Money, Banking, and the Federal Reserve

Vocabulary practice flashcards covering Money and Banking, the Federal Reserve System, monetary tools, and the 2008 Financial Crisis.

Commodity Money

Money that has value in itself and can also be used as a good (examples: salt, gold).

Representative Money

Money that represents something valuable and can be exchanged for it (example: checks).

Fiat Money

Money that has value because the government declares it legal tender (example: U.S. dollar).

Physical Characteristics of Money

The four physical traits of money: portable (easy to carry), divisible (can be divided into smaller amounts), durable (lasts through many transactions), and uniform (recognizable and difficult to counterfeit).

Economic Characteristics of Money

The three economic traits of money: accepted (widely accepted as payment), scarcity (limited supply to maintain value), and stability of value (purchasing power remains relatively stable).

Primary Functions of Money

The three primary functions of money: medium of exchange (used to buy and sell goods/services), unit of account (measures and compares the value of goods/services), and store of value (holds value for future use).

M1 and M2

M1 consists of the most liquid forms of money (currency, checking deposits, traveler's checks), while M2 includes everything in M1 plus less-liquid forms of money such as savings accounts, CDs, and mutual funds.

Liquidity

How easily an asset can be converted into cash or used for payments.

Bank Revenue Generation

The process where banks accept deposits, lend or invest most of that money, and earn revenue from interest on loans and investments while paying interest to depositors.

Wildcat Banking Era

A period from 1837 to 1863 of relatively unregulated banking when banks operated with little federal oversight, sometimes making poor decisions and failing.

Federal Reserve Act of 1913

Legislation that created the Federal Reserve System (FED), America's central bank, and divided the country into Federal Reserve districts.

Monetarism

The belief that the government should control the money supply because changes in the money supply strongly influence the economy.

Results of Banking Deregulation

Led to bank mergers (creating larger banks with more branches that made banking more accessible) and the expansion of services (banks became financial supermarkets offering loans, insurance, stocks, and bonds).

FDIC (Federal Deposit Insurance Corporation)

A government agency that insures bank deposits up to a certain limit ($\$250{,}000$ per depositor, per insured bank, per ownership category), protecting customers if a bank fails.

Inflation

A general increase in prices over time, which decreases the purchasing power of money.

Functions of the Federal Reserve Bank

Four key responsibilities: regulation and oversight of banks, acting as a banker's bank, providing emergency financial assistance during crises, and issuing currency while regulating the money supply.

Fractional Reserve Banking

A banking system in which banks keep only a fraction of deposits as reserves and lend out the rest; these loans create additional checking deposits, thereby expanding the money supply.

Expansionary vs. Contractionary Policy

Expansionary (easy money) policy is when the FED increases the money supply to encourage borrowing, spending, and economic growth; contractionary (tight money) policy is when the FED decreases the money supply to reduce spending and control inflation.

Reserve Requirements Manipulation

When the FED lowers reserve requirements, banks can lend more and the money supply increases; when the FED raises reserve requirements, banks must hold more money, causing lending and the money supply to decrease.

Monetary Policy vs. Fiscal Policy

Monetary policy is controlled by the FED by adjusting the money supply and interest rates, whereas fiscal policy is controlled by Congress and the President by adjusting government spending and taxes.

Glass-Steagall Act (1933)

A law created after the Great Depression to limit risky banking activities and separate commercial banking from investment banking.

The Panic of 1907

A severe financial crisis that caused several banks to fail and exposed weaknesses in America's banking system, encouraging banking reform.

FOMC (Federal Open Market Committee)

A 12-member committee responsible for making decisions about buying and selling Treasury bonds (open market operations) that meets 8 times per year to review economic conditions and monetary policy.

The 12 District Banks of the FED

The regional Federal Reserve Banks that monitor commercial banks and help clear checks, located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

Open Market Operations (Buying vs. Selling Bonds)

When the FED buys bonds, money enters the banking system and bank reserves increase, expanding lending and the money supply; when the FED sells bonds, money leaves the banking system and bank reserves decrease, reducing lending and the money supply.

Discount Rate

The interest rate the FED charges commercial banks when they borrow money from it; a lower rate increases borrowing and the money supply, whereas a higher rate decreases borrowing and the money supply.

U.S. Treasury vs. Federal Reserve

The U.S. Treasury manages government finances, issues Treasury bonds to finance deficits, and does not control the money supply; the Federal Reserve manages monetary policy, buys and sells Treasury bonds to influence the money supply, and controls the money supply.

Money Multiplier Formula

The relationship defined by $\text{Money Multiplier} = \frac{1}{\text{Reserve Ratio}}$; for example, if the reserve ratio is $10\%$ ($0.10$), then $\frac{1}{0.10} = 10$, making the money multiplier equal to $10$.

Credit Default Swap (CDS)

A financial contract that acts like insurance against a borrower defaulting on a loan or bond, where the buyer pays a fee for protection.

Subprime Mortgage

A mortgage given to borrowers with poor credit histories or a higher risk of default, often with higher interest rates.

CDOs (Collateralized Debt Obligations)

Financial products created by bundling different debts (such as mortgages) together and selling them to investors in different risk levels.

Dodd-Frank Act (2010)

A law passed after the 2008 financial crisis that increased bank oversight, created the Consumer Financial Protection Bureau (CFPB), restricted risky bank trading via the Volcker Rule, regulated derivatives, and required stronger bank reserves.

Systemic Risk

The risk that the failure of one major financial institution could spread throughout the financial system and cause a widespread economic crisis.

Moral Hazard

A situation where someone takes greater risks because they know someone else (such as the government) may cover their losses.

Capital Injections

Money provided to struggling banks or companies, often by the government, to help them stay financially stable and avoid failure.

Mortgage-Backed Securities (MBS)

Investments created by bundling many home mortgages together and selling shares of the combined mortgage payments to investors.

Rating Agency Fault in 2008 Crisis

The fault of rating agencies in giving risky mortgage-backed securities and CDOs high credit ratings (sometimes AAA), misleading investors into believing they were safe investments.

Mortgage Broker Fault in 2008 Crisis

The fault of mortgage brokers in encouraging people to take out mortgages they could not afford and approving risky borrowers to earn commissions, without properly evaluating repayment ability.

Synthetic CDOs

CDOs that use credit default swaps instead of actual mortgages or loans, allowing investors to bet on whether mortgage-related investments will succeed or fail.

Shorting

An investment strategy betting an asset's price will decrease by borrowing shares, selling them at current price, buying them back later at a lower price, and returning them to keep the difference as profit.