Macro Monetary Policy Vocab

fractional reserve banking system

banks hold only a fraction of customer deposits as cash reserves, lending out the rest, which allows them to create new money, expand the money supply, and stimulate economic activity through loans, driven by the central bank's reserve requirement and the money multiplier effect.

balance sheet

a financial statement showing a bank's (or firm's) Assets (what it owns, like loans/reserves) and its Liabilities (what it owes, like deposits) plus Equity (owner's stake) at a specific time.

vault cash

the physical currency (paper bills and coins) held within a bank's premises, such as in its vaults and teller drawers. It is primarily used to meet the daily withdrawal demands of customers.

required reserves

the minimum cash or central bank deposits banks must hold against customer deposits, set by the central bank (like the Fed), to ensure liquidity for withdrawals and control the money supply.

reserve ratio

the percentage of customer deposits a bank must hold in reserve (cash in vault or at the Fed), not lend out, as mandated by the central bank (like the Federal Reserve in the U.S.) to control the money supply and ensure bank liquidity.

excess reserves

the extra funds banks hold beyond the minimum amount required by the central bank.

actual reserves

the physical cash in a bank's vault plus its deposits at the Federal Reserve, representing the real money a bank holds, unlike Required Reserves (the minimum set by the Fed) or Excess Reserves (what's left over after meeting requirements).

FOMC

the branch of the Federal Reserve (the U.S. central bank) that sets the nation's monetary policy

discount rate

the interest rate the Federal Reserve charges commercial banks for short-term loans.

liquidity

the ease and speed with which an asset can be turned into cash without losing significant market value. (Cash - most liquid asset), (Real-estate - illiquid takes time and often a price drop to sell).

monetary multiplier

shows how an initial bank deposit creates a larger total money supply through lending, calculated simply as 1 / reserve ratio; it explains how banks "multiply" money by lending out a portion of deposits, which gets re-deposited and re-lent, expanding the money supply by a multiple of the original reserves.

assets

a valuable resource owned by an individual or entity that can generate future economic benefits, like cash, income, or increased sales. Can be physical or non-physical.

Liabilities

what a person or company owes to others, representing a financial obligation requiring future payment of money, goods, or services, like a loan, mortgage, or unpaid bill, essentially the opposite of an asset (what you own)

money creation

the process where banks expand the money supply by lending out a portion of customer deposits, not by printing cash, through a system called fractional reserve banking.

federal funds rate

the target interest rate banks charge each other for overnight loans to meet reserve requirements, set by the Federal Reserve (FOMC).

federal reserve

the U.S. central bank managing monetary policy to achieve maximum employment and stable prices (controlling inflation) by influencing money supply and interest rates, ensuring a healthy, stable financial system for the nation's economy.

M1

the narrowest measure of the money supply, including the most liquid assets used for immediate spending: physical currency (cash/coins) and checkable deposits (like checking accounts), plus other highly liquid deposits like savings accounts (post-2020 update).

M2

a broad measure of the money supply that includes everything in the narrower M1 (cash, checking deposits) plus easily convertible "near-money" assets like savings accounts, small-denomination time deposits (CDs), and retail money market funds.

MZM (Money Zero Maturity)

a measure of the money supply that includes all financial assets redeemable at par on demand, essentially capturing all money that is immediately available for spending.