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Three functions of money:
- 1. medium of exchange
- 2. unit of account
- 3. store of value
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M1 includes:
paper currency + checkable deposits
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What is the largest part of the M1 money supply?
Checkable deposits
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Two main types of financial institutions:
Commercial banks and thrift institutions (including S&Ls, credit unions)
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M2 includes:
M1 + savings deposits, market deposit accounts (MMDAs), small time deposits, and money market mutual funds (MMMFs).
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M3 includes:
M2 + large time deposits
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Why are credit cards not considered money?
They act as a short loan, but have no value.
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Money is a debt of what?
the Federal Reserve Banks
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What three reasons give money its value?
- 1. acceptability
- 2. legal tender ("designated currency")
- 3. relative scarcity
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What is the relationship between price levels and the purchasing power of the dollar?
Inverse
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What two factors stabilize the value of money?
- 1. appropriate fiscal policy
- 2. intelligent management of the money supply
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What are the three types of demand for money?
- 1. transactions demand
- 2. asset demand
- 3. total money demand
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Transaction Demand
the need of money to pay for things
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Asset Demand
the need to hold stocks, bonds, etc.
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Total Money Demand
the inverse relationship between interest rate and amount of money people want to hold
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Money Market
the demand for money versus the supply of money
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What is the relationship between interest rates and bond prices?
Inverse
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Federal Reserve System
controls the lending activity of the nation's banks
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Federal Open Market Committee
sets the Fed's monetary policy and directs purchases/sales of govt securities
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Federal Reserve Banks
collectively serve as the nation's central bank ("banker's bank")
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What are the seven functions of the Federal Reserve?
- 1. issue currency
- 2. set reserve requirements/hold reserves
- 3. lend money to banks
- 4. provide for check collection
- 5. act as fiscal agent
- 6. supervise banks
- 7. control money supply
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Balance Sheet of a Commercial Bank
a statement of assets and claims on assets that summarizes the financial position of the bank at a certain time (assets = liability + net worth)
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Fractional Reserve System
a fraction of the total money supply is held in reserves as currency
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What are two characteristics of a fractional reserve banking system?
- 1. money creation and reserves
- 2. bank panics and regulation
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Eight Steps in the Creation of a Single Commercial Bank
- 1. acquire a charter; sell equity shares
- 2. acquiring property and equipment
- 3. accepting deposits
- 4. depositing reserves in a Fed Reserve Bank
- 5. clearing a check drawn
- 6. granting a loan
- 7. repaying a loan
- 8. buying govt securities
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Required Reserves
amount of funds equal to a specified percentage of the banks own deposit liabilities
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Reserve Ratio
reserve ratio = commercial bank's required reserves/commercial bank's checkable deposit liabilities
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Excess Reserves
actual reserves - required reserves
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What do required reserves help the Fed to control?
The lending ability of commercial banks; facilitating of the collection/clearing of checks
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How does giving a loan and paying back a loan create and destroy money?
- Makes: by considering an IOU a form of payment
- Destroys: when the loan is paid back the IOU is returned because real money has been deposited in its place
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Monetary Multiplier
magnifies a change in initial spending into a larger change in GDP (1/req reserve ratio)
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The balance sheet of the Fed Banks is made up of these fives things:
- Assets:
- 1. securities
- 2. loans to commercial banks
- Liabilities:
- 3. reserves of commercial banks
- 4. Treasury deposits
- 5. outstanding Fed Reserve Notes
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Open Market Operations
the buying/selling of bonds from/to commercial banks and general public
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When the Fed banks buys securities in the open market, commercial banks' reserves increase
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When the Fed banks sell securities in the open market, commercial banks' reserves decrease
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Discount Rate
the interest rate charged by Fed banks to commercial banks
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Easy Monetary Policy
- Increase: excess reserves, money supply, investment spending, aggregate demand, and real GDP
- Decrease: reserve ratio, discount rate, and interest rate
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Tight Money Policy
- Increase: reserve ratio, discount rate, and interest rate
- Decrease: excess revenue, money supply, investment spending, aggregate demand, and inflation
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Two strengths of monetary policy:
- 1. speed and flexibility
- 2. isolation from political pressure
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Three weaknesses of monetary policy:
- 1. less control?
- 2. change in the velocity of money
- 3. cyclical assymetry
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Velocity of money
the number of times per year the average dollar is spent on goods/services
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Cyclical Assymmetry
the unreliability of monetary policy to push an economy from a recession
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Fed Funds Rate
the interest rate that banks charge one another on overnight loans of reserves
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Prime Interest Rate
interest rate banks charge their most credit worthy customers
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Monetary Net Export Effect
Easy: decreased interest rate = decreased foreign demand for the dollar; thus the dollar depreciates and net exports increase
Tight: increased interest rate = increased foreign demand for the dollar; thus the dollar appreciates and net exports decrease
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What three things does an easy money policy do?
- 1. alleviates unemployment
- 2. alleviates sluggish growth
- 3. corrects balance of trade deficit
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What two things does a tight money policy do?
- 1. alleviates inflation conflicts
- 2. corrects balance of trade deficits
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