AP Econ Unit 5A quiz

What are the three functions of money

• Medium of exchange

• Unit of account

• Store of value

What is medium of exchange

buying and selling G & S without bartering

Widely accepted as payment

What is unit of account

A standard unit that prices can be stated and value of G & S can be compared. It is a unit of measurement

What is a store of value

an asset that is set aside for future use

What is M1

• Most liquid money supply

  • Includes currency (paper $ + coins), checkable deposits (aka demand deposits

What is M2

M1+ savings accounts + money market deposit accounts + small time deposits (deposits less than $100,000)

What backs the money supply

It is backed by faith in the banking system

What is Fiat Money

Money because the government said so

What is transactions demand (D_t)

• People needing money for everyday purchases

When GDP ↑ D_t __

↑

When GDP ↓ D_t ___

↓

What is Demand for money made up of

D_m = D_t + D_a

What is Asset Demand (D_a)

• People needing $ (and holding it outside of banks) to buy assets

  • Ex: Car, house, appliance

When i ↓, D_a ___

↑

When i ↑, D_a __

↓

Why is the D_m curve downward sloping

Because of asset demand

Sm is only changed by the…

Fed

• They are in charge bc they figure out how much CBS can lend, then the CBS do the lending

Dm is only changed by the…

people

What is the opportunity cost of Asset demand

The interest rate.

When it is in a checking account the interest is very low compared to other assets like bonds or stocks. But, money holds better value and is steady

What graph is this

A money Market graph

What is loanable funds

Excess reserves

The money CBS CAN lend

What are the 3 main interest rates

• Discount rate

• Fed Funds Rate

  • Prime rate

What are reserves

The money banks hold for people at the Fed

What are demand deposits

Peoples checking accounts

Checkable deposits

M1 is___

Near money. It is very liquid because of checking accounts

What is the discount rate

The interest rate from Fed to CBS

• 3.75%

What is the Fed Funds Rate

Interest rate between CBS

• Aka Short-term lending rate / Overnight lending rate

  • Target range: 3.5-3.75%

Who sets the target fed funds rate range?

The FOMC

It is the feds responsibility

What is a prime rate

The interest rate from CBS to the public

• 6.75% to the BEST customer

Who controls the supply of money

The Fed

They are the lender of last resort

Why do banks borrow from each other

The get loanable funds to lend money to the public

What is a reserve requirement

The amount of reserves that the banks cannot lend

What are the three tools of monetary policy

• Change the discount rate

• Change the reserve requirements

  • Open Market operations

What is the only way Sm can shift

If CBS lend. If banks don’t lend, monetary policy will not work

What is a monetary base

The cash held by people and the reserves banks have

In a recession the Fed ___ securities

buys

In inflation the Fed ___ securities

sells

Conventional policy works when…

interest rates fall and banks lend/stop lending

The FOMC can ___ securities when the FFR is too high

buy

The FOMC can ___ securities when the FFR is too low

sell

How do CBS make money

By earning interest on securities

Info about the Board of Governors:

• Washington DC

• They are apolitical

  • 14 year terms

Info about BOG members

• 7 members.

• Members are appointed by president, confirmed by senate

• President chooses chairperson and vice president.

  • pres and VP have 4 year terms

What are the responsibilities of the BOG

• Oversee the 12 Fed Banks

• Set the Reserve Requirement

• Sit on FOMC

  • Share responsibility of setting discount rate

Info about FOMC

• Washington DC

• Meet every 6 weeks

  • 12 members (7 are BOG, 1 is NY Fed Pres, 4 others serve 1 year terms)

Why is the NY president vice chair of the FOMC

Because they carry out OMO only at NY

What is the FOMC’s job responsibilities

• Set OMO

• Set the target fed funds rate

• Create economic reports

info on 12 Fed Banks

• 12 member banks

• Supervised by BOG

• Each bank has a board of directors

Job responsibilities of 12 fed banks

• Issue currency

• Hold reserves

• Set reserve requirement

• Lend money

  • Control flow of money

What are the job responsibilities of NY fed bank

• Store other nation’s gold

  • Open Market operations

Board of Directors info

• 9 members

• 3 yr terms

  • 1 for each bank

Job responsibilities of board of directors

• Run day to day operations of bank

• Appoint reserve bank pres and vice

  • Set banks discount rate

Who is the chair of the fed

Jerome Powell

• Chair BOG and FOMC

  • 2018-present

Who is John Williams

• President of NY bank

  • Vice chair FOMC

What were the 4 causes of the 2008 financial crisis

• Deregulation

• Leveraging

• Rating agencies

• Credit Default Swap

Explain Deregulation

• CBS would lend money to subprime borrowers and had no rules (bad credit)

