chapter 10 & 11 macroeconomics

money

means of payment, a store of value, a unit of account

barter

the direct exchange of goods and services for other goods and services

what must happen in order to effect a trade?

you have to find someone who has what you want and that person must also want what you have

medium of exchange (or means of payment)

what sellers generally accept and buyers generally use to pay for goods and services

store of value

an asset that can be used to transport purchasing power from one time period to another

liquidity property of money

the property of money that makes it a good medium of exchange as well as a store of value: It is portable and readily accepted and thus easily exchanged for goods

main disadvantage of money as a store of value

the value of money falls when the prices of goods and services rise

unit of account

a standard unit that provides a consistent way of quoting prices

commodity monies

items used as money that also have intrinsic value in some other use

fiat, or toke, money

items designated as money that are intrinsically worthless

legal tender

money that a government has required to be accepted in settlement of debts

currency debasement

the decrease in the value of money that occurs when its supply is increased rapidly

m1: transactions money

money that can be directly used for transactions

m1 formula

currency held outside of banks + demand deposits + traveler's checks + other checkable deposits

what does it mean when m1 is a stock measure?

it is measured at a point in time

what was the value of m1 at the end of march 2018?

$3664.3 billion

m2: broad money

m1 plus savings accounts, money market accounts, and other near monies.

m2 formula

m1 + savings accounts + money market accounts + other near monies

what was the value of m2 at the end of march 2018?

$13,918.1 billion

beyond m2

-one of the very broad definitions of money includes the amount of available credit on credit cards as a part of the money supply
-no rules for deciding what is and is not money

how banks created money

gold was used as money but was hard to carry around, so people kept their gold with goldsmiths for safekeeping. receipts were issued to the depositor in the form of paper money. goldsmiths found that people didn't come often to withdraw gold, but instead exchanged their paper receipts. people started doubting the safety of goldsmiths and demanded their gold back from the vault.

run on a bank

occurs when many of those who have claims on a bank present them at the same time

net worth formula

assets - liabilities = net worth

assets

things a firm owns that are worth something

what are a bank's most important assets?

loans, cash on hand, and deposits with the fed

federal reserve bank (the fed)

the central bank of the united states

a firm's liabilities are its...

debts (what it owes)

A bank's most important liabilities are...

its deposits

what does net wort represent

the value of the firm to its stockholders or owners

reserves

the deposits that a bank has at the federal reserve bank plus its cash on hand

required reserve ratio

the percentage of its total deposits that a bank must keep as reserves at the federal reserve

current required reserve ratio

0, lowered from 10%

what must a balance sheet always contain?

balance so that the sum of assets (reserves and loans) equals the sum of liabilities (deposits) and net worth.

excess reserves

the difference between a bank's actual reserves and its required reserves.

formula for excess reserves

actual reserves - required reserves

what happens to the supply of money when loans becomes deposits?

the supply of money increases.

required reserves

reserves that a bank is legally required to hold, based on its checking account deposits

required reserves formula

required reserve ratio x total deposits

what happens to the money supply when there's an increase in bank reserves

there is a greater than one-for-one increase in the money supply

money multiplier

the multiple by which deposits can increase for every dollar increase in the reserves

money multiplier formula

1/required reserve ratio

when was the federal reserves system founded

1913 by an act of congress

who is the most important group within the federal reserve system

the board of governors

what does it mean when the fed is an independent agency?

it does not take orders from the president or congress

federal open market committee (FOMC)

composed of 7 members of the fed's board of governors, the president of the new york federal reserve bank, and 4 of the other 11 district bank presidents on a rotating basis.

function of fomc

-sets goals concerning the federal funds rate target and directs the operations of the open market desk in new york
-control the fed funds rate
-clearing interbank payments
-assisting bank that are in difficult financial position
-facilitates the transfer of funds among banks and is responsible for many of the regulations governing banking practices and standards

open market desk

the office in new york federal reserve bank from which government securities are bought and sold by the fed

lender of last resort

provides funds to troubled banks that cannot find any other source of funds

the amount of money you want to hold is

-positively related to the size of your transactions
-negatively related to the interest rate (the opportunity cost of holding money)

what happens to the opportunity cost of holding money as the interest rate decreases?

