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Chapter 29: The Monetary System
Chapter 29: The Monetary System
Barter: the exchange of one good or service for another to obtain the things they need
Double coincidence of wants: the unlikely occurrence that two people each have a good or service that the other wants
The existence of money makes trade easier
Chapter 29.1: The Meaning of Money
Money: the set of assets in an economy that people regularly use to buy goods and services from other people
Money is related to wealth
29.1a: The Functions of Money
Money serves as a
Medium of exchange: an item that buyers give to sellers when they want to purchase goods and services
Unit of account: the yardstick people use to post prices and record debts
Store of value: an item that people can use to transfer purchasing power from the present to the future
Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange
Since money is the designated medium of exchange, it is the most liquid
When allocating wealth, the liquidity of each asset has to be balanced
29.1b: The Kinds of Money
Commodity money: money that takes the form of a commodity with intrinsic value
Intrinsic value means an item would have value even if it were not used as money
Ex: Gold, because it is used in the industry. When an economy uses gold as money, it operates under a gold standard
Fiat money: money without intrinsic value that is used as money by government decree
Ex: The US dollar
29.1c: Money in the US Economy
Money stock: the quantity of money circulating in the economy
Currency: the paper bills and coins in the hands of the public
Demand deposits: balances in bank accounts that depositors can access on demand by writing a check
Chapter 29.2: The Federal Reserve System
Federal Reserve (Fed): the central bank of the United States
Central bank: an institution designed to oversee the banking system and regulate the quantity of money in the economy
29.2a: The Fed’s Organization
Lender of last resort: a lender to those who cannot borrow anywhere else. This is in reference to the Fed
Money supply: the quantity of money available in the economy
Monetary policy: the setting of the money supply by policymakers in the central bank
29.2b: The Federal Open Market Committee
The Federal Open Market Committee makes decisions. Through this, the Fed has the power to increase or decrease the number of dollars in the economy
Open-market operation: the purchase and sale of US government bonds. This is the Fed’s primary tool to change the money apply
Prices rise when the government prints too much money. The Fed determines the inflation in the long run
Chapter 29.3: Banks and the Money Supply
29.3a: THe Simple Case of 100-Percent-Reserve Banking
Reserves: deposits that banks have received but have not loaned out
A 100-percent-reserve-banking is an imaginary economy where all deposits are held as reserves
A balance sheet is an accounting statement where the assets and liabilities are equivalent
If banks hold all deposits in reserve, banks do not influence the supply of money
29.3b: Money Creation with Fractional-Reserve Banking
Fractional-reserve banking: a banking system in which banks hold only a fraction of deposits as reserves
Reserve ratio: the fraction of deposits that banks hold as reserves
The Fed sets a minimum amount of reserves that banks must hold. This is called a reserve requirement
Banks can hold above the reserve requirement, called a excess reserves
When banks hold only a fraction of deposits in reserve, the banking system creates money
29.3c: The Money Multiplier
Money multiplier: the amount of money the banking system generates with each dollar of reserves
The money multiplier is the reciprocal of the reserve ratio
The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier
29.3d: Bank Capital, Leverage, and the Financial Crisis of 2008-2009
Bank capital: the resources a bank’s owners have put into the institution
Leverage: the use of borrowed money to supplement existing funds for purposes of investment
Leverage ratio: the ratio of assets to bank capital
A bank is insolvent when it is unable to pay of its debt in full, since its assets fell below its liabilities
Capital requirement: a government regulation specifying a minimum amount of bank capital
A credit crunch is a shortage of capital which induces banks to reduce lending
29.4: The Fed’s Tools of Monetary Control
29.4a: How the Fed Influences the Quantity of Reserves
Open-Market Operations
Open-Market Operations: the purchase and sale of US government bonds by the Fed.
To reduce the money supply, the Fed sells government bonds to the public. The public affords this with currency and bank deposits, which reduces the money in circulation
Fed Lending to Banks:
Typically, banks borrow from the Fed’s discount window and pay an interest on that loan
Discount rate: the interest rate on the loans that the Fed makes to banks
Term Action Facility: the quantity of funds the Feds wanted to lend to banks, where banks bid on those funds. ran from 2007-2010
The Fed lends to banks to help financial institutions
29.4b: How the Fed Influences the Reserve Ratio
Reserve Requirements
Reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits
An increase of reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply
When the Fed changes their requirements, it affects banks.
