AP Macro Unit 4

Medium of Exchange

Accepted as payment for goods and services

Unit of Account

aka standard of value; can be used to compare the value of goods and services

• (1 goat = $50 = 5 chickens OR 1 chicken = $10)

Store of Value

can be saved; people use money to save for something

Commodity Money

money that has other uses other than its use as money (ex. spices during the middle ages or cigarettes in prison)

Fiat Money 

money that has no other use other than its use as money

Liquidity 

the degree/ease with which an asset can be converted into cash. The easier an asset can be converted to cash the more liquid the asset

M1 

Highest Liquidity:

• includes currency in circulation

• Checkable/savings bank deposits (checking accounts)

• Traveler’s checks

checking accounts are the biggest part of M1  

M2

M1 +:

• savings time deposits (money market accounts)

• Time deposits (CDs = certificates of deposit)

• Money market funds

• and other “less liquid” assets that can be converted into cash (certificates of deposit) 

Demand Deposits

aka transaction deposits; checking and simple savings accounts that are counted in M1

Assets

items of value owned by banks (loans that banks make to borrowers, investments, and reserves)

Liabilities

items owed by a bank (financial responsibilities) Examples: loans the bank has taken out and deposits held by the bank.

Nominal Interest Rates 

expected rate of inflation + real interest rate (the real rate of return that lenders want to receive)

Real Interest Rates

nominal interest rate - the actual rate of inflation (this is also the rate of return a lender wants to earn beyond inflation) 

Rate of Return

the percentage change in the value of an investment

Financial Sector:

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

Bonds:

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.

• Bond price and interest rates are inversely related

Stocks:

Represents ownership of a corporation and the stockholder is often entitled to a portion of the profit

Fisher Effect

Formula: NIR = RIR + Inflation 

How are lenders and borrowers impacted when inflation is higher than expected?

• Lenders are hurt because they are paid back fewer real dollars or they yield a lower real interest rate than expected.

• Borrowers are helped because they pay back fewer real dollars or the real interest rate is lower than expected.

How are lenders and borrowers impacted when inflation is lower than expected?

• Lenders are helped because they are paid back more real dollars or they yield a higher real interest rate than expected

• Borrowers are hurt because they pay back more real dollars or they pay a higher real interest rate.