Unit 4

Financial Sector

The part of the economy made up of institutions (like banks) that bring together savers and borrowers.

Asset

Anything of value that is owned.

Liability

A debt or obligation owed to others.

Interest

The cost of borrowing money or the return on saving money.

Nominal Interest Rate

The interest rate actually paid or received without adjusting for inflation.

Real Interest Rate

The interest rate adjusted for inflation (Real = Nominal – Inflation).

Money

Anything that serves as a medium of exchange, unit of account, and store of value.

M1

A narrow definition of the money supply: currency, demand deposits, and other checkable deposits.

M2

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

Liquidity

How easily an asset can be converted into cash without losing value.

Money Market

The market for short-term loanable funds and monetary instruments.

Money Demand

The desire to hold money rather than other assets; downward-sloping with respect to the interest rate.

Money Supply

The total amount of money in circulation, assumed to be vertical (fixed) when set by a central bank.

Fractional Reserve Banking

A banking system where banks hold a fraction of deposits as reserves and loan out the rest.

Required Reserve Ratio

The minimum percentage of deposits that banks must keep in reserve.

Money Multiplier

The amount of money the banking system generates with each dollar of reserves (1 / reserve ratio).

Federal Reserve System (The Fed)

The central bank of the United States, which conducts monetary policy.

Monetary Policy

Central bank actions aimed at influencing the money supply and interest rates to achieve macroeconomic goals.

Open Market Operations

The Fed’s buying and selling of government securities to influence the money supply.

Discount Rate

The interest rate the Fed charges banks for short-term loans.

Federal Funds Rate

The interest rate banks charge each other for overnight loans of reserves.

Administrative Rates

Interest rates directly controlled by the Fed to influence the Federal Funds Rate.