Unit 4: Monetary Policy

Money

Anything that is generally accepted in payment for goods and services.

Commodity Money

Something that performs the function of money and has intrinsic value, e.g., gold or silver.

Fiat Money

Something that serves as money but has no other value or uses, such as paper money or digital money.

Function of Money: Medium of Exchange

Money can be used for goods and services without complications of a barter system.

Function of Money: Unit of Account

Money measures the value of all goods and services, acting as a measurement of value.

Function of Money: Store of Value

Money allows you to store purchasing power for the future.

Demand for Money

The desire to hold money in liquid form; it has a downward sloping curve representing the inverse relationship between interest rates and the quantity of money demanded.

US Money Supply

Set by the Board of Governors of the Federal Reserve System (FED).

Open Market Operations

Buying and selling bonds; to increase the money supply, the FED buys government securities.

Money Multiplier

The ratio of the amount of deposits created by banks to the amount of reserves held, calculated as 1/Reserve Requirement (1/RR).

Discount Rate

The interest rate that the FED charges commercial banks for borrowing money.

Federal Funds Rate

The interest rate that one bank charges another for loans of reserves.

Interest on Reserves (IOR)

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

Administered Rates

Interest rates set by the FED rather than being determined by the market.

Fractional Reserve Banking

When banks hold only a small portion of deposits to cover potential withdrawals and loan out the rest.

Liquidity

Ease with which an asset can be accessed and used as a medium of exchange.

M1

The highest liquidity measure of money, including currency in circulation and checkable bank deposits.

M2

A broader measure of money that includes M1 plus savings deposits, time deposits, and money market funds.

Assets

Anything tangible or intangible that is owned.

Liabilities

Anything that is owed.

Demand Deposits

Money deposited in a commercial bank in a checking account.

Required Reserves

The percent of deposits that banks must hold by law.

Excess Reserves

The amount that banks can loan out beyond required reserves.

Loanable Funds Market

The private sector supply and demand for loans.

Stabilization policy

The use of government policy to reduce the severity of recessions and rein in excessively strong expansions.

The balanced budget multiplier

The factor by which a change in both spending and taxes changes real GDP.

Lump-sum taxes

Taxes that don’t depend on the taxpayer’s income.

Automatic stabilizers

Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts.

Discretionary fiscal policy

fiscal policy that is the result of deliberate actions by policy makers rather than rules.

The budget surplus

The difference between tax revenue and government spending when tax revenue exceeds government spending

The budget balance

The difference between tax revenue and government spending.

Capital inflow

Equal to the total inflow of foreign funds minus the total outflow of domestic funds to other countries.

Default

Occurs when a borrower fails to make payments as specified by the loan or bond contract.

A loan-backed security

An asset created by pooling individual loans and selling shares in that pool.