U6: The Monetary System

what is money?

the set of assets that people regularly use to buy goods/services

what is an asset?

any item that has value

what are the functions of money?

medium of exchange, unit of account, store of value

what is liquidity?

the ease/quickness that an asset can be converted to an economy’s medium of exchange

what is wealth?

all types of value (money and non-monetary assets)

what are some examples of assets?

cash, stocks/bonds, real estate/property, art and antiques

what are the two kinds of money?

commodity and fiat

what is commodity money?

money that takes the form of an item with intrinsic/inherent value (would still have value if not using as money)

what is fiat money?

money without any inherent/intrinsic value; money with value by decree

who is the fiat money established by?

established and regulated by the government

what is the fairly stable, most internationally recognized and accepted fiat money?

us currency

the amount of money in circulation is _____ related to its value

inversely

what are the two major categories of money? which one is most liquid?

M1 and M2; M1 is most liquid

what does M1 currency include?

currency, all checkable deposits, savings deposits

what does M2 money include?

everything in M1 AND small time deposits (CD’s lasting a year or less), money market mutual funds

what is the federal reserve board and what does it do?

they are the central bank of the US. responsible for regulating commercial banks (lender of last resort) and controlling money supply through monetary policy

what are the fed’s tools of money control?

collectively called monetary policy:

• open market operations

• reserve requirements (what’s required to be kept in bank no matter what)

• discount rate (the interest rates commercial banks must pay to loan)

explain open market operations

when fed buys and sells bonds

what happens to the money supply when the fed sells bonds? when is it normally done?

takes money out of circulation, used during inflation

what happens to the money supply when the fed buys bonds? when is it normally done?

puts money into circulation, used during recession

explain reserve requirements

fed can increase/decrease minimum amount of reserves that must be kept in banks

what happens to the money multiplier, money supply, and interest rates when there’s a high reserve rate?

• low money multiplier

• less money can be loaned out

• interest rates rise

what happens to the money multiplier, money supply, and interest rates when there’s a low reserve rate?

• higher money multiplier

• higher money supply

• lower interest rates

what is the discount rate?

the interest rate charged ot banks for borrowing money from the Fed

what happens when there’s a higher discount rate?

• banks discouraged to borrow

• reduces money supply

• interest rates rise

what happens when there’s a lower discount rate?

• banks encouraged to borrow

• increases money supply

• interest rates drop

how do you calculate the money multiplier value?

1/reserve rate = money multiplier