ap macro money market

Money Market Review/ guided notes


Money: any commodity/token that is generally accepted as a means of payment for goods amd services


Commodity: good w/ built-in value

Token: currency whose stated value is greater than its built-in value


  1. List and explain the three functions of money.

a. Medium of exchange: anything that is acceptable as payment.Without it money you would have to barter.

b.  Unit of account: the yardstick people use to post prices and record debts, simplifying price comparisons.

c. Store of Value: an item that people can use to transfer purchasing power from present to future


  1. List and explain the six characteristics of a good currency.

a. Durable: must withstand wear and tear

b. Portable: people need to be able to take 

c. Divisible: money must be easily divided into smaller denominations or units of value

d. Uniform: two units of money must be the same in terms of what they will buy

e. In Limited Supply: money must be available only in limited quantities

f. Acceptable: everyone must be able to exchange the money for goods and services



  1. Describe the structure and roles of the various Parts of the FED.

Ex.  Chairman…..

  • Fed (Federal Reserve): serves as the nation’s central bank

    • designed to oversee the banking system.

    • regulates the quantity of money in the economy and promotes price stability.

  • Board of Governors: seven members appointed by the President and confirmed by the Senate 

    • Chairman: directs the Fed staff, presides over board meetings, and testifies about Fed policy in front of Congress committees 

  • Regional Federal Reserve Banks: 12 Federal Reserve Banks one for each of the districts. Each had nine directors, three appointed by the Board of Governors and six elected by the commercial banks in the district.

  • Federal Open Market Committee (FOMC): serves as the main policy-making organ of Fed system. It determines the monetary policy.

    • members: chairman of Board of Governors, president of the Fed Reserve Bank of New York, president of the other regional Fed Reserve Banks

    • meets approx. every six weeks to review the economy



  1. What steps were taken in 1913 to protect the Federal Reserve from political pressures?

  • Each member of the Board of Governors has a 14-year term, and one person’s term expires every two years. A president can appoint a maximum of 3 to 4 members.


  1. Explain the process of Fractional Reserve Banking. (draw it out if needed)

  • This is when banks are required to keep a fraction of their deposits in a reserve and allowed to lend out the rest. This creates money by lending, which increases the money supply.

  • Money supply is the total money available in the economy. Including the money in circulation and also the bank deposits, loans, and other forms of credit.

action

bank balance

initial deposit: $1000

$1,000 in bank

reserve requirement (10%)

$100 kept in reserves

bank lends $900

$900 to borrower

borrowed money is deposited to bank 2

bank 2 gets a $900 deposit

reserve requirement (10%)

$90 kept in reserves

bank 2 lends $810

bank 2 lends $810 to another borrower



  1. List and explain the three tools of Monetary Policy:  And describe how each would be used in (a.)  Expansionary Monetary Policy  (b.) concretionary policy

  1. Open Market Operations: buying and selling bonds. (most common) 

    1. Buying Bonds: Central Bank buying bonds injects money into the banking system, increasing the reserves of commercial banks. This drives interest rates down and thus encourages lending and spending. (Expansionary Monetary Policy)

    2. Selling Bonds: When the Central Bank sells bonds, it pulls money out of the banking system, decreasing the reserves thus driving interest rates up and discouraging lending and spending. (Contractionary Monetary Policy)

  2. Discount rates: the interest rate at which commercial banks can borrow funds directly from the central bank. Used as a tool by the Fed to influence the cost of borrowing money. 

    1. Lowering DR: Borrowing from the central bank is cheaper for commercial banks, so they are more likely to lend money, increasing the money supply and economic activity. (Expansionary Monetary Policy)

    2. Raising DR: Borrowing from the central bank is more expensive for commercial banks, so they are less likely to lend money, decreasing the money supply and economic activity. (Contractionary Monetary Policy)

  3. Reserve Requirements: a fraction of deposits that commercial banks must hold in reserve and not lend out.

    1. Lowering RR: Banks can lend out more of their deposits, thus increasing the money supply and encouraging economic activity. (Expansionary Monetary Policy)

    2. Raising RR:  Banks must hold more money in reserve, leaving less available for lending. This reduces the money supply and discourages economic activity. (Contractionary Monetary Policy)

  1. What makes up the M1 and M2 Measurements? 

  • M1: currency, traveler’s checks, demand deposits, other checkable deposits

  • M2: everything in M1, saving deposits, small time deposits, money market mutual funds

  • M3=M2+Large Time Deposits(Treasury bonds)


  1. What was the purpose of the TARP bailout of 2008? (p. 648) Do you agree with the principle used to justify TARP?

  • It was the response to the 2008 financial crisis that resulted from collapsing in housing and banking sectors. The purpose was to stablize the financial system, restore confidence in the markets, and prevat a bigger economic collapse. This was done by providing the US Treasury the authority to purchase/insure troubled assets from banks. I agree that government intervention was needed but I wish another apporoach would have taken. An approach that did not reward banks for taking on too much risk.


