AP Macroeconomics Unit 4

commodity money

performs the function of money, but has alternate uses

ex. gold, silver

fiat money

serves only as money with no alternate uses

ex. paper money

loans

agreement between the lender and borrower to pay back a set amount over time

bank deposits

money deposited into a bank

stocks

a share of ownership in a company

bonds

an IOU to repay principal and interest, which represents debt obligations in the form of borrowing

what are the 4 types of financial assets?

loans, bank deposits, stocks, bonds

liquidity

how fast, easily, and reliably something can be converted into cash

M0

monetary base (central banks money) all the money we know exists

M1

currency in circulation—demand deposits and other liquid deposits like savings accounts and checkable deposits—”the money supply”

M2

near money—mutual funds, long-term/high yield savings, time deposits, money market accounts

expansionary policy

easy money—designed to counteract a recession by increasing the money supply

contractionary policy

tight money—designed to counteract inflation by decreasing the money supply

central bank

makes efforts to promote full employment, maintain price stability, and encourage long-run economic growth through control of the money supply and interest rates

fractional reserve banking

banks are required to hold on to a portion of their deposits in their reserves

required reserves

money the bank MUST hold based on the reserve requirement

excess reserves

usable money for the bank

open market operations

purchase and sale of government securities (bonds) by the Fed to increase/decrease the banks’s excess reserves

federal funds rate

the interest rate banks pay each other for overnight loans

expansionary

the fconed buying bonds is a(n) _____ policy

contractionary

the fed selling bonds is a(n) _____ policy

the fed gives money to the public in exchange for bonds

the fed buying bonds is an expansionary policy because…

the fed takes money from the public in exchange for bonds

the fed selling bonds is a contractionary policy because…

discount rate

the interest rate banks pay the fed for overnight loans to meet the required reserve

expansionary

lowering discount rates is a(n) _____ policy

it lowers the cost of borrowing for banks

lowering discount rates is an expansionary policy because…

contractionary

raising discount rates is a(n) _____ policy becauseit

it raises the cost of borrowing for banks

raising discount rates is a contractionary policy because…

administered interest rates

the interest rate controlled by the fed that are meant to incentivize the banking system towards/away from lending

ex. discount rates and IOR rates

expansionary

lowering IOR rates is a(n) _____ policyco

contractionary

raising IOR rates is a(n) _____ policy

banks get less money by storing with the fed, and therefore loan out more money

lowering IOR rates is an expansionary policy because…

banks get more money by storing with the fed and therefore loan out less money

raising IOR rates is a contractionary policy because…

IOR (interest on reserves) rate

rates provided by the fed to banks when they store money with the fed

money demand

the desire for people to hold money in spendable form

reserve requirement/required reserve ratio

the percentage of deposits the bank must hold

expansionary

decreasing the reserve ratio is a(n) _____ policy

contractionary

increasing the reserve ratio is a(n) _____ policy

limited reserves

the amount of money in the banking system is limited, and all monetary policies are effective

• change the amount of money banks have, changing interest rates

ample reserves

banks have ample money, only administered interest rate policies are effective

• maintain amount of reserves, not influence interest rates

what are the two rules of banks balance sheets?

• assets = liabilites

  • reserve requirement must be followed

what are the three functions of money?

• medium of exchange: used to buy goods and services

• unit of account: measures the value of goods and services

  • store of value: allows you to store purchasing power for the future

inverse

interest rates and the price of previously issues bonds have a(n) _____ relationship

inverse

interest rates and investment spending have a(n) _____ relationship

direct

money supply and supply of loanable funds have a(n) _____ relationship

fisher equation

nominal interest rate = real interest rate + inflation rate

real interest rate = nominal interest rate - inflation rate

money multiplier equation

Mm = 1/reserve ratio

equation to find the change in money supply

Δ excess reserves x Mm = Δ money supply (S money)

money market graph

loanable funds market graph

reserve market graph

expansionary shifters of the money supply

• decreasing the reserve requirement

• buying bonds

• lowering discount rates

contractionary shifters of the money supply

• increasing the reserve requirement

• selling bonds

• raising discount rates

shifters of the money demand

• changes in price level: more spendable money is needed to meet higher price levels

• changes in income: higher income = more spendable money

• very specific tech: the development of tech to increase the desire to have and ability to hold spendable money

shifters of the supply of loanable funds

• changes in money supply

• profitability of loans

• saving behavior

• foreign investment

shifters of the demand of loanable funds

• consumer borrowing

• business optimism

• government borrowing

shifters of the demand of reserves

• change in administered interest rates