Unit 4: The Financial Sector

fiat money

money that has value because it is backed by the word of the federal government and not by gold or other valuable resources

demand deposits

the amount of required reserves and excess reserves that a bank has not loaned out or otherwise invested

excess reserve

the portion of every dollar that is deposited that a bank can loan out or otherwise invest

money multiplier

shows how much a new deposit in the bank can impact the money supply (1/reserve requirement)

required reserve

the portion of every dollar that is deposited that a bank cannot loan out or otherwise invest

required reserve ratio

the amount of money each bank must keep by law from every dollar deposited in the bank

crowding out

when government spending increases real interest rates causing private investment to decrease

loanable funds graph

a graphic representation of the relationship between real interest rates and loanable funds

nominal interest rates

interest rate stated in current prices

real interest rates

interest rates adjusted for inflation

M1

currency

M2

M1 plus savings accounts

M3

The broadest component of the money supply. Equal to M2 plus large time deposits.

Future Value of Money (FV)

Present Value (PV) x (1 + interest rate (r))

Present Value of Money (PV)

Future Value (FV) / (1 + interest rate (r))

Equation of Exchange

MV=PY

Velocity of Money

The average number of times that a dollar is spent in a year

Certificate of Deposit

A time deposit where a fixed rate of interest is earned for a specified length of time.

Currency

Coins and paper bills used as money

Discount Rate

The rate of interest that the Federal Reserve charges when it loans funds to banks.

Government Securities

IOUs that the government issues when it borrows money

Liquidity

The ease with which an asset can be converted into cash.

Money

anything that is generally accepted as payment for goods and services

Open Market Operations

activities in which the FED buys and sells government securities in the secondary market

Savings Account

A secure bank account that provides modest interest rates.

Secondary Market

place where government securities that have already been issued may be bought or sold

Transaction Account

a checking account at a bank or a similar account at some other depository institution

Change in Money Supply

Money Multiplier X Change in Bank Reserves

M

The stock of money

V

Income (GDP) velocity of circulation

P

The average price level of the final goods and services in GDP.

Y

Real output

interest on reserves (IOR)

The interest rate that the federal reserve pays commercial banks to hold reserves.

Limited Reserves Framework

the Federal Reserve sells or buys U.S. Treasury securities in the open market to shift the supply of reserves left (right)

Ample Reserves Market

the Federal Reserve raises (lowers) its administered rates to move the FFR higher (lower). Small shifts of the supply curve have little or no effect on the FFR rate.