Important Terms

Money

any asset that people are generally willing to accept in exchange for goods and services or for payment of debts.

Asset

Anything of value owned by a person or a firm

Bartering

trading goods and services directly for other goods and services that requires a double coincidence of wants

Commodity money

goods used as money that also have value independent of their use as money—like animal skins or precious metals.

4 primary functions of money

1. Medium of exchange

2. Unit of account

3. Store of Value

4. Standard of deferred payment

Liquid

easily exchanged for goods

Characteristics of Money

1. Acceptable to most people

2. Standardized quality

3. Durable

4. Valuable relative to its weight

5. Divisible enough for low and high priced goods

Federal Reserve

the central bank of the United States

Fiat Money

any money, such as paper currency, that is authorized by a central bank or governmental body and does not have to be exchanged by the central bank for gold or some other commodity money

M1

narrow definition of the money supply, the sum of currency in circulation and checking account deposits in banks.

M2

broader definition of the money supply that includes M1, plus small-denomination time deposits, savings account deposits (including balances in money market deposit accounts in banks), and noninstitutional money market fund shares.

Reserves

deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve.

Required Reserve Ratio (RR)

the minimum fraction of deposits banks are required by law to keep as reserves; 10%

Excess Reserves

reserves that banks hold over the legal requirement.

Simple Deposit Multiplier

the ratio of the amount of deposits created by banks to the amount of new reserves

Fractional Reserve Banking System

banks keep less than 100% of deposits as reserves

Bank Run

many depositors simultaneously lose confidence in a bank and try to withdraw their money

Bank Panic

many banks experience bank runs at the same time

Federal Open Market Committee (FOMC)

responsible for open market operations and managing the money supply in the United States.

4 Monetary Policy Tools

• Open market operations

• Discount policy

• Reserve requirements

• Interest on reserves

Open Market Operations

the buying and selling of Treasury securities by the Federal Reserve in order to control the money supply.

Commercial banks

primary role is to accept funds from depositors and make loans to borrowers

Security

financial asset—such as a stock or a bond—that can be bought and sold in a financial market

Securitization

The process of transforming loans or other financial assets into securities.

Investment Banks

banks that do not typically accept deposits from or make loans to households; they provide investment advice and also engage in creating and trading securities such as mortgage-backed securities.

Money market Mutual Funds

funds that sell shares to investors and use the money to buy short-term Treasury bills and commercial paper (loans to corporations).

Hedge Funds

funds that raise money from wealthy investors, and make “sophisticated” (often non-standard, high-risk) investments

Quantity Equation

• M: Money supply

• V: Velocity of money: the average number of times each dollar in the money supply is used to purchase goods and services included in G D P.

• P: Price level

• Y: Real output

Quantity Theory of Money

A theory about the connection between money and prices that assumes that the velocity of money is constant