Unit 9, Money and banking flashcards

money

an item which is generally acceptable as a means of payment

double coincidence of wants

a situation where two people each have something the other one wants

functions of money

medium of exchange, store of value, unit of account, standard of deferred payment

medium of exchange (function of money)

having money overcomes the need for the double coincidence of wants in order to exchange goods and services

store of value (function of money)

money enables people to save, keeping the money they receive from goods and services for future use

unit of account (function of money)

money enables to the value of different items to be compared as prices are expressed in money terms

standard of deferred payment (function of money)

money enables people, firms and the government to borrow and lend and to buy and sell in the future

characteristics of money

generally acceptable, recognisable, portable, divisible, homogenous, limited in supply, not easy to counterfeit

generally acceptable (characteristic of money)

the most important characteristic, people must be prepared to accept an item in exchange for products, as a store of value and a standard of deferred payments for it to act as money

recognisable (characteristic of money)

people have to identify item as money and distinguish it from other items, central banks make the country’s notes and coins distinctive

portable (characteristic of money)

money must be easy to carry around, bank notes and coins, as well as credit and debit cards are very light

divisible (characteristic of money)

any form of money must be divisible into units of different value

homogenous (characteristic of money)

each unit of money must be identical in terms of appearance and value, ensuring that every unit is interchangeable with another.

limited in supply (characteristic of money)

there must be a limited supply of money in order to give it a value and make it acceptable

not easy to counterfeit (characteristic of money)

money that is easy to counterfeit loses its value, central banks build in special features to their bank notes to try to prevent counterfeiting

money supply

the total amount of money in an economy

narrow money

money that can be spent directly

broad money

money used for spending and saving

quantity theory of money

the theory that links inflation in an economy to changes in the money supply

Fisher equation

the statement that MV = PT, where M is the money supply, V is the velocity of money, P is the price level, and T is the volume of transactions.

Argument against the Fisher equation

Keynesians argue that the equation cannot be turned into an equation as the velocity of money and volume of transactions can change with a change in the money supply and so no predictions can be made about the effect on the price level

Keynesian theoretical approach

Economists whose ideas are based on the work of John Maynard Keynes, they believe that the level of GDP can deviate from the full employment level by a large amount and for long periods and as such favour government intervention to influence the level of economic activity, they also argue that if there is high unemployment, the government should use a large budget deficit to increase aggregare demand and that the avoidance of unemployment is a key priority.

Monetarist theoretical approach

Economists who see the control of inflation as a top priority for governments and argue that inflation is the result of an excessive growth of the money supply, as such the main role of the government is to control the money supply. They also believe that attempts to reduce unemployment by causing government spending will only succeed in raising inflation in the long run, the economy is inherently stable unless disturbed by erratic changes in the growth of the money supply

demand deposit account

a bank account that allows the holder to make an receive payments

savings deposit account

a bank account which pays interest and may require notice to be given before money can be withdrawn from it

government securities

bills and bonds issued by the government to raise money

equities

shares in firms

overdraft

permission to spend more than is in a demand deposit account

loan

a sum of money lent at an agreed interest for a specific time period

reserve ratio

the proportion of liquid assets to total liabilities

capital ratio

a bank’s available financial capital as a percentage of its riskier assets

liquidity

the ability to turn an asset into cash quickly and without loss

main objectives of a commercial bank

profitability, liquidity, and security, by aiming to achieve high profits for their shareholders while maintaining adequate liquidity and sufficient capital to cover their riskier loans

causes of changes in the money supply

an increase in commercial bank lending, an increase in government spending financed by borrowing from the central bank, an increase in government spending financed by borrowing from the central bank, the sale of government bonds to private sector financial institutions (quantitative easing), more money entering than leaving the country

bank credit multiplier

the process by which banks can make more loans than deposits available, calculated as value of new assets created divided by value of change in liquid assets or 100 divided by the liquidity ratio, allowing them to estimate what reserve ratio to keep

quantitative easing

a situation where a central bank buys government and private securities from the private sector in order to increase the money supply and so stimulate economic activity

total currency flow

the net amount of money that flows into or out of the country as a result of international transactions, related to the balanced of payments

economic and monetary union

co-ordination of policies and the operation of a single currency by a group of countries

the monetary transmission mechanism

the process by which a change in monetary policy works through the economy via a change in aggregate demand to the price level and real GDP

liquidity preference

a keynesian concept that explains why people demand money, consists of the transaction, precautionary and speculative motives

transactions motive

the desire to hold money for the day-to-day buying of goods and services

precautionary motive

a reason for holding money for unexpected or unforeseen events

active balances

the amount of money held by households or firms for possible near-future use

speculative motive

a reason for holding money with a view to make future gains from buying financial assets

idle balances

the amount of money held temporarily as the returns from holding financial assets are too low

liquidity trap

a situation where interest rates cannot be reduced any more in order to stimulate an upturn in economic activity

loanable funds theory

a theory that suggests that the rate of interest is determined by the demand and supply of loanable funds