Macroeconomics Exam 2

Financial system

group of institutions in the economy that help to match one person’s saving with another person’s investment

Financial institutions

institutions through which savers can directly provide funds to borrowers

Financial markets

financial institutions through which savers can directly provide funds to borrowers

Bond

a certificate of indebtedness (an IOU)

Principal

the amount borrowed from a bond

Date of maturity

the time at which the loan’s principal will be repaid (of a bond)

Rate of interest

borrower will this pay periodically until the loan matures (of a bond)

Debt finance

sale of bonds to raise money

Term

length of time until bond matures; can be short or long (with long carrying higher risk and interest)

Perpetuity

a bond that never matures; only receive interest, not principal

Credit risk

probability of borrower default; higher carries higher interest

Junk bonds

bonds issued by financially shaky corporations; pay very high interest rates

Tax treatment

way the tax laws treat the interest earned on the bonds; interest on most bonds is taxable income

Municipal bonds

bonds issued by state and local governments; no tax, lower interest rates

Inflation protection

the adjustment of bonds for changes in inflation

Indexed to a measure of inflation

when prices rise, the payments received from a bond rise proportionally; lower interest rates

Stock

a claim to partial ownership in a firm; carries greater risk than a bond

Equity finance

the sale of stocks to raise money

Stock index

an average of a group of stock prices (ex. Dow Jones Industrial Average)

Financial intermediaries

financial institutions through which savers can indirectly provide funds to borrowers

Banks

take in deposits from savers (and grant a small interest rate); use deposits to make loans to borrowers (and charge a higher interest rate)

Mutual funds

sells shares to the public and use the proceeds to buy a portfolio of stocks and bonds; allow ordinary people to diversify and have access to the skills of professionals

Private saving

income remaining after households pay their taxes and pay for consumption; Y - T - C

Investment

the purchase of new capital; not including purchase of stocks and bonds

Market for loanable funds

the market in which those who want to save supply funds and those who want to borrow to invest demand funds

Saving

the source of the supply of loanable funds

Investment

the source of the demand for loanable funds

Government debt

accumulation of past government borrowing

Employed

group including paid employees, self-employed, and unpaid workers in a family business, full-time, and part-time

Unemployed

people not working, are available for work, and have looked for work during the previous 4 weeks

Not in the labor force

group including everyone outside of the fields of employed or unemployed

Labor force

the total number of workers (employed + unemployed)

Unemployment rate

percentage of the labor force that is unemployed

Labor force participation rate (LFPR)

percentage of adult population that is in the labor force

Natural rate of unemployment

the normal rate of unemployment around which the unemployment rate is fluctating

Cyclical unemployment

the deviation of unemployment from its natural rate; positive when the unemployment rate is above the natural rate of unemployment (and vice versa)

Frictional unemployment

results because it takes time for workers to search for the jobs that best suit their tastes and skills; short-term for most workers

Structural unemployment

results because the number of jobs available in some labor markets is insufficient to provide jobs for everyone who wants one; usually long-term

Job search

process by which workers find appropriate jobs given their tastes and skills

Sectoral shifts

type of frictional unemployment; changes in the composition of demand among industries or regions

Government-run employment agencies

agency which provides information about job vacancies

Public training programs

aim to ease workers’ transitions from declining to growing industries; helps disadvantaged groups escape poverty

Unemployment insurance (UI)

a government program that partially protects workers’ incomes when they become unemployed; reduces the hardships of unemployment

Minimum wage laws

cause of structural unemployment; legal regulation that sets the lowest amount employers are permitted to pay workers

Union

cause of structural unemployment; worker associations that bargain with employers over wages, benefits, and working conditions

Insiders

workers who remain employed after union action; are better off

Outsiders

workers who lose their jobs after union action; are worse off

Collective bargaining

the negotiation process between an employer and a group of workers (labor union) to come to an agreement

Strike

a collective withdrawal of work by employees

Efficiency wages

cause of structural unemployment; firms voluntarily pay above-equilibrium wages to boost worker productivity and increase firm profitability

Barter

exchange of one good or service for another; requires a double coincidence of wants

Money

the set of assets in an economy that people regularly use to buy goods and services

Medium of exchange

function of money; item that buyers give to sellers when they want to purchase goods and services

Unit of account

function of money; yardstick people use to post prices and record debts

Store of value

function of money; item that people can use to transfer purchasing power from the present to the future

Wealth

the total of all stores of value, including both money and nonmonetary assets

Liquidity

the ease with which an asset can be converted into the economy’s medium of exchange

Commodity money

money comprised of an item intrinsic value

Fiat money

money without intrinsic value; viewed as money because of government degree

Money stock

the quantity of money circulating in the economy

Currency

paper bills and coins in the hands of the (non-banking) public

Demand deposits

balances in bank accounts that depositors can access on demand by writing a check

M1

currency, demand deposits at banks, some other liquid deposits (balances in saving accounts)

M2

everything in M1 plus small time deposits and money market funds (except those held in restricted retirement accounts)

Federal Reserve (Fed)

central bank of the US; consists of the Board of Governors (7 members)

Central bank

an institution designed to oversee the banking system and regulate the quantity of money in the economy

Federal Open Market Committee (FOMC)

made up of all 7 members of the Board of Governors, plus 5 of the 12 regional bank presidents

Open-market operations (OMO)

buy US governments to increase the money supply; sell US government bonds to decrease the money supply

Fractional-reserve banking system

banks keep a fraction of deposits as reserves and use the rest to make loans

Reserve

deposit that a bank has received but has not loaned out

Reserve ratio (R)

fraction of deposits that banks hold as reserves; total reserves as a percentage of total deposits

T-account

simplified accounting statement that shows a bank’s assets and liabilities

Assets

amount the bank owes; deposits, bank borrowing, etc.

Liabilities

amount the bank owns; reserves, loans, securities, etc.

Money multiplier (1/R)

amount of money that results from each dollar of reserves

Bank capital

the resources a bank obtains by issuing equity to its owners; also known as owner’s equity; equal to bank assets - bank liabilities

Leverage

the use of borrowed funds to supplement existing funds for investment purposes

Capital requirement

a government regulation specifying a minimum amount of bank capital; ensures that banks can pay off depositors and debts

Credit crunch

the shortage of capital inducing the banks to reduce lending

Bank run

people quickly withdrawing money from banks when they suspect that banks are in trouble; holding more currency and less deposits

Federal funds rate

interest rate at which banks make overnight loans to other banks

Deflation

decrease in the overall level of prices

Inflation

increase in the overall level of prices

Hyperinflation

extraordinarily high rate of inflation

Classical theory of inflation

prices rise when the government prints too much money

Quantity theory of money

asserts that the amount of money in circulation determines the value of money

Price level (P)

number of dollars needed to buy a basket of goods and services

Value of money (1/P)

the quantity of goods and services that can be bought with 1 dollar