ECON 202: The Monetary System

Flashcards covering key vocabulary from the ECON 202 lecture on 'The Monetary System'.

Barter

The exchange (trade) of one good or service for another, requiring a double coincidence of wants.

Double coincidence of wants

An unlikely occurrence that two people each have a good the other wants, which is necessary for barter to occur.

Money

The set of assets in an economy that people regularly use to buy goods and services from other people. It functions as a medium of exchange, a unit of account, and a store of value.

Medium of exchange

An asset that buyers give to sellers when they want to buy goods and services.

Unit of account

The yardstick people use to post prices and record debts (e.g., dollars in units of ten).

Store of value

An item that people can use to transfer purchasing power from the present to the future.

Wealth

The total of all assets (stores of value), including both money and nonmonetary assets (stocks, bonds, precious metals, etc.).

Liquidity

The ease with which an asset can be converted into the economy's money (medium of exchange).

Commodity money

Money that takes the form of a commodity with intrinsic value, meaning it would have value even if it were not used as money (e.g., gold coins, cigarettes).

Fiat money

Money without intrinsic value, used by government decree (e.g., US dollar).

Private money

New forms of money without intrinsic value (e.g., Bitcoin) or backed by commodities/assets (e.g., stable coins).

M1 money stock

Includes currency, demand deposits, other liquid (checkable on-demand) deposits, and saving deposits (including MMDA).

M2 money stock

Includes M1 plus small time deposits (CD's < $100,000) and Retail Money Market Funds (excluding IRA and Keough).

Credit

An amount of money loaned by a creditor to a borrower who is indebted to the creditor (must pay back later with money).

Debt

An amount of money owed by a debtor to a lender who expects to be repaid money + interest.

Credit cards

Are not money; they are a form of debt.

Required Reserve Ratio

The fraction of deposits commercial banks were required to keep as reserves by the Central Bank (now effectively 0%).

Deposit-to-Loan Ratio (D/L)

The fraction of deposits that commercial banks choose to lend out, operating within a 'fractional reserve' system.

Central bank

An institution designed to oversee and regulate banks, manage the public payment system, and regulate the quantity of money or interest rates in the economy.

Federal Reserve (Fed)

The central bank of the United States.

Monetary policy

The control of the money supply (quantity of money available in the economy) and/or the interest rate on money by a central bank like the FOMC.

Lender of Last Resort

A role of the Federal Reserve where it holds deposits for banks and makes loans to them, especially during financial crises.

Board of Governors

The federal government component of the Federal Reserve System, consisting of 7 members appointed for 14-year terms, located in Washington, DC.

Federal Reserve Banks

Twelve regional banks that are private commercial banks with a monopoly on money supply, regulated by the Fed’s Board of Governors.

Federal Open Market Committee (FOMC)

Composed of 7 Governors and 12 presidents of Fed Regional Banks, which conducts monetary policy by setting the target interest rate, Open-Market Operations, and managing Quantitative easing/tightening.

Open-Market Operations (OMO)

The buying of U.S. government bonds to increase the money supply or selling of U.S. government bonds to decrease the money supply.

Quantitative easing/tightening (QE/QT)

Buying other bonds (like mortgages) to 'ease' credit conditions (lower long-term interest rates) or selling other bonds to 'tighten' credit conditions (raise long-term interest rates).

Discount rate

The interest rate the Fed charges banks for short-term loans, now called the primary credit rate.

Federal funds rate (FFR)

The rate at which banks make overnight loans to other banks, for those with excess reserves lending to those needing reserves.

Interest on reserves (IOR)

The rate the Fed pays banks for reserve deposits held at the Fed.

Fractional reserve banking system

A system where banks keep only a fraction of deposits as reserves at the Fed and use the rest to make loans or other investments.

Reserves

The fraction of deposits that banks hold against deposits, consisting of currency and deposits at the Fed.

Reserve requirements

Regulations on the minimum reserves banks were required to hold against deposits; federal reserve eliminated mandated required reserves in March 2020.

Reserve ratio (R)

The fraction of deposits that banks hold as reserves, calculated as total reserves as a percentage of total deposits.

T-account

A simplified accounting statement that shows a bank's assets and liabilities.

Money multiplier

The amount of money the banking system generates with each dollar of reserves, calculated as the reciprocal of the reserve ratio (1/R).

Bank capital

The resources a bank obtains by issuing equity to its owners, equal to bank assets minus bank liabilities (owner's equity).

Leverage

The use of borrowed funds to supplement existing funds for investment purposes, measured by the leverage ratio ($Assets / $BankCapital).

Bank run

If people suspect their banks are in trouble, they 'run' to the bank to withdraw their funds, holding more currency and less deposits, potentially causing banks to close.

FDIC/deposit insurance

Established in 1933 to help prevent bank runs by insuring customer deposits.

Forward Guidance (FG)

Signals about the future federal funds rate, used by the Fed to indirectly affect expectations and long-term interest rates.