  1. Explain the difference between an asset and a liability on a bank’s balance sheet.

  • An asset asset is what the bank owns or what the bank is owed (i.e loans, cash).

  • A liability is what the bank owes to others (i.e. customer deposits, or borrowings).


  1. Summarize the Taylor Rule. 

  • It is a rule that adjusts the nominal interest rate in response to changes in inflation, unemployment,  and GDP. 

  1. Explain what can cause MS curve shifts.(money supply)

  • Changes in the OMOs, DRs, RRs


  1. Explain what can cause MD curve shifts.  (money demand)

  • changes in income

  • changes in price level

  • changes in technology (credit cards)


  1. What is the formula for the money multiplier?

  • money multiplier= 1/ reserve rat

14.  Draw an AD/AS graph and a Money market graph for the following scenario:

a. The nation is currently experiencing a recessionary gap characterized by high unemployment rates.  (B.) To lower unemployment the Fed engages in expansionary monetary policy through the Use of OMO’s.  Explain how OMO’s will be used.  (c.) show effects on Money market graph and AD/AS graph.  


  1. Draw an AD/AS graph and a Money market graph for the following:

    1. the economy is experiencing an expansionary gap, characterized by high rates of inflation.  (b.) To counter inflation the fed follows a concretionary monetary policy using the reserve requirement.  Explain how the reserve requirement will be used.  (c.)  Show effects on AD/AS graph and Money Market Graph.

15.  Vocab:  Define the following:

  1. Liquidity: the ease with which an asset can be converted into money


  1. Token Money: currency whose stated value is greater than its built-in value


  1. Checkable deposits: deposits in a bank that can be converted into checks, debit cards, or electronic payments. Considered part of the money supply.


  1. Commercial banks: financial institutions that accept deposits, making loans, and provide saving accounts and certificates of deposit


  1. Thrift institutions: financial institutions that focus on accepting savings deposits and making loans, primarily for home mortgages. Similar to commercial banks, but with a focus on consumer savings and housing finance.

  2. Near-monies: assets that are highly liquid and can be quickly converted into cash with little or no loss in value (savings accounts, treasury bills, money market deposit accounts)


  1. Savings accounts: deposit account offered by banks that provide a interest rate in exchange for keeping funds in the account


  1. Money Market deposit Accounts: type of savings account that offers a higher interest rate in exchange for higher minimum balance requirements and limited check-writing privileges


  1. Time deposits: savings accounts that require the depositor to leave the money in the account for a fixed term (such as six months or one year) in exchange for a higher interest rate


  1. Legal tender: money that must be accepted for the payment of debts. (in US, US bills and coins)


  1. Subprime mortgage loans: home loans made to borrowers with low credit scores or poor credit histories, which makes them riskier for lenders (come w/ higher interest rates)


  1. Mortgage backed securities: investment products made by pooling together mortgages (such as home loans) and selling them as securities to investors. Investors receive payments based on interest payments paid by homeowners.


  1. TARP: the response to the 2008 financial crisis that resulted from collapsing in housing and banking sectors. The purpose was to stablize the financial system, restore confidence in the markets, and prevat a bigger economic collapse. This was done by providing the US Treasury the authority to purchase/insure troubled assets from banks. 


  1. Securitization: the process of pooling various types of debt (such as mortgages, car loans, or credit card debt) and selling them as securities to investors. They are backed by the cash flow from underlying assets allowing the original lender to free capital for new loans.


  1. Balance sheet: financial statement that shows a company's financial position at a specific point in time. Lists assets, liabilities, and equity (Assets = Liabilities + Equity)


  1. Vault cash: physical cash held in a bank's vault/reserve to meet withdrawal demands from customers.


  1. Required reserves: minimum amount of reserves a bank must hold as mandated by the central bank

  2. Excess reserves: reserves held by a bank above and beyond the required reserve. Used to make loans or buy security thus increasing the money supply


  1. Actual reserves:the total reserves held by a bank, which include both required reserves and excess reserves


  1. Monetary multiplier= 1/rr; factor that describes how an initial deposit/reserve leads to an increase in the money supply through the banking system.


  1. Interest: cost of borrowing money, reward for saving


  1. Transaction demand for money: demand for money based on the need to carry out everyday transactions. Depends on level of income and the frequency of transactions in economy.


  1. Asset demand for money: demand for money as a store of value


  1. Total demand for money: sum of the transaction demand and the asset demand for money. 


  1. Federal Funds Rate: the interest rate at which banks lend money to each other overnight


  1. Liquidity trap:  when interest rates are very low and savings rates are high, so people prefer holding cash rather than investing or spending, even when central banks attempt to stimulate the economy by lowering interest rates. Monetary policy becomes less effective in stimulating economic activity