AP Macro (31, 23, 33)

medium of exchange

socially acceptable and acts as an intermediary in the exchange of goods and services

unit of account

it is a “yardstick” for measuring the relative worth of a variety of goods. Used to compare the worth of one good vs. another

M0

• currency in circulation

• reserves of banks

M1

• currency in circulation

• checking accounts/demand deposits

• savings accounts

M2

• includes M1

• money market accounts

• Small time deposits - certificates of deposits (CD’s) less than $100,000

M3

• includes M2

• large time deposits more than $100,000

Value of a dollar/purchasing power

inverse relationship - price level up - purchasing power down

transaction demand

varies directly with GDP - primary function - medium of exchange - money needed to purchase a certain level of GDP

money demand shifters

• changes in price level

• changes in RGDP/spending (C+I+G)

demand pull inflation (money market)

the FED would decrease the money supply from MS1 to MS3 to increase I-rates to decrease borrowing/spending and thus AD

recession (money market)

the FED would increase the money supply from MS1 to MS2 to decrease I-rates to increase borrowing/spending and thus AD

inverse

relationship between bond prices and interest rates

Rate of Return equation

fixed dividend/bond price

future value of money equation

$(1+r)

present value of money equation

$/(1+r)

fractional reserve system

banks only keep a fraction of their deposits on reserve at any time

money multiplier

1/RRR – The multiple by which a single commercial bank can increase the money supply out of its excess reserves.

currency drains

people hold on to cash

excess reserves

The amount by which a bank's actual reserves exceed its required reserves. This is typically the amount of money banks can loan out

asset demand

The amount of money people want to hold for use as a store of value

demand deposit

Any deposit into a financial institution against which a check can be written – also known as a demand deposit.

required reserves

The amount that banks must hold to meet the legal reserve requirement.

* = total reserves x required reserve ration

required reserve ratio

The fraction of checkable deposits a financial institution must hold in reserve. The percent is set by the Federal Reserve.

total/actual reserves

The amount that banks are currently holding in reserve. Can be excess or required.

excess reserves

The amount by which a bank's actual reserves exceed its required reserves. This is typically the amount of money banks can loan out.

* total reserves - required reserves

change in money supply

= excess reserves x 1/RRR

Total amount demand deposits

= change in money supply + initial demand deposit

Monetary Policy

A central bank’s changing of the money supply to influence interest rates to achieve the economic goals of price level stability and full employment.

Three tools of monetary policy

• Open Market Operations

• Reserve Ratio

• Discount Rate

OMO - Buy

Buying securities/bonds - expands the money supply (FED buys: commercial banks sell)

* do this in a recession to lower I-rates, which increases borrowing/spending thus increasing AD to fix low RGDP

OMO - Sell

Selling securities/bonds - decreases the money supply (FED sells: commercial banks buy)

* do this during periods of demand-pull inland to raise I-rates, which decreases borrowing/spending thus decreasing AD to fix a high price level. This also decreases the price of bonds in the bond market

Raising RRR

banks must hold more required reserves; money supply decreases (during inflation)

lowering RRR

banks may hold less required reserves; money supply increases (during recession)

discount rate

The interest rate the Federal Reserve charges member banks for loans and also the rate the FED pays banks to keep money on reserve at the FED.

federal funds rate

The interest rate banks charge one another on overnight loans.

prime lending rate

the rate banks charge their best customers

Quantity theory of Money

The formula pure monetarists use to support their argument that the quantity of money determines the value of money. (M \* V) = (P \* Q)aka nominal GDP

Major shifters money supply

1. OMO - Buy/sell bonds

2. RRR

3. discount rates

major shifters demand

1. Price level up = demand up

2. RGDR/income up = demand up

3. fiscal policy/deficit spending up = demand up

nominal I-rate

= real + expected rate of inflation

real I-rate

= nominal - expected rate of inflation

loanable funds market

the hypothetical market for a loan or borrowed $/funds. Axis is labeled real interest rate because the financial institutions are concerned about what the real purchasing power of the money is

• supply curve shifters: depositors - households, foreign investors, savers/bond issuers

• Demand curve shifters: anyone who seeks a loan/borrowing money/bond issuers

Depreciate

expansionary monetary policy causes a countries currency on the foreign exchange market to…

appreciate

contractionary monetary policy causes a countries currency on the foreign exchange markets to…

expansionary monetary policy

When the central bank increases the money supply through buying bonds, decreasing the reserve requirement or lowering the discount rate.

contractionary monetary policy

When the central bank decreases the money supply through selling bonds, increasing the reserve requirement or increasing the discount rate.

Crowding out

when fiscal policy is used rather than monetary policy. Increase government spending and decrease taxes. Run a deficit. Potentially keeps us in recession