Chapter 2 - Finance

What caused the 2007-08 financial crisis?

A rapid decline in housing prices, falling mortgage-backed security values, and inadequate equity capital at financial institutions.

What is a surplus economic unit?

An entity that generates more money than it spends, resulting in excess funds.

What is a deficit economic unit?

An entity that generates less money than it spends, resulting in a need for additional funds.

What are the three ways savings are transferred into investments?

Direct transfers, indirect transfers through investment banking firms, and indirect transfers through financial institutions.

What are the two major participants in the U.S. monetary system?

The central bank and the banking system.

What is the central bank in the United States?

The Federal Reserve System (the Fed).

What are the components of the Federal Reserve System?

The Board of Governors and the Federal Reserve Banks.

What are the two main functions of the central bank?

Define and regulate the money supply and facilitate the transfer of money.

What are the four functions of the banking system?

Create money, transfer money, provide financial intermediation, and process/clear checks.

What are real assets?

Land, buildings, homes, equipment, inventories, durable goods, and precious metals.

What are financial assets?

Money, debt instruments, equity securities, and other financial contracts backed by real assets and earning abilities.

What is money?

Anything generally accepted as payment for goods, services, and debts.

What is barter?

The exchange of goods or services without using money.

What is liquidity?

The ease and low cost of converting an asset into money.

What is the primary function of money?

Medium of exchange.

What is the store of value function of money?

Money can be held over time before being spent without losing value.

What is the standard of value function of money?

Prices and debts are stated in terms of a monetary unit.

What is full-bodied money?

Coins containing metal equal in value to their face value.

What are token coins?

Coins containing metal worth less than their stated value.

What is representative full-bodied money?

Paper money fully backed by a precious metal.

What is fiat money?

Legal tender declared money by law and not backed by a precious metal.

What is credit money?

Money worth more than the material it is made from and backed by the creditworthiness of the issuer.

What is deposit money?

A type of credit money backed by the depository institution that issued it.

What are ATS accounts?

Automatic Transfer Service accounts that allow direct deposits and payments from checkable deposit accounts.

What is a debit card?

A card that provides immediate transfer of deposit amounts and ATM access.

What is a money market?

A market where debt securities with maturities of one year or less are issued or traded.

What are money market securities?

Debt securities with maturities of one year or less.

What is a Treasury bill?

A short-term debt obligation issued by the U.S. federal government.

What is a negotiable certificate of deposit (CD)?

A short-term debt instrument issued by depository institutions that can be traded.

What is commercial paper?

A short-term unsecured note issued by a high-credit-quality corporation.

What is a banker's acceptance?

A promise of future payment issued by an importing firm and guaranteed by a bank.

What is a repurchase agreement (repo)?

A short-term debt security where the seller agrees to repurchase the security at a specified price and date.

What are federal funds?

Very short-term loans between depository institutions.

What are the two major measures of the U.S. money supply?

M1 and M2.

What are the components of M1?

Currency, traveler's checks, demand deposits, and other checkable deposits.

What is included in M2?

M1 plus savings accounts, small-denomination time deposits, MMDAs, and retail MMMFs.

What does MMDA stand for?

Money Market Deposit Account.

What does MMMF stand for?

Retail Money Market Mutual Fund.

What is the Monetarists' view of economic activity?

The amount of money in circulation determines the level of economic activity.

What is the Keynesians' view of economic activity?

Changes in money supply affect interest rates, which then affect demand for goods and services.

What is the Monetarists' equation?

MS × VM = GDP.

What does GDP stand for?

Gross Domestic Product.

What is GDP?

A measure of the output of goods and services in an economy.

What does MS stand for?

Money Supply.

What does VM stand for?

Velocity of Money.

What is velocity of money?

The rate at which money circulates through the economy.

What is another equation for GDP?

RO × PL = GDP.

What does RO stand for?

Real Output.

What is real output?

The quantity of goods and services produced.

What does PL stand for?

Price Level.

What is price level?

The average price of goods and services.

What is the combined equation relating money and GDP?

MS × VM = RO × PL.

What increases nominal GDP according to the combined equation?

Increases in money supply, velocity of money, real output, or price level.

What was the gold standard?

A monetary system where currency value was tied to gold.

What was the Bretton Woods System?

A 1944 agreement using fixed exchange rates tied to the U.S. dollar or gold.

What happened to exchange rates in the early 1970s?

The world moved toward a flexible or floating exchange rate system.

What is a currency exchange rate?

The value of one currency relative to another currency.

What is the euro?

A single currency used by many European Union member countries.

Which measure of money supply is larger, M1 or M2?

M2 because it includes all of M1 plus additional savings-type accounts.

Which money supply measure includes savings accounts?

M2.

Which money supply measure includes checking accounts?

M1.

Which type of security is issued by the U.S. government and matures in one year or less?

Treasury bill.

Which function of money allows people to buy goods and services?

Medium of exchange.

Which function of money allows wealth to be held over time?

Store of value.

Which function of money allows prices to be quoted in dollars?

Standard of value.