Econ Exam 3

Chapters 11-13. (Ch. 11 - Money, Banks, and Interest Rates; Ch. 12 - Government in the Macroeconomy: Monetary Policy; Ch 13 - Monetary Theory: The Impact of Money on the Economy)

Barter

The direct exchange of goods and services, and is the primary alternative to money for conducting voluntary exchange.

Double coincidence of wants

Where two individuals each hold an item or service that the other person wants, making a direct trade possible.

Functions of money

1. Medium of exchange

2. Unit of account (standard of value)

3. Store of value (store of wealth)

4. Standard of deferred payment

Medium of Exchange

Something that is generally accepted in payment for goods and services and settlement of debts.

Unit of account (or Standard of value)

Standard unit of measurement of the market value goods, services, and other transactions.

Store of value (or Store of wealth)

An asset that keeps its worth and can be saved and used later on without losing much value.

Standard of deferred payment

Allows businesses, individuals, and governments to make payments at a future date for goods or services received today.

Liquidity

The ease with which an asset can be converted into a medium of exchange (cash) without loss of value.

Interest

The price you pay for the use of somebody else’s money

Commodity money

An item that has intrinsic value, or value in a use other than as a medium of exchange (Gold, silver, spices, animals).

Fiat money

Paper or coin currency that the government designates as legal tender.

Digital currency

Currency in electronic, or digital form; there are no physical bills or coins.

Some are regulated and some are unregulated.

Virtual currency

Digital currencies that are unregulated; they are created and managed by a private issuer and used as payment by members of a specific virtual community.

Cryptocurrency

Type of virtual currency; uses cryptography technology to validate and secure transactions using block-chain networks.

Characteristics of ‘Good’ Money

• Durable

• Portable

• Recognizable

• Divisible

• Inexpensive to produce

• Difficult to reproduce

• Little or no intrinsic value

Federal Reserve Money Stock Measures

The Federal Reserve (the Fed) publishes two monetary aggregates to measure and define money supply: M1 and M2

M1 Money Supply

Represents the narrow money supply—a nation’s most liquid forms of money, including currency (cash), demand deposits, and checking accounts, that are effectively directly spendable.

Components of M1

• Physical Currency

• Demand Deposits

• Other Liquid Deposits

[M1 = Currency + Demand Deposits + Other Liquid Deposits]

M2 Money Supply

Broad measure of the money supply—includes all elements of M1 plus non-cash (less liquid) assets that can be easily be converted into cash.

Components of M2

• All of M1

• Saving Deposits

• Small-denomination time deposits

• Retail money market mutual fund shares

[M2 = M1 + Small Denomination Time Deposits + Retail Money Market Funds]

Monetary Base

The amount of currency in circulation plus reserve balances, or deposits held by banks and other depository institutions in their accounts at the Fed.

[Monetary Base = Currency in Circulation + Reserve Balances]

Interest rates

The percentage of interest relative to the principal.

To keep price level and inflation under control, the Fed controls the economy by influencing interest rates.

Fractional reserve banking system (banks)

A system where banks keep only a fraction of their customer deposits as liquid reserves and lend out the remainder to generate loans and stimulate economic growth.

t-account

A balance sheet that can be used to organize information and show major assets and liabilities of a bank.

Both sides must be equal; total assets on the left-hand side must be equal to total liabilities on the right-hand side.

Asset

Something of value that a bank owns, is holding, or is owed.

Liability

A financial obligation that a person or company owes to another party, typically involving a future payment of money, goods, or services.

Monetary Policy

Refers to actions by the Federal Reserve that influences and controls the flow of money and credit through the economy to help achieve macroeconomic goals.

General Functions of the Federal Reserve

• Conduct monetary policy to help achieve goals of maximum employment and price stability

• Promote stability of the financial system

• Promote safety and soundness of individual financial institutions

• Foster payment and settlement system safety and efficiency

• Promote consumer protection and community development

Federal Reserve System

Comprised of three main entities:

• the Board of Governors

• the Federal Open Market Committee (FOMC)

• Twelve main Federal Reserve District Banks

The Board of Governors

The governing body of the Federal Reserve System and is directly responsible for the discount rate and reserve requirements (All members serve on the FOMC, so they also determine monetary policy).

Federal Open Market Committee (FOMC)

Meets 8 times per year to review economic and financial conditions, and to determine monetary policy.

The voting members consists of 7 Board of Governor members, the president of the Fed Reserve Bank of NY, and 4 other Fed Reserve Bank presidents who serve on a rotating basis.

12 Federal Reserve District Banks

• Lends to depository institutions

• Holds reserve accounts of depository institutions

• Provides financial services to banks, credit unions, and thrifts

• Issues new currency; destroying currency taken out of circulation

• Supervises and examines state member banks

• Enforces federal consumer protection and fair lending laws

National Banks

Chartered by the Office of the Comptroller of the Currency and are required to be members of the Federal Reserve System.

Expansionary Monetary Policy (easy money policy)

When the Fed increases the money supply, puts downward pressure on interest rates and lowers borrowing costs allowing credit to stimulate the economy during a recession.