AP Macroeconomics: Financial Sector, Money, and Monetary Policy

Economic Growth

Comes from increases in human capital and physical capital.

Savings

Investment Spending

Investment Spending

National Savings + Capital Inflow

Financial asset types

Loans, Bonds, Loan-backed securities, Stocks, Bank Deposits

Bonds

Bonds & interest rates for bonds are inversely related.

Financial Intermediaries

Mutual Funds, Life insurance companies, Pension funds, Banks

Inflation rate formula

[ (PL in Year 2 - PL in Year 1) / PL in Year 1 ] * 100

Nominal interest rate

Unadjusted for inflation.

Real interest rate

Nominal interest rate - actual interest rate

Higher inflation than expected

Winners: Borrowers; Losers: Lenders

Lower inflation than expected

Winners: Lenders; Losers: Borrowers

Interest rate

Additional rate charged by lenders to borrowers for money lent.

National Savings

Private savings + budget balance

Capital inflow

Net inflow of funds into a country.

Liquid asset

Can be converted into cash without much loss of value.

Illiquid asset

Loses a lot of value when converted to cash.

Diversification

When an investor invests in several different assets to avoid total loss.

Money

Any asset accepted as a means of payment.

Medium of exchange

Used to trade for goods and services.

Unit of account

Can be stored and saved without losing value.

Store of value

A commonly accepted measure to set prices and make economic calculations.

Types of money

Commodity money, Commodity-backed money, Fiat Money

M1

Currency in circulation + traveler's checks + checkable bank deposits

M2

M1 + near-moneys (savings account, time deposits, small denomination CDs)

Net Present Value

PV of current & future benefits - PV of current & future costs

Bank runs

When many depositors demand their money at the same time.

Deposit insurance

Guarantees security of the first $250,000 of every bank account.

Reserve requirements

Banks are required to maintain the required reserve ratio.

Discount Window

Banks can get loans and money from the FED.

Money multiplier

1 / reserve ratio

Liquidity Preference Model

Name for money market model.

Fisher Effect

A rise in expected future inflation → a rise in the interest rate.

Federal Reserve functions

Provides financial services, supervises banking institutions, maintains stability of financial system, conducts monetary policy.

Expansionary monetary policy

Decrease in required reserve ratio, lower discount rate, Fed buying more T-bills.

Contractionary monetary policy

Increase in required reserve ratio, increase in discount rate, FED sells T-bills.

Demand Deposit x Reserve Ration

Required Reserves

Demand Deposits - Required Ratio

New Loans

Change in Money Supply

Initial Loans x Money Multiplier