Money, Banking, and Central Banking

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