Econ 2020 Final - Coppock

Why are the three reasons we would buy cryptocurrency?

An alternative currency and speculation.

What are the three functions of money?

Medium of exchange, unit of account, store of value.

What does medium of exchange mean?

What we normally trade for goods and services.

What is the medium of exchange in the U.S.?

Wampum (Native Americans), Gold/silver coins, Tobacco (Colonial Virginia), U.S. Dollar - paper currency (today)

Unit of Account

A means for comparing the values of goods and services

Store of Value

Personal assets in actual currency, physical dollars.

What is the most important function of money?

Medium of exchange

What are the four types of money?

Commodity Money, Commodity-backed Coney, Fiat money, Cryptocurrency.

What is commodity money?

Physical good used as money.

Examples of commodity money?

Gold/silver, wampum, tobacco

What is the advantage of commodity money?

Intrinsic value tied to something real.

What is the disadvantage of commodity money?

Transportation

What is commodity-backed money?

Certificate that represents real commodities.

What is an example of a commodity backed money?

Gold or silver standard

What is the problem of commodity backed money?

Changes in commodity price then affects the entire economy.

When would commodity-backed money make sense?

If your country is unstable.

Fiat Money

No inherent (intrinsic) value.

What is a problem with fiat money?

Discretion can be abused; if the government decides to pay off their debts by printing more money, it devalues everyone else's money, leading to inflation.

The Federal Reserve

The central banking system of the United States. No politics here, they decide how much money is in the economy.

Cryptocurrency

Like commodity money if limited in quantity, and like fiat money with no intrinsic value.

How much U.S. currency do we currently have?

$2.216 trillion

What are the main components of M2?

Currency, Bank Deposits (checkable deposits, savings deposits), small time deposits, retail money funds.

How much checkable deposits do we have in the U.S. economy today?

$5.043 trillion

How much savings deposits do we have in the U.S. economy today?

$12.078 trillion

How much M2 do we have in the U.S. Economy today?

$21.063 trillion

What is M2 equation?

Money Supply (M) = currency + deposits

What are the basic functions of commercial banks?

Accept deposits and extend loans.

What are the two macroeconomic roles commercial banks have?

Middlemen in the loan market, channel for monetary policy.

What does "middlemen in the loan market mean" for commercial banks?

Indirect finance; if lenders have their funds converted into loans, the banking system has to function well to produce GDP.

What is a bank's main source of funds?

Deposits

Assets

Uses of Funds

Liabilities + Owner's Equity

Sources of Funds

Credit Card

Bank loans, borrowing money (and hoping to pay it back)

Bank Reserves

Vault cash or deposits at the central bank (Fed). Money set aside that are not loaned out, they earn interest called IORB>

Treasury Securities

Low Risk

What is the interest rate on bank reserves called?

IORD = Interest on Reserve Balances

What is the current IORB?

4.9%

What is the reserve ratio?

(rr); reserves/deposits

What is the current rr in the U.S.?

15 to 20%

Fractional Reserve Banking

Banks keep only a fraction of deposits on reserve

Bank Run

When many depositors try to withdraw their funds at the same time

How many bank failures occurred within the Great Depression?

12,000 bank failures

FDIC

Federal Deposit Insurance Corporation; government deposit insurance; today up to 250k insured today.

What is the new problem the FDIC and other safety nets create?

Moral Hazard

Moral Hazard

The lack of incentive to guard against risk where one is protected from its consequences.

What is the second rotunda principle?

Incentives affect behavior

What is the first rotunda principle?

Trade creates value.

What is the third rotunda principle?

The three sources of economic growth are resources, technology, and institutions.

What rotunda principle does Moral Hazard affect?

Incentives affect behavior

IORB

Interest on reserve balances

What were banks required to do historically with our money?

Banks were required to hold reserves

What is the most recent percentage that banks hold on reserves?

20%

When did reserve requirements end?

2020

When did the Fed begin paying interests on reserves?

2008

What is the interest on reserves called?

IORB (Interest on Reserve Balances)

What is M2 equal to?

Currency, savings deposits, checking deposits

How do banks create money?

Multiplying deposits.

What does a fractional reserve banking system?

Leads to deposit multiplication.

What happens to money deposited into banking systems?

It multiplies.

m^m

A simplified money multiplier.

What does m^m assume?

Constant reserves, and no currency held outside banks.

What happens to the simple money multiplier when withdraws increase?

Decrease in simple money multiplier.

What are the major duties of the Federal Reserve?

Central Banking, regulate banks, monetary policy

Central banking definition

A bank for commercial banks

What do central banks do?

Take deposits from banks and make loans to banks.

Making loans to banks

Lender of last resort, at the "discount window"

What are the four Monetary Policy Tools?

Interest on Reserves (IORB), Open Market Operations (OMO), Quantitative Easing (QE), Loan Facilities

What happens when the Fed lowers the IORB?

Decrease in IORB, decrease in rr (reserve ratio), banks will loan out more funds, increase in m^m (simple money multiplier), increase in M (total money).

What happens when the IORB is increased?

Increase in IORB, increase in rr (reserve ratio), decrease in m^m (simple money multiplier), decrease in M.

Why would we want to increase the IORB?

When inflation is super high, we need to lower M, so we increase the IORB in order to not have prices rise so fast.

OMO

Open Market Operations

Open Market Operations

Buying (and selling) in the open market.

What happens to Money supply when government uses open market operations to buy more?

Increases Money Supply

What is a typical OMO?

Buy and sell short-term Treasury securities.

Quantitative Easing (QE)

Buying other securities

What are two types of securities in quantitative easing?

Longer-term securities, targeted purchases in troubled markets.

What is an example of a targeted purchase in a troubled market based on quantitative easing?

Mortgage-backed securities

What are the two key interest rates?

Interest on Reserves (IORB), Fed Funds Rate

What interest rate is set by the Fed?

Interest on Reserves (IORB)

How much has the IORB increased since last year?

4.9%

What is the Federal Funds Rate?

A short-term market rate targeted by the Fed.

How does the Fed influence the Federal Funds Rate?

The Fed pushed this up and down through monetary policy.

What is the Fed Funds Rate right now?

Target range up to 4.75-5%

What event drastically increase the money supply?

Covid-19

What occurs if aggregate demand increases too much?

Inflation

What do the four expansionary monetary policies do?

Make more loans available, increase supply in loanable funds market.

Equation of Exchange

MV=PY

What will happen in the short-run if you increase aggregate demand in terms of the equation of exchange?

Increase in Money Supply (MV) = Increase in real GDP (PY).

What direction is money supply going right now?

Going down

Why is the money supply decreasing right now?

In the long run, all prices adjust, and there is no change in real GDP or unemployment, but an increase in Price Level leading to lots of inflation.

Why does expansionary monetary policy reduce unemployment in the short run?

Some prices are sticky in the short-run.

What happens with an increase in money supply when all prices fully adjust?

There are no REAL effects on the macroeconomy.

When does monetary policy work?

Short run

What does monetary policy cause in the long run?

Inflation

What would happen if workers knew for sure that inflation was coming?

Prices all adjust together, would move directly to LR equilibrium (A-C), there would be no real effects.

What was the primary response to the Great Response?

Fiscal Policy: Keynesian Model; New Deal; shifting out AD through spending.

When did Monetary Policy begin to become popular?

1950s

What is the definition of the Phillips Curve?

Inverse relationship between inflation and unemployment.

What does the slope of the Phillips Curve look like?

Negative

Who is the Phillips Curve named after?

British empirical economist named A.W. Phillips