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Functions of money
Medium of exchange, unit of accounting, store of value, standard of deferred payment
Financial intermediaries
Entities like banks that exist to facilitate the flow of funds between savers and borrowers
Federal Reserve System
The central banking system of the United States responsible for monetary policy and regulation of financial institutions
Money creation
Process by which the Federal Reserve increases the money supply through actions like open market operations
Federal deposit insurance
A government guarantee that deposits in banks will be repaid if the bank fails
Barter
Direct exchange of goods and services without using money, requiring a double coincidence of wants
Unit of accounting
Measure by which prices are expressed, a central property of money
Store of value
Property of money that allows it to hold value over time and transfer wealth into the future
Standard of deferred payment
Property of money that makes it desirable for settling debts maturing in the future
Liquidity
Degree to which an asset can be quickly bought or sold without significant loss in value
Transactions deposits
Checkable and debitable account balances in financial institutions for easy payments
Fiduciary monetary system
Currency system where value is based on public confidence in its exchangeability for goods and services
M1 money supply
Measure of money including currency, checkable deposits, traveler's checks, and savings deposits
M2 money supply
Measure of money including M1 plus small-denomination time deposits and retail money market mutual funds
Central bank
Institution that regulates commercial banks, acts as a banker's bank, and manages a country's monetary policy
Direct finance
Individuals directly purchase securities like bonds from businesses
Indirect finance
Individuals deposit money in banks, which then lend it to businesses
Financial intermediation
The process by which financial institutions accept savings from businesses, households, and governments and lend the savings to other businesses, households, and governments
Asymmetric information
Information possessed by one party in a financial transaction but not by the other
Adverse selection
The tendency for borrowers to use their borrowed funds for high-risk projects
Moral hazard
The possibility that a borrower might engage in riskier behavior after a loan has been obtained
Larger scale and lower management costs
People can pool funds in an intermediary, reducing costs and risks. Examples are pension funds, investment companies, and government-sponsored financial institutions such as the Federal National Mortgage Association.
Liabilities
Amounts owed. The legal claims against a business or household by nonowners. The sources of funds for financial intermediaries
Assets
Amounts owned. All items to which a business or household holds legal claim. The uses of funds by financial intermediaries
Reserves
In the U.S. Federal Reserve System, deposits held by Federal Reserve district banks for depository institutions, plus depository institutions' vault cash
Reserve ratio
The fraction of transaction deposits that banks hold as reserves. Its size is determined by required reserves (reserves that the Fed requires banks to hold) and excess reserves (additional reserves that banks voluntarily hold)
Balance sheet
Statements of assets (what is owned) and liabilities (what is owed)
Open market operations
The purchase and sale of existing U.S. government securities (such as bonds) in the open private market by the Federal Reserve System
Money multiplier
A number that, when multiplied by a change in reserves in the banking system, yields the resulting change in the money supply
Potential money multiplier
The reciprocal of the required reserve ratio, assuming no leakages into currency and no excess reserves. Equal to 1 divided by the required reserve ratio
Bank run
An attempt by many of a bank's depositors to convert transactions and time deposits into currency out of fear that the bank's liabilities may exceed its assets. The result is the failure of that depository institution
Federal Deposit Insurance
In 1933, at the height of bank failures, the Federal Deposit Insurance Corporation (FDIC) was founded to insure the funds of depositors and remove the reason for runs on banks. The FDIC is a government agency that insures the deposits held in banks and most other depository institutions; all U.S. banks are insured this way. The current maximum of insured deposits is $250,000 per depositor per institution
