ECON Monetary Policy

without money, trade would require what

barter, or the exchange of one good/service for another

what is the double coincidence of wants

the unlikely occurrence that two people have a good the other wants

medium of exchange

an item buyers give to sellers when they want a good or service

Unit of account

the yardstick people use to post prices and record debts

store of value

an item people can use to transfer purchasing power from the present to the future (i.e gold bars that will not depreciate in value)

what are the two kinds of money

Commodity and Fiat Money

Commodity money

takes form of commodity with intrinsic (real) value (i.e. gold coins)

Fiat money

money with value due to government decree (i.e. paper dollars)

money supply

quantity of money available in the economy

what 2 assets are in the money supply

currency and demand deposits

currency

paper bills and coins in the hands of the public (not in the banks)

demand deposits

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

what is the M1

currency, demand deposits, travelers checks and any checkable deposits

what is the M2

everything in M1 plus savings deposits, small time deposits and money market mutual funds

Central Bank

an institution that oversees the banking system and regulates the money supply

monetary supply

money supply set by policymakers of the central bank

Federal Reserve (Fed)

central bank of the United States

fractional reserve banking system

banks keep a fraction of deposits as reserves and give the rest out as loans

reserve requirements

set by the Fed, regulation of minimum reserves a bank must hold against deposits

can banks hold more reserves than the reserve requirement

yes

reserve ratio

fraction of deposits banks hold as reserves

for banks, what are assets

reserves and loans

for banks, what are liabilities

deposits

money multiplier

the amount of money a bank generates with each dollar or reserves

what is the equation for the money multiplier

1/Reserve Ratio

what is the Fed’s 3 tools of monetary control

1. Open market operations (buying or selling govt bonds)

2. increasing/decreasing the reserve requirement

3. increase/decrease the discount rate

what happens when the fed sells govt bonds, what happens when they buy them?

When the Fed sells govt bonds they decrease the money supply by taking money out of circulation. When they buy bonds, they increase the money supply by paying in new dollars, raising bank reserves, which is then given out as loans.

what happens when the fed raises the reserve requirement, what happens when they lower it?

When the fed lowers the RR, banks give out more money as loans, and when they raise the RR, banks keep more money which decreases the money supply.

what happens when the fed raises the discount rate, what happens when they lower it?

when the Fed raises the discount rate less money is borrowed but when the Fed lowers it, more borrowing happens, increasing the money supply.

what do banks with insufficient funds do

borrow from banks with excess reserves, the interest on these loans is called the federal funds rate