the opportunity cost decreases as well.

what happens to the money demand curve when there's an increase in transactions?

the money demand curve shifts to the right

interest-bearing securities are issued by...

firms, and the government seeking to borrow money

what are securities issued with?

a face value and fixed payments, or coupons, over time.

what happens to the prices of existing securities when interest rates rise?

the price of existing securities fall

what happens when the fed increases the money supply?

the interest rate falls

what does the federal reserve determine?

the federal reserve determines the supply of bank reserves

how does the federal reserve control the supply of bank reserves

they buy and sell securities

what happens to the curve when you buy securities?

the curve shifts to the right

what happens to the curve when you sell securities?

the curve shifts to the left

feds in march 2008

the fed became an active participant in the private banking system in response to the financial troubles faced by many large financial institutions

feds in november 2008

the fed began buying securities of fannie mae and freddie mac

feds in september 2012

the fed opted to buy mortgage-backed securities and long-term government bonds to the tune of $85 billion per month

traditional approach to monetary policy

managing the fed funds rate, now near the zero bound

balance sheet approach to monetary policy

adjusting size, maturity, composition

forward guidance approach to monetary policy

aimed at informing the public and markets to align expectations of prospects for short-term interests and balance sheet policies with those of FOMC

what can happen if interest on reserves are paid?

the fed could expand its balance sheet without having the funds rate fall to zero

in theory, how does fomc increase the floor on funds rate?

by raising the ioer

federal funds rate

the rate banks are charged to borrow reserves from other banks

prime rate

a benchmark that banks often use in quoting interest rates to their customers

aggregate supply (as)

the total supply of all goods and services in an economy

aggregate supply (as) curve

a graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level

aggregate supply curve in the short run

positive slope (slopes upward and to the right)

the curve at low levels of aggregate output

the curve is fairly flat

what happens to the curve when the economy approaches capacity?

the curve becomes nearly vertical

why does the aggregate supply curve have a positive slope

wages are a large faction of total costs, and wage changes lag behind price changes.

axises on the aggregate supply curve

x axis: aggregate output (income) (y)

y axis: price level (p)

why does the aggregate supply curve have a curving shape

increased demand for labor and output can only be met with an increase in prices

what does it mean when the curve has an undefined slope (vertical slope)?

the curve reached the economy's maximum output

what shifts the AS curve?

increase or decrease in costs of products

cost shock, or supply shock

a change in costs that shifts in the short-run aggregate supply curve

aggregate demand (ad) curve

a curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government

planned expenditure and the interest rate

AE = C + I + G

what happens to the total planned spending as the interest rate increases

the total planned spending increases as well

a high interest rate [blank] planned investment

discourages

planned aggregate expenditure at every level of income [blank]

falls

a decrease in AE [blank] equilibrium output by a multiple of the initial decrease in I

lower

IS curve

relationship between aggregate output and the interest rate in the goods market

with the interest rate fixed, an increase in government spending (g) [blank] AE and thus Y in equilibrium

increases

relationship between output and interest rate

negative relationship

why is there a negative relationship between output and interest rate?

planned investment depends negatively on the interest rate

what happens to the IS curve when the government spending increases

there is a shift to the right, assuming the interest rate is fixed

fed rule equation

r = aY +bP + yZ (Z includes economic factors that lie outside the model)

fed rule

equation that shows how the Fed's interest rate decision depends on the state of the economy

the intersection of the fed rule and IS curve

equilibrium values of output and the interest rate for given values of government spending (g), the price levels (p), and the factors in Z

why does the AD curve fall when P increases?

higher prices leads the feds to raise r, which decreases I, thus Y

what happens to aggregate output when interest rates increase?

aggregate output falls when interest rates increase

aggregate output and aggregate price level are determined by...

the intersection of the AS and AD curves

real wealth effect

the change in consumption brought about by a change in real wealth that results from a change in the price level (contributes to a downward-sloping curve)

what happens to the equilibrium price level and output when the AD curve shifts to the right?

the curve increases

what does it mean when the price levels increase?

wages are responding to the price change. if wages fully adjust, the output will go back to its original position (potential gdp)