Reserve System and sets national monetary policy.

Bonds

IOUs issued by governments or corporations promising to pay back principal with interest.

Capital inflow

Money that flows into a country from foreign investors.

Capital outflow

Money that flows out of a country to invest abroad.

Central bank

The institution that manages a country's money supply and monetary policy (U.S. = Federal Reserve).

Checkable bank deposits / demand deposits

Bank account balances that can be withdrawn on demand by check or debit card.

Currency

Paper bills and coins in circulation used as money.

Demand deposits

Same as checkable deposits; funds that can be accessed immediately.

Deposit insurance (FDIC)

A federal guarantee that protects depositors' funds (up to $250,000) if a bank fails.

Discount rate

The interest rate the Federal Reserve charges banks for loans directly from it.

District Banks

The 12 regional banks that make up the Federal Reserve System.

Easy Monetary Policy (Expansionary)

When the Fed increases the money supply (buying bonds, lowering rates) to encourage borrowing and growth.

Excess reserves

Reserves held by banks beyond what is legally required; can be loaned out.

Federal funds market

The market where banks lend reserves to each other, usually overnight.

Federal funds rate

The interest rate banks charge each other for overnight loans; a key target of monetary policy.

Federal Open Market Committee (FOMC)

The Fed's main policy-making group that conducts open-market operations.

Fiat money

Money that has value because the government declares it legal tender, not because it's backed by a commodity.

Financial asset

A paper claim that entitles the holder to future income (stocks, bonds, loans).

Financial intermediary

An institution that connects savers and borrowers (e.g., banks, credit unions, mutual funds).

Fisher effect

The idea that nominal interest rates rise with expected inflation, keeping real interest rates unchanged.

Fractional reserve system

A banking system where banks keep only a fraction of deposits as reserves and lend out the rest.

Future value

The amount an investment will be worth after earning interest over time.

Interest on Reserve Balances (IORB)

The interest the Fed pays banks on reserves held at the Federal Reserve.

Interest rate

The cost of borrowing money or the return on savings, expressed as a percentage.

Liability

A financial obligation or debt; what a bank or person owes to others.

Liquid

Easily converted into cash without losing value.

Loanable funds market

The market where savers supply funds and borrowers demand them; determines the real interest rate.

Loan-backed securities

Assets created by pooling loans (like mortgages) and selling shares of the combined loans.

M1

The narrowest measure of money: currency in circulation, traveler's checks, and checkable deposits.

M2

M1 plus near-monies (savings accounts, small time deposits, and money market funds).

Medium of exchange

Money is used to buy goods and services.

Monetary aggregate

A measure of the total money supply (e.g., M1 or M2).

Monetary base

Currency in circulation plus reserves held by banks at the Fed.

Monetary policy

Actions by a central bank to control the money supply and influence interest rates to achieve economic goals.

Money

Any asset that serves as a medium of exchange, store of value, and unit of account.

Money demand curve

Shows the inverse relationship between the interest rate and quantity of money demanded.

Money market

Market in which money supply (vertical) and money demand (downward-sloping) determine the nominal interest rate.

Money multiplier

The ratio showing how much the money supply can increase based on new deposits and lending.

Money supply

The total quantity of money available in the economy.

Near-monies

Financial assets that can easily be converted into cash (savings deposits, time deposits).

Open-market operation (OMO)

The Fed's buying or selling of government securities to change the money supply.

Policy rate

The key interest rate used by a central bank to influence the economy (in the U.S., the federal funds rate).

Physical asset

A tangible object that holds value (like property, gold, or machinery).

Reserve ratio

The fraction of bank deposits held as reserves.

Reserve requirement

The minimum percentage of deposits banks must hold in reserve, set by the Fed.

Savings

Income not spent on consumption; funds available for investment.

Securities

Tradable financial assets such as bonds, stocks, or loan-backed securities.

Store of value

The ability of money to hold value over time and be saved for future use.

Tight Monetary Policy (Contractionary)

When the Fed decreases the money supply (selling bonds, raising rates) to fight inflation.

Transaction costs

Costs associated with making a financial transaction (time, effort, fees).

Transaction demand

The demand for money to make everyday purchases.

Unit of account / measure of value

A standard measure for comparing the value of goods and services.

Velocity of money

The number of times each dollar is used to purchase goods and services in a given period.