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3 functions of money
medium of exchange, unit of account, and a store of value
medium of exchange
a tool that allows you to make a purchase
unit of account
a measure of the value of goods and services
store of value
doesn’t die or spoil
money types
commodity money, specie money, fiat money
commodity money
when a resource or good is used as money
ex. when ramen is used as currency in prison
specie money
a commodity metal, historically gold or silver, backing money or currency
fiat money
money whose purchasing power derives from a declaratory fiat of the government issuing it
3 types of liquidity
M1(high liquidity), M2(medium liquidity), M3(low liquidity)
liquidity
how easy it is to access and convert an asset into cash (liquidized)
M1(high liquidity)
coins, currency, and check-able deposits plus savings deposits (money market accounts, personal, and checking accounts) in general is money supply
M2(medium liquidity)
M1 plus time deposits (CDs= certificates of deposit), and mutual funds below $100 k
M3(low liquidity)
M2 plus time deposits above $100k
why we need financial markets
individuals, businesses, and the government all borrow and save, so they need institutions to help with this
financial sector
network of institutions that link borrowers and lenders
assest
anything tangible/ intangible that is owned
liability
anything that is owed
financial assets
stock, bonds, and loans
stock
ownership of a company
bond
loan to a company or government
bond prices
there is a secondary market for bonds where people can sell bonds that they own. There is a direct relationship between demand and bond prices. There is an inverse relationship between bond prices and interest rates
the demand for money
at any given time, people demand a certain amount of liquid assets (money) for everyday purchases. inverse relationship between nominal interest rate and quantity demanded.
money demand shifters
changes in price level and income
the supply for money
the US money supply is set by the board of governors of the federal reserve system
FED system
non-partisan government office that sets and adjusts the money supply to adjust the economy. this is monetary policy!!
increasing the money supply
if the FED increases the money supply, a temporary surplus of money will occur, causing rates to fall
what happens to aggregate demand when money supply increases
when money supply increases, interest rates decrease, causing investment to increase and ultimately causing aggregate demand to increase
what should the Fed do with gov. securities to increase the money supply
buy gov. securities
what should the Fed do with gov. securities to decrease the money supply
sell gov. securities
open market operations
when the Fed buys or sells gov. bonds (securities). This used to be the most important and widely used monetary policy
the discount rate
the interest rate the Fed charges commercial banks
what should the Fed do to the discount rate to increase the money supply
decrease the discount rate (easy money policy)
what should the Fed do to the discount rate to derease the money supply
increase the the discount rate (tight money policy)
money multiplier
1/r
in a recession, the Fed lowers the reserve ratio
(banks hold less money and have more excess reserves, they create more money by loaning out excess, and money supply increases, interest rates fall, and AD goes up)
during inflation, the Fed increases the reserve ratio
banks hold more money and have less reserves, they create less money, money supply decreases, interest rates go up, and AD goes down
using reserve requirement
in a recession, the Fed lowers the reserve ratio. During inflation, the Fed increases the reserve ratio
federal funds rate
the interest the banks charge one another for 1 day loans of reserves
interest on reserves
when a bank has reserves, they keep them with the Fed in return for guaranteed interest
what will the Fed do interest on reserves to lower the money supply
they will increase the interest rates
what will the Fed do interest on reserves to raise the money supply
they will decrease the interest rates
what do banks do to their interest rates when the Fed increases interest rates on reserves
banks will raise their interest rates
what do banks do to their interest rates when the Fed decreases interest rates on reserves
banks will lower their interest rates
number one rule of the bank balance sheet
liabilities must equal assets
liabilities categories (rights side of balance sheet)
demand deposits (dd)/ check-able deposits, bank debt, and owners equity (stock shares)
assets categories (left side of balance sheet)
required reserves (rr), securities (federal bonds), and customer loans
demand deposits (dd)/ check-able deposits
cash deposits from the public (checking account)
bank debt
the amount the bank borrowed to fund its operations
owners equity (stock shares)
values of stocks held by the public ownership of bank shares
required reserves (rr)
percentage of demand deposits only. anything more is considered excess reserves
securities (federal bonds)
bonds purchased by the bank, or new bonds sold to the bank by the Fed. These can be purchased from the bank and turned into cash that immediately becomes available as “excess reserves”
customer loans
loans owed to the bank by prior customers
