AP Macroeconomics - Unit 4

Financial Sector

Network of institutions that link borrowers and lenders. Includes banks, mutual funds, pension funds, and other financial intermediaries.​

Assets

Anything tangible or intangible that has value.​

Interest Rate

The amount a lender charges borrowers for borrowing money. It’s the “price” of a loan. ​

Interest-bearing Assets

Assets that earn interest over time. e.g. bonds.

Liquidity

the ease with which an asset can be converted to a medium of exchange. In general, the higher the liquidity the lower the rate of return. (saving methods like bonds +checking +saving, investment methods like stocks or real estate, speculation investments like collectables or future)

Bonds

• (securities) are loans, or IOUs, that represent debt that the government, business, or individual must repay to the lender. ​

• The bond holder has NO OWNERSHIP of the company and is paid interest.​

Stocks

(equities) represent ownership of a corporation and the stockholder is often entitled to a portion of the profit paid out as dividends.​

Bond price and interest rates relationahip​

Inversely related; A bond is issued at a specific interest rate that doesn’t change throughout the life of the bond. ​

Present Value

The current worth of some future amount of money. ​

Present Value ​of $X in 1 Year​

$X / (1 + ir)^N (ir is in this way: 10% = .1)​

Equation to Calculate Future Value ​

$X in N Years​ = $X (1 + ir)N​

3 Functions of Money

1. A Medium of Exchange​

2. A Unit of Account (Measure of Value)​

3. A Store of Value

Fiat Money

Something that serves as money but has no other value or uses.​ (us) NOT a source of intrinsic value.

M1 money supply

1. Currency in circulation.​

2. Checkable bank deposits (checking accounts).​

3. Traveler’s checks.​

M2 money supply

M1 plus the following: ​

1. Savings deposits (money market accounts).​

2. Time deposits (CDs = certificates of deposit).​

3. Money market funds.​

Fractional Reserve Banking​

When banks hold a portion of deposits to cover potential withdrawals and then loans the rest of the money out. ​​

The Money Multiplier​

1 / reserve requirement (ratio)

Change in $ Supply

Money multiplier x New Loans

Demand Deposits

Money deposited in a commercial bank in a checking account.​

Required Reserves

The percent that banks must hold by law.​

Excess Reserves

The amount that the bank can loan out.​

Total Reserves

Excess + Required Reserves​

Balance Sheet

A record of a bank’s assets,  liabilities, and net worth. ​

Are demand deposits in a bank an asset or a liability?​

Liability for the bank, asset to the depositor.

If the fed increases money supply…

then interest rates will fall, causing investment to increase, causing aggregate demand to increase

3 Shifters of Money Supply (the fed actions)​

1. The Reserve Requirements (Ratios)​

2. The Discount Rate​

3. Open Market Operations​

If there is a recession, what could the Fed do to the reserve requirement? (Explain the steps.)​

Decrease the Reserve Ratio​

1. Banks hold less money and have more excess reserves.​

2. Banks create more money by loaning out excess.​

3. Money supply increases, interest rates fall, AD up.​

If there is inflation, what could the Fed do to the reserve requirement? (Explain the steps.)​

Increase the Reserve Ratio​

1. Banks hold more money and have fewer excess reserves.​

2. Banks create less money.​

3. Money supply decreases, interest rates up, AD down.​

Discount Rate

interest rate that the Fed charges commercial banks.​

Discount rate: To increase the Money supply, the Fed should..

Decrease the Discount Rate (Easy Money Policy).​

DR: To decrease the Money supply, the Fed should…

increase the Discount Rate (Tight Money Policy).

Open Market Operations

when the Fed buys or sells government bonds (securities). ​

OMO: To increase the Money supply, the Fed should..

BUY government securities.​

OMO: To decrease the Money supply, the Fed should…

Sell government securities.​

Federal funds rate

the interest rate that banks charge one another for one-day loans of reserves. (Fed cant regulat, but uses OMO to hit target)

A change in saving in any part of the national savings will

shift the supply of loanable funds.​

National Savings

public + private saving​

Capital Inflow

the amount of money entering the country.​

Capital Outflow

the amount of money leaving the country. ​

Net Capital Inflow

inflow - outflow​

Private Investment

borrowing by businesses and consumers.​

Government Borrowing

deficit spending when government spending is greater than tax revenue.​

Loanable Funds Mrkt - Demand Shifters

1. Changes in borrowing by consumers​

2. Changes in borrowing by businesses (investment spending)​

3. Changes in borrowing by the government (ex: deficit spending)​

LFM - Supply SHifters

1. Changes in private savings behavior​

2. Changes in public savings​

3. Changes in foreign investment (ex: more inflow of foreign financial capital)​