Paying Interest on Reserves
When a bank holds reserves at the Fed, the Fed now pays the bank interest on those deposits
29.4c: Problems in Controlling the Money Supply
The Fed’s control of the money supply is not precise, so problems can still arise
The Fed does not control the amount of money that households choose to hold as deposits in banks
The Fed does not control the amount that bankers choose to lend, therefore the Fed cannot be sure of how much money the banking system will create
29.4d: The Federal Funds Rate
Federal funds rate: the interest rate at which banks make overnight loans to one another
The discount rate is an interest rate paid to borrow directly from the Fed. The federal funds rate consists of borrowing reserves from another bank rather than from the Fed
Interest rates of different loans are strongly correlated with one another, so the federal funds rate has an impact on the economy
Open-market purchases lower the federal funds rate. Open-market sales raise the federal funds rate
Chapter 29: The Monetary System
Chapter 29: The Monetary System
Barter: the exchange of one good or service for another to obtain the things they need
Double coincidence of wants: the unlikely occurrence that two people each have a good or service that the other wants
The existence of money makes trade easier
Chapter 29.1: The Meaning of Money
Money: the set of assets in an economy that people regularly use to buy goods and services from other people
Money is related to wealth
29.1a: The Functions of Money
Money serves as a
Medium of exchange: an item that buyers give to sellers when they want to purchase goods and services
Unit of account: the yardstick people use to post prices and record debts
Store of value: an item that people can use to transfer purchasing power from the present to the future
Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange
Since money is the designated medium of exchange, it is the most liquid
When allocating wealth, the liquidity of each asset has to be balanced
29.1b: The Kinds of Money
Commodity money: money that takes the form of a commodity with intrinsic value
Intrinsic value means an item would have value even if it were not used as money
Ex: Gold, because it is used in the industry. When an economy uses gold as money, it operates under a gold standard
Fiat money: money without intrinsic value that is used as money by government decree
Ex: The US dollar
29.1c: Money in the US Economy
Money stock: the quantity of money circulating in the economy
Currency: the paper bills and coins in the hands of the public
Demand deposits: balances in bank accounts that depositors can access on demand by writing a check
Chapter 29.2: The Federal Reserve System
Federal Reserve (Fed): the central bank of the United States
Central bank: an institution designed to oversee the banking system and regulate the quantity of money in the economy
29.2a: The Fed’s Organization
Lender of last resort: a lender to those who cannot borrow anywhere else. This is in reference to the Fed
Money supply: the quantity of money available in the economy
Monetary policy: the setting of the money supply by policymakers in the central bank
29.2b: The Federal Open Market Committee
The Federal Open Market Committee makes decisions. Through this, the Fed has the power to increase or decrease the number of dollars in the economy
Open-market operation: the purchase and sale of US government bonds. This is the Fed’s primary tool to change the money apply
Prices rise when the government prints too much money. The Fed determines the inflation in the long run
Chapter 29.3: Banks and the Money Supply
29.3a: THe Simple Case of 100-Percent-Reserve Banking
Reserves: deposits that banks have received but have not loaned out
A 100-percent-reserve-banking is an imaginary economy where all deposits are held as reserves
A balance sheet is an accounting statement where the assets and liabilities are equivalent
If banks hold all deposits in reserve, banks do not influence the supply of money
29.3b: Money Creation with Fractional-Reserve Banking
Fractional-reserve banking: a banking system in which banks hold only a fraction of deposits as reserves
Reserve ratio: the fraction of deposits that banks hold as reserves
The Fed sets a minimum amount of reserves that banks must hold. This is called a reserve requirement
Banks can hold above the reserve requirement, called a excess reserves
When banks hold only a fraction of deposits in reserve, the banking system creates money
29.3c: The Money Multiplier
Money multiplier: the amount of money the banking system generates with each dollar of reserves
The money multiplier is the reciprocal of the reserve ratio
The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier
29.3d: Bank Capital, Leverage, and the Financial Crisis of 2008-2009
Bank capital: the resources a bank’s owners have put into the institution
Leverage: the use of borrowed money to supplement existing funds for purposes of investment
Leverage ratio: the ratio of assets to bank capital
A bank is insolvent when it is unable to pay of its debt in full, since its assets fell below its liabilities
Capital requirement: a government regulation specifying a minimum amount of bank capital
A credit crunch is a shortage of capital which induces banks to reduce lending
29.4: The Fed’s Tools of Monetary Control
29.4a: How the Fed Influences the Quantity of Reserves
Open-Market Operations
Open-Market Operations: the purchase and sale of US government bonds by the Fed.
To reduce the money supply, the Fed sells government bonds to the public. The public affords this with currency and bank deposits, which reduces the money in circulation
Fed Lending to Banks:
Typically, banks borrow from the Fed’s discount window and pay an interest on that loan
Discount rate: the interest rate on the loans that the Fed makes to banks
Term Action Facility: the quantity of funds the Feds wanted to lend to banks, where banks bid on those funds. ran from 2007-2010
The Fed lends to banks to help financial institutions
29.4b: How the Fed Influences the Reserve Ratio
Reserve Requirements
Reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits
An increase of reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply
When the Fed changes their requirements, it affects banks.
Paying Interest on Reserves
When a bank holds reserves at the Fed, the Fed now pays the bank interest on those deposits
29.4c: Problems in Controlling the Money Supply
The Fed’s control of the money supply is not precise, so problems can still arise
The Fed does not control the amount of money that households choose to hold as deposits in banks
The Fed does not control the amount that bankers choose to lend, therefore the Fed cannot be sure of how much money the banking system will create
29.4d: The Federal Funds Rate
Federal funds rate: the interest rate at which banks make overnight loans to one another
The discount rate is an interest rate paid to borrow directly from the Fed. The federal funds rate consists of borrowing reserves from another bank rather than from the Fed
Interest rates of different loans are strongly correlated with one another, so the federal funds rate has an impact on the economy
Open-market purchases lower the federal funds rate. Open-market sales raise the federal funds rate