• Created mortgage backed securities

• Risky loans piled up → housing bubble → collapse

Explain leveraging

• Banks used large amounts of borrowed money to buy mortgage assets Banks used huge amounts of borrowed money to buy MBS

• Small losses became huge ones

• When housing prices fell, banks couldn’t cover debts

• Many banks became unstable or failed

Explain the rating agencies problem

• Rating agencies: S & P, Moodys, and Fitch rated mortgage securities

• Very risky and bad MBS’s were rated AAA because the rating agencies were corrupt

  • Risk spread across financial system

Explain credit default swaps

CDS= insurance against loan default

• Investors bought CDS to protect against mortgage failures

• Companies sold huge amounts of CDS

• When mortgages failed, the companies couldn’t pay all the insurance back

• Big losses and panic

What is easy monetary policy

• Fed lowers interest rates (FFR)

• Fed buys securities in OMO

  • This increases bank reserves

• Money supply increases → borrowing is cheaper.

Boosts economy

What is tight monetary policy

• Fed raises interest rates

• Fed sells securities → reduces bank reserves

• Money supply decreases → borrowing is more expensive

Slows down economy

Why didn’t banks, realtors and investors care about selling MBS and CDOS to subprime borrowers

Because if they defaulted then they would get the house, and since house prices were increasing so much, it would’ve made even more money

What is shorting

It is betting against something

How did the Fed respond to the financial crisis with QE

• Fed bought huge amounts of long-term securities (QE)

  • This injected money into banks

  • LF increased

• This gave banks more capacity to lend

How did the Fed respond to the financial crisis using conventional monetary policy

• FOMC lowered discount rate

  • FOMC lowered target Fed Funds Rate using OMO

Why did the conventional monetary policy response to the crisis not work

• Banks didn’t lend

  • They were scared people wouldn’t pay back bc people foreclosed mortgages, there was a recession, and high unemployment

  • Banks started buying treasury bonds instead

• People were afraid to borrow

  • They were scared they would lose their jobs and not be able to pay mortgage

• People did not redeposit money

  • People had no faith in banks

How did the fed respond to the crisis using unconventional mon pol.

• Quantitative easing

  • Impacts long term interest rates (THIS MAKES IT UNCONVENTIONAL)

• Forward guidance

  • Fed publicly communicates its future plans to influence

• Fed implemented regulation

Why did the Fed respond to the crisis

• To stop a systemic collapse of the banking system

  • To prevent another great depression

What changes are in the system today after the crisis

• Stronger regulation on risk, there is higher excess reserve requirements, and stress tests.

How were balance sheets impacted in the crisis

• Assets (loans and MBS) lost value

• Liabilities (demand deposits) stayed, banks couldn’t pay debts without Fed support

  • Loanable Funds increases

Why did recovery from the financial crisis take so long

• Massive private debt

  • Households and banks had to fix balance sheets

• Banks were cautious about lending

• Housing market lagged: foreclosures and price declines stayed for years

• Banks borrowed too much (high leverage) and invested in MBS, CDOS, and CDS, that were hard to sell post crisis

What is leveraging

Borrowing more money than you have to invest

What were some things put in place to stop a collapse from happening again

• Banks have to hold more reserves so they can survive losses without collapsing

• Fed tests big banks to see if they could survive economic crisis (stress tests)

• Banks must have enough liquid assets to cover short-term needs

• Stricter rules on subprime loans, MBS, and CD

• Fed gives interest on LF to encourage banks to hold reserves

• Fed can quickly inject money during a crisis

• Dodd-Frank act created the Consumer Financial Protection Bureau to stop predatory lending

What is a reserve

CBS money held at the Fed

What is the main tool of monetary policy is the BOD is responsible for

Discount rate

What is the main tool of monetary policy is the BOG is responsible for

Reserve requirement

What is the main tool of monetary policy is the FOMC is responsible for

OMO