Money and Banking Practice Flashcards CHAPTER 5

Vocabulary flashcards covering fundamental concepts of money, banking, monetary aggregates, central bank operations, and interest rates based on the Economics 2 lecture by Hélène Latzer.

Money

Any form of wealth detention that may be directly used to pay for transactions and is unanimously accepted in the economic environment in which it is being used.

Overnight deposits

Funds held by the public in accounts offered by commercial banks that are immediately available for payment.

Unit of account (numeraire)

A function of money meaning its nominal value is known and constant.

Medium of exchange

A function of money that allows it to be used as a means of payment for goods and services.

Store of value

A function of money that allows individuals to hold wealth over time.

Purchasing power in $t$

The value of one monetary unit expressed as $\frac{1}{P_t}$, where $P_t$ is the aggregate price level in $t$.

Liquidity

The property of an asset that allows it to be quickly exchanged for goods and services with little transaction cost and little uncertainty about its nominal value.

Monetary assets (quasi-money)

Financial assets with a positive nominal yield that cannot be directly used for payment but are easily transformed into money.

M1

A monetary aggregate consisting of the most liquid assets: currency (coins and banknotes) and overnight deposits.

M2

A monetary aggregate consisting of $M1$ plus saving deposits and term deposits with a fixed maturity of up to two years.

M3

A monetary aggregate consisting of $M2$ plus money in market mutual funds and debt securities with a fixed maturity of up to two years.

Monetary base (MB)

The sum of currency in circulation ($CH$) and reserves ($R$) held by banks at the central bank: $MB = CH + R$.

Money supply ($M_s$)

The sum of currency in circulation ($CH$) and all deposits held by the public with commercial banks ($D$): $M_s = CH + D$.

Financial intermediaries

Institutions that transform savings ($S$) into investments ($I$) by receiving deposits and using them to purchase securities or grant loans.

Second-Rank Banks (SRB)

A collective term for financial intermediaries like commercial banks, excluding the Central Bank.

Reserve requirement ratio

The legal requirement for banks to hold a specific proportion of reserves relative to their current accounts.

Open Market Operations (OMOs)

Central bank transactions involving the buying or selling of government bonds, treasury bills, or commercial paper to change the monetary base.

Repurchase agreement (repo)

A loan granted by the ECB in exchange for collateral (typically government bonds) where banks buy back the bonds at maturity using their reserves.

Main refinancing operations (MROs)

One-week repurchase agreements used by the ECB to provide reserves to the banking sector.

Refinancing rate

The policy rate decided by the ECB, representing the percentage difference between the collateral price and the buy-back price.

Interbank market

A market where banks and large financial institutions trade deposits with maturities ranging from one day to several months.

Marginal lending facility

An ECB facility allowing banks to borrow reserves overnight at a rate that acts as a higher bound for the interbank rate.

Deposit facility

An ECB facility remunerating excess reserves at the deposit rate, which acts as a lower bound for the interbank rate.

Money multiplier (mm)

The relationship between money supply and monetary base, expressed as $mm = \frac{1}{c + \rho(1 - c)}$.

Reserve ratio ($\rho$)

The amount of reserves that commercial banks hold per euro of demand deposits: $R = \rho D$.

Cash preference (c)

The ratio of banknotes in circulation to the total money supply: $CH = c M_s$.

Money demand ($M^d$)

The quantity of money agents wish to hold based on the price level ($P$), economic activity ($Y$), and interest rate ($i$): $M^d = PY L(i)$.

Expected inflation rate ($\text{π}^e_{t+1}$)

The growth in the price level between $t$ and $t+1$ as anticipated in $t$: $\text{π}^e_{t+1} = \frac{P^e_{t+1} - P_t}{P_t}$.

Fischer’s interest rate equation

A simplified relationship between real and nominal interest rates: $r_t = i_t - \text{π}^e_{t+1}$.

Real money demand

The quantity of money demanded measured in commodity baskets: $\frac{M^d}{P} = Y L(i)$.