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UNIT 4
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1
financial markets
Channels private savings into investment spending and government borrowing.
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investment spending
Spending on new productive physical capital, such as machinery and structures, and on changes in inventories.
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3
government borrowing
The amount of funds borrowed by the government in the financial markets.
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4
financial intermediaries
Financial institutions through which savers can indirectly provide funds to borrowers.
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5
assets
Money and other valuables belonging to an individual or business.
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6
liquidity
The ease with which an asset can be converted into cash.
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risk
Degree of uncertainty of return on an asset; in business, the likelihood of loss or reduced profit.
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8
money
Cash and demand deposits.
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9
bond
A loan (IOU) to the government or business that must be repaid to the lender.
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10
stock
Certificate representing equity (ownership) in a company.
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11
personal finance
The way individuals and families budget, save, and spend.
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12
demand deposits
Balances in bank accounts that depositors can access on demand by writing a check.
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13
rate of return
Percentage of increase in the value of savings from earned interest.
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14
relationship between price of bonds and interest rates
Inverse relationship.
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15
nominal interest rates
Percentage increase in money that the borrower pays not adjusting for inflation.
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16
formula for nominal interest rates
Nominal interest rate = Real interest rate (RIR) + expected inflation.
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real interest rates
Percentage increase in purchasing power that a borrower pays (adjusted for inflation).
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18
real interest rates indicate
The amount of goods and services a unit of money can buy.
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19
how real interest rates are calculated
Real interest rate = nominal interest rate - expected inflation.
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20
money
Any asset that is accepted as a means of payment.
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21
wealth
Collection of assets.
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22
income
Flow of earnings per unit of time.
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23
functions of money
1. Medium of exchange 2. Unit of account 3. Store of value.
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24
medium of exchange
Any item sellers generally accept and buyers generally use to pay for a good or service.
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25
barter
Exchange goods without involving money.
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unit of account
A measurement of value that allows comparison of prices.
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store of value
Store purchasing power for future use.
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28
money aggregates
Overall measures of the money supply.
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29
M0 (or MB)
The monetary base; currency in circulation and bank reserves.
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M1
Currency in circulation plus checkable bank deposits.
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M2
M1 plus savings accounts, certificates of deposit, and other liquid assets.
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fractional reserve banking
A banking system in which banks hold only a fraction of deposits as reserves.
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banks use excess reserves
To make loans.
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excess reserves
A bank's reserves over and above its required reserves.
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loans are
Assets for the bank and liabilities for the borrower.
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bank balance sheets (T accounts)
Banks record their assets, liabilities, and net worth with these.
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asset
Items of ownership.
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liabilities
Claims of the non-owners.
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net worth
The claims of the owners against the firm's assets.
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reserve requirement
The percentage of deposits that banking institutions must hold in reserve.
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reserve ratio
The fraction of deposits that banks hold as reserves.
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excess reserves =
Actual reserves - required reserves.
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a bank can only loan an amount equal to its excess reserves
True.
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simply money multiplier
The ratio of the money supply (M1) to the monetary base (M0).
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simply money multiplier indicates
The change in M1 from the new excess reserves created by new deposits.
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limitation of the simply money multiplier
It may overstate the predicted amount because it doesn't consider banks' desire to hold excess reserves.
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how the simply money multiplier is calculated
(1)/(RR ratio).
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transaction demand for money
The demand for money based on the desire to facilitate transactions.
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asset demand for money
The amount of money people want to hold as a store of value; varies inversely with the interest rate.
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opportunity cost of holding money
The interest you could be earning from other finances like stocks, bonds, and real estate.
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relationship between interest and quantity of money demanded
Inverse.
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shifters of money demanded
1. Changes in PL 2. Changes in RGDP 3. Changes in technology.
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money supply curve
Shows how the quantity of money supplied varies with the interest rate.
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monetary policy
The actions of a nations central bank to manage the money supply to stabilize the economy.
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money market graph
At equilibrium, Qm = MS; nominal interest rate is determined by MS = MD.
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relationship between interest rate and asset rate
Positive.
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the federal reserve
The central bank of the US that regulates the banking industry.
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why does the Fed use monetary policy
To counter SR output gaps.
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effective monetary policy must be
Counter cyclical.
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how can the Fed manipulate the MS and change IR
Change the reserve requirement, conduct open market operations, and target a specific discount rate.
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open market operations
The purchase and sale of U.S. government bonds by the Fed.
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recessionary output gap
Requires expansionary cyclical policy.
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inflationary output gap
Contractionary monetary policy.
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changing the reserve requirement in a recession
Decrease the reserve ratio.
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changing the reserve requirement when there is inflation
Increase the reserve ratio.
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relationship between reserve ratio and MS
Inverse.
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the discount rate
The interest rate that the fed charges commercial banks to borrow money.
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when the fed buys securities from banks
It directly increases the reserves of the commercial bank.
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federal funds
The balances that banks maintain in their accounts at the fed.
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federal funds rate
The target interest rate set by the fed at which banks borrow and lend their extra reserves.
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ample reserves system
A Federal Reserve policy that keeps enough reserves in the banking system to control interest rates.
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under an ample reserves system
Changing the MS has little or no effect on interest rates.
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administered rates
Interest rates set by the Fed rather than determined in a market.
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interest on reserve balances (IORB)
Interest rate paid by the fed on funds held in the banks' reserve balance accounts.
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do reserves at the fed have a risk
No.
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under contractionary policy
The fed will increase the IORB.
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under expansionary policy
The fed will decrease the IORB.
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the reserve market model
There is an inverse relationship between the Federal Funds Rate and the quantity of reserves demanded.
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what happens if the fed buys bonds from banks when there are limited reserves?
Banks will have more reserves.
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what happens if the fed buys bonds from banks when there are ample reserves?
The interest rate does not change.
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what can the CB do to change IR when there are ample reserves
Decrease or increase interest on reserves.
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when the fed increases the MS
Interest rates decrease.
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who demands loanable funds and who supplies them
Borrowers demand, savers supply.
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loanable funds market
A hypothetical market that illustrates the demand for funds by borrowers and the supply of funds by lenders.
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demand for loanable funds shifters
1. Changes in perceived business opportunities 2. Changes in government borrowing.
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supply of loanable funds shifters
1. Changes in public and private saving behavior 2. Changes in foreign investment.
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closed economy
National savings = public savings + private savings.
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open economy
Investment = national savings + net capital inflow.
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