Money, The Price Level, and Inflation

Flashcards based on the key concepts of money, banking, and the Federal Reserve from the lecture notes.

What is money?

Money is any commodity or token that is generally acceptable as a means of payment.

What are the three functions of money?

Medium of exchange, unit of account, and store of value.

Define medium of exchange.

A medium of exchange is an object that is generally accepted in exchange for goods and services.

What is the unit of account function of money?

A unit of account is an agreed measure for stating the prices of goods and services.

What are the two main official measures of money in the United States?

M1 and M2.

What is M1 composed of?

Currency, traveler’s checks, and checking deposits owned by individuals and businesses.

What is included in M2?

M1 plus time deposits, savings deposits, money market mutual funds, and other deposits.

What is a depository institution?

A firm that takes deposits from households and firms and makes loans to other households and firms.

What is the role of the Federal Reserve System?

The Fed regulates a nation's depository institutions and controls the quantity of money.

What are the three main policy tools of the Fed?

Open market operations, last resort loans, and required reserve ratios.

Define liquidity.

Liquidity is the property of being instantly convertible into a means of payment with little loss of value.

What is the money multiplier?

The money multiplier is the ratio of the change in the quantity of money to the change in the monetary base.

How do banks create money?

Banks create deposits when they make loans, and new deposits created are considered new money.

What is the difference between M1 and M2?

M1 includes only currency and checking deposits, while M2 includes M1 plus savings deposits and other liquid assets.

What is an example of financial innovation?

The development of new financial products to lower deposit costs or increase lending returns.

What is the relationship between price level and money demanded?

A rise in the price level increases the quantity of nominal money demanded.

What does the demand for money depend on?

The demand for money depends on price level, nominal interest rate, real GDP, and financial innovation.

What happens in the money market when there's excess demand for money?

People sell bonds, causing bond prices to decrease and interest rates to rise.