Module 10: Monetary Policy

What are the four functions of money?

Medium of exchange, unit of accounting, store of value, and standard of deferred payment.

Which function of money refers to any asset that sellers will accept as payment?

Medium of exchange.

What is 'liquidity' in the context of financial assets?

The degree to which an asset can be acquired or disposed of without much danger of loss in nominal value and with small transaction costs.

Which function of money describes its role as a measure by which prices are expressed, also known as a standard of value?

Unit of accounting.

Which function of money describes its ability to hold value over time, allowing for the transfer of wealth into the future?

Store of value.

Which property of an asset makes it desirable for settling debts that mature in the future?

Standard of deferred payment.

What are the primary components of the M2 measure of the money supply?

Currency and various types of deposits, including checking and savings.

According to the source material, what component was recently added to the M1 money supply measure?

Savings deposits are now part of M1.

When was the Federal Reserve System established and by which act of Congress?

It was established in 1913 by the Federal Reserve Act.

What is the common nickname for the central bank of the United States?

The Fed.

Identify the first of the Fed's eight listed functions.

The Fed supplies the economy with currency.

Identify the second of the Fed's eight listed functions.

The Fed provides a clearing mechanism for checks.

Identify the third of the Fed's eight listed functions.

The Fed holds depository institutions' reserves.

Identify the fourth of the Fed's eight listed functions.

The Fed acts as the government’s fiscal agent.

Identify the fifth of the Fed's eight listed functions.

The Fed supervises member banks.

Identify the sixth of the Fed's eight listed functions, which involves providing emergency loans to banks.

The Fed acts as the 'lender of last resort.'

Identify the seventh of the Fed's eight listed functions.

The Fed regulates the money supply.

Identify the eighth of the Fed's eight listed functions.

The Fed intervenes in foreign currency markets.

What is the name of the committee within the Federal Reserve that is responsible for determining monetary policy?

The Federal Open Market Committee (FOMC).

Who are the four types of members that compose the Federal Open Market Committee (FOMC)?

The Board of Governors, the president of the NY Fed, and the presidents of 4 other rotating district banks.

What is fractional reserve banking?

A system where depository institutions hold reserves that are less than the total amount of their deposits.

What are Legal (Total) Reserves?

Anything that the law permits banks to claim as reserves.

What are required reserves?

The value of reserves that a depository institution must hold, either as vault cash or as deposits with the Fed.

The _____ is the percentage of total deposits that the Fed requires depository institutions to hold in reserve.

Required Reserve Ratio

How are excess reserves calculated?

They are the difference between legal (total) reserves and required reserves.

What are Open Market Operations (OMO)?

The purchase and sale of existing U.S. government securities in the open private market by the Federal Reserve.

In the fractional reserve system, how do banks 'create' new money?

By lending out their excess reserves, which then become new deposits in other banks.

The _____ gives the maximum potential change in the money supply due to a change in excess reserves.

Money Multiplier

What is the formula for the potential money multiplier?

$Potential\ money\ multiplier = \frac{1}{\text{required reserve ratio}}$

How is the total potential change in the money supply calculated using the money multiplier?

It is the potential money multiplier multiplied by the change in excess reserves.

With a 10% required reserve ratio, a new deposit of $100,000 creates $90,000 in excess reserves. What is the maximum amount of new money the entire banking system can create?

$900,000.00

What are the three primary tools of monetary policy?

The reserve requirement, the discount rate, and open market operations.

What three macroeconomic variables are related by the Quantity Theory of Money?

The money supply, the price level (inflation), and real GDP.

What economic problem is expansionary monetary policy used to address?

A recessionary gap, where real GDP is below its potential.

In the AD-AS model, what is the intended effect of an expansionary monetary policy?

To shift the Aggregate Demand (AD) curve to the right, increasing real GDP and closing the recessionary gap.

What economic problem is contractionary monetary policy used to address?

An inflationary gap, where real GDP is above its potential, causing high inflation.

In the AD-AS model, what is the intended effect of a contractionary monetary policy?

To shift the Aggregate Demand (AD) curve to the left, reducing inflationary pressure and returning real GDP to its long-run potential.