AP Macro Unit 4 Test Review

Fractional Reserve Banking System

Fraction of checkable deposits are backed up by cash in bank vaults or deposits in the central bank

Balance sheet

Statement of assets and liabilities. Both must equal.

Assets

What you own

Required Reserves

rules set by the Fed that determine how much money must stay inside banks

Excess Reserves

banks reserves over and above its required reserves

Money Multiplier

1/rr

Functions of Money

a medium of Exchange, unit of account, store of Value.

M1

Consists of currency, all checkable deposits, savings, travelers checks

M2

M1+ small time deposits (CDs), individual money market mutual fund balances

The "Fed" (Federal Reserve System)

The U.S central bank that consists of Board of Governors of Federal Reserve and the 12 Federal Reserve Banks that controls monetary policy

liquidity

The ease with which an asset can be turned into cash

stocks

a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.

bonds

certificates that represent money the government has borrowed from private citizens. Interest baring asset.

fiat money

money that is backed by the issuer; has no instrinsic value since it's only paper

Money Market Model

plots the Money Demand vs. Money Supply (MS); MS is vertical bc the supply of money is controlled by the Federal Reserve

nominal interest rate

equal to the real interest rate + the inflation rate

Liabilities

what you owe

Crowding Out

when an increase in government spending and borrowing or deficit spending causes interest rates to rise and private investment to fall in the loanable funds market

Crowding In

When a decrease in government spending and borrowing causes interest rates to fall and private investment to increase in the loanable funds market

Tools of Monetary Policy- Limited Reserve

Open Market Operations, Discount Rate, and Reserve Ratio

Expansionary monetary policy

used to combat a recessionary gap; buying bonds, lowering the RR and discount rate (limited), lowering interest on reserve (ample).

Contractionary monetary policy

used to combat an inflationary gap; selling bonds, raising the RR, and discount rate, raising administered rate or IOR (ample)

loanable funds market

a market where banks supply loans to the government, consumers, and firms; connected to fiscal policy

Money created from the Fed buying or selling bonds (Formula)

Value of Purchase/sale X (1/rr)

Money created from a deposit in the bank (Formula)

1st Excess Reserves X (1/rr)

Administered rate

changes the discount rate & interest on reserve.

federal funds rate

the interest rate at which banks make overnight loans to one another

interest on reserves (IOR)

The interest rate that the Federal Reserve pays commercial banks to hold reserves. Sets the floor for the federal funds rate.

real interest rate

nominal interest rate - inflation rate

opportunity cost of holding money

varies directly with the interest rate. loose out on interest on holding other assets.

Bond prices

move in opposite direction of interest rates

Money supply

the quantity of money available in the economy, vertical, controlled by Federal Reserve

Transactional Demand for money

refers to the money people hold as cash for the payment of day-to-day expenses. Varies with nominal GDP so it's tied to AD. AD shifts - Demand for Money shifts.

Monetary Base (MB)

banking system reserves plus currency held by the public

when the actual rate of inflation is less than the expected rate of inflation

borrowers lose if they have a fixed interest rate

How do banks increase the money supply?

by making loans

Any increase in C+I+GS+Xm

increases the demand for money and nominal interest rate

Supply of loanable funds

The amount of saving made available for lending at each real interest rate

Change in price level on aggregate model

impacts transactional demand for money (shifting money demand), interest rates, and then aggregate demand (C + I).

easy money policies

Expansionary monetary policy when it believes the economy is in danger of sliding into a recession. Intended to spread the growth of money supply. As the amount of money flowing into the economy increases, the interest rates decrease and borrowing becomes easier.

tight money policies

monetary policy resulting in higher interest rates and restricted access to credit; associated with a contraction of the money supply

Contractionary Monetary policy impact on the aggregate model

AD shifts left, Price level & Real GDP goes down

Expansionary Monetary policy impact on the aggregate model

AD shifts right, Price level & Real GDP goes up