ECN EXAM 2

double coincidence of wants

unlikely occurrence two people have a good or service the other wants

liquidity

the ease it can be converted to medium of exchange

commodity money

has value outside of being used for money

fiat money

established as money by government decree

money stock

quantity of money circulating in the economy

money stock does not include

credit cards

M1

currency, demand deposits, liquid deposits

demand deposits

bank account balances accessible by writing a check, outstanding loans

M2

M1+ small time deposits and money market funds

liquid deposits

bank account balances that depositors can easily access on demand

small time deposits

interest-bearing bank deposits with a fixed maturity date that incur a penalty for early withdrawal

money market funds

investment funds that invest in short-term, high-quality debt securities, providing liquidity and stability while aiming for returns

how many members of the federal reserve board of directors?

7

dual mandate

stable prices and maximum sustainable employment

the roles of the fed

1. lender of last resort to banks

2. control quantity of money, monetary policy

if the fed wants to increase money supply

buy bonds in open market operations

federal open market committee

board of governors + 5 regional presidents

open market operation

purchase and sale of US government bonds, decrease money supply

fractional-reserve banking

only a fraction are in reserves, creates money from loans and currency

money multiplier

amount of money that results from each dollar of reserves, reciprocal of the reserve ratio

the higher the reserve ratio

less of each deposit banks loan out and the smaller the money multiplier

reserve ratio

fraction of deposits that banks hold as reserves

reserve requirement

minimum amount of reserves that banks are legally required to hold against deposits

bank capital

resources a bank obtains from issuing equity to its owners

value of owners equity

value of banks assets-value of liabilities

leverage ratio

ratio of the bank’s total assets to bank capital

capital requirement

ensure banks can pay off their depositors, without it leads to economic turmoil

credit crunch

put public funds into banking system

increase securities

increase capital

increase loan

increase deposits

when considering how to allocate assets banks use

reserve requirements

feds tools

1. influence quantity of reserves

2. influence reserve ratio and money multiplier

how does the fed influence quantity of reserves

1. open market operations

2. lending to banks

fed open market operations

pays for bonds with new dollars, tells people to buy from the public in bond markets

fed lending to banks

discount window, helps institutions in trouble

how does the fed influence reserve ratio and money multiplier

1. reserve requirements

2. interest on reserves

reserve requirements increase

reduces money supply and money multiplier

increase interest on reserves

increase reserve ratio, decrease money multiplier, decrease money supply

fed problems

can’t control how much households choose to deposit or bankers chose to lend

federal funds rate

short-term interest rate banks charge each other for loans

amount of capital required depends on

the type of assets the bank has

3 functions of money

medium of exchange, unit of account, store of value

medium of exchange

facilitates quick/cheap transactions

unit of account

acts as a means of stating prices, denotes value

store of value

maintain value over time

price level rises

value of money falls

influences to money supply

the fed: fractional reserve banking, policy variable

why is the supply curve vertical?

it is fixed by the fed

monetary injection

shifts the supply curve to the right

quantity theory of money

quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate

economic variables

1. nominal variables

2. real variables

nominal variables

measured in monetary units

real variables

adjusted for inflation, relative prices, real wage, real interest rates

monetary neutrality

changes in money supply do not affect real variables over long periods of time

velocity of money

rate at which money changes hands

velocity of money equation

V= (PxY)/M, nom GDP/ money supply

quantity equation

MxV=PxY

increase in quantity of money is reflected in one of these

1. price level rise

2. quantity output rise

3. velocity of money fall

inflation tax

revenue government raises by creating money, tax on everyone that holds money

fisher effect

if a central bank increases the rate of money growth, long run result is an equal increase in the inflation rate and nominal interest rate

shoeleather costs

resources wasted when inflation encourages people to reduce their money holdings

menu cost

cost of changing prices

increase inflation rate

increase relative prices

unexpected inflation

wild redistribution of wealth

US reserve ratio

0% to encourage banks to lend

to increase money supply

buy bonds with money not previously in circulation

to decrease money supply

sell bonds and remove money recieved in sale

assets increase

liabilities increase

as r increases

cost of money holding increases, hold less

as r decreases

cost of money holding decreases, hold more

r shifts down

consumption and investment are up

when assets go up

buying bonds

when assets go down

selling bonds

cost of spending, money holding, the price of money is

r

reserves

assets

deposits

liabilities

federal funds rate (FFR)

target rate used by Fed, baseline risk-free rate banks can borrow, all other short term rates move with it

higher borrowing

higher quantity of reserves, money supply rises

lower borrowing

lower quantity of reserves, money supply falls

new nominal interest rate

old nominal interest rate+change in inflation rate

nominal interest rate

inflation rate+real interest rate

after tax real interest rate

after tax nominal interest rate-inflation rate

lower inflation rate

higher after tax real interest rate, encourages saving

monetary base

currency+bank reserves (subset of deposits)

money supply

currency+deposits

change in money supply

money multiplier x change in monetary base

money multiplier increases if

increased willingness to deposit and lend

during a crisis

m comes close to 0

m measures

how effective monetary policy is

quantitative easing

bypass banks, move long term rates

short term

sticky prices, somewhat fixed

long term

flexible prices, fully adjustable

theoretical time horizon

long run represents that enough time has passed for prices to fully adjust to any shock

MV=PY

M-M2, V-velocity, P-price level, Y-real gdp/nom gdp

MV=PY in long run

V and Y are constant

classical dichotomy

in the long run nominal shocks only have nominal effects

as gdp increase and distance decrease

more likely to trade

real exchange rate

nominal exchange rate x (domestic P/foreign P)

surplus leads to

lending abroad

arbitrage opportunity

good can be bought in one country at a low price and sold in another country at a higher price