In-Depth Exam Notes on Money and Monetary Policy

Chapter 11: Money and Financial Markets

What is Money
  • Definition of money: a medium of exchange, store of value, unit of account.
  • Types of money: fiat money, commodity money.
Functions of Money
  • Medium of Exchange: Facilitates transactions.
  • Store of Value: Retains purchasing power over time.
  • Unit of Account: Standard measure for pricing goods/services.
M1 and M2
  • M1: The most liquid forms of money (cash, checking deposits).
  • M2: Includes M1 plus near money (savings accounts, time deposits).
Liquidity
  • Definition: The ease with which an asset can be converted into cash.
  • Importance in financial markets and personal finance.
Shifts in Demand for Loanable Funds
  • Factors affecting demand: interest rates, economic growth, consumer confidence.
  • Higher interest rates typically reduce demand for loans.
Shifts in Supply of Loanable Funds
  • Factors affecting supply: savings rates, government borrowing, international capital flows.
  • Increased saving leads to greater supply of funds.
Role of Financial Institutions
  • Financial intermediaries that facilitate the flow of funds from savers to borrowers.
  • Include banks, credit unions, and investment firms.
Bond Prices and Interest Rates
  • Inverse relationship: when bond prices rise, interest rates fall, and vice versa.
  • Factors that affect bond prices include inflation expectations and credit risk.
Calculate Yield and Price of a Bond
  • Yield: The return on investment for holding the bond, typically expressed as a percentage.
  • Price: Determined by the present value of future cash flows (interest payments and face value).
  • Formula for yield: Yield=Annual Interest PaymentCurrent Market PriceYield = \frac{Annual\ Interest\ Payment}{Current\ Market\ Price}

Chapter 12: Money Creation and Monetary Policy

Reserve Ratio, Excess Reserves
  • Reserve Ratio: The fraction of deposits banks are required to hold as reserves.
  • Excess Reserves: Funds banks retain above the required minimum.
Money Creation
  • Process by which banks create money through lending.
  • Involves turning deposits into loans, which can increase the money supply.
Money Multiplier
  • Concept that illustrates how an initial deposit can lead to greater total money supply.
  • Formula: Money Multiplier=1Reserve RatioMoney\ Multiplier = \frac{1}{Reserve\ Ratio}
Money Leakages
  • Situations where money leaves the banking system, such as cash withdrawals.
Leak Adjusted Multiplier
  • Adjusts the money multiplier for leakages in the banking system.
Tools of Monetary Policy
  • Reserve Requirement Ratio: Minimum reserves banks must hold.
  • Discount Rate: Interest charged to commercial banks for borrowing funds from the central bank.
  • Open Market Operations: Buying and selling government securities by the central bank to regulate the money supply.
    • Fed Buying: Increases money supply, lowers interest rates.
    • Fed Selling: Decreases money supply, raises interest rates.
Federal Funds Rate
  • Interest rate at which banks lend reserves to other banks overnight.
  • Tool used by the Federal Reserve to influence monetary policy.

Chapter 13: Monetary Policy Goals and Theories

Goals of Monetary Policy
  • Promote maximum employment, stable prices, and moderate long-term interest rates.
Expansionary Monetary Policy
  • Policy aimed at increasing the money supply to stimulate economic growth.
  • Tools include lowering interest rates and buying government securities.
Contractionary Monetary Policy
  • Policy aimed at reducing the money supply to curb inflation.
  • Tools include raising interest rates and selling government securities.
Classical Monetary Theory
  • Argues that markets are self-correcting and focus on long-term growth without government intervention.
Keynesian Monetary Theory
  • Suggests active government involvement to manage economic cycles and focus on demand-side policies.
Monetarists Theory
  • Emphasizes the role of governments in controlling the amount of money in circulation.
  • Focus on long-term stability and inflation control.
Demand Shock and Effectiveness of Monetary Policy
  • Demand shocks impact aggregate demand; monetary policy effectiveness varies based on timing.
Supply Shocks and Effectiveness of Monetary Policy
  • Supply shocks (e.g., natural disasters) can lead to inflation or recession, complicating monetary policy effectiveness.