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in everyday conversation, ppl use "money" to refer to...

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wealth

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money

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Any asset that can easily be used to purchase g/s

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currency in circulation

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cash held by the public

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checkable bank deposits

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bank accounts on which people can write checks

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money supply

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total value of financial assets in the economy that are considered money

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double coincidence of wants

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two parties can trade only when each wants what the other has to offer.

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what solves the problem of the "double coincidence of wants"

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Money solves this problem: individuals can trade what they have to offer for money and trade money for what they want

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medium of exchange

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an asset that indivs acquire for the purpose of trading g/s rather than for their own consumption

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store of value

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A means of holding purchasing power over time

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One simple measure of a currency's importance is...

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the value of the quantity of that currency in circulation

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4 Leading Currencies

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1. Euro = bc of EU 2. Dollar = bc of large economy 3. Japan = bc make much more use of cash (vs checks and credit cards) 4. China = bc of rapidly growing economy

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unit of account

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A measure used to set prices and make economic calcs

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commodity money

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a good used as a medium of exchange that has intrinsic value in other uses *ie: gold, silver, cigarettes

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when was there widespread use of paper money?

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By 1776 after US independence and after Adam Smith published "Wealth of Nations"

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commodity-backed money

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A medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods *ie: bank notes, credit card, check

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fiat money

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medium of exchange whose value derives entirely from its official status as a means of payment *ie: cash

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2 advantages that fiat money has over commodity-backed money

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1. creating it doesn't use up any real resources beyond the paper it's printed on. 2. the supply of money can be adjusted based on the needs of the economy, instead of being determined by the amount of gold and silver prospectors happen to discover

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risk of fiat money

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counterfeiting

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monetary aggregate

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An overall measure of the money supply *M1 + M2

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near-moneys

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Financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits

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M1 consists of...

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mostly currency in circulation + checkable bank deposits *a LITTLE travelers checks

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M2 consists of...

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mostly savings deposits *a little M1, money market funds, time deposits

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Suppose you hold a gift certificate, good for certain products at participating stores. Is this gift certificate money? Why or why not?

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The defining characteristic of money is its liquidity: how easily it can be used to purchase g/s. Although a gift certificate can easily be used to purchase a very defined set of g/s (avail at the store issuing the gift certificate), it cannot be used to purchase any other g/s. A gift certificate is therefore not money, since it cannot easily be used to purchase all g/s.

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Although most bank accounts pay some interest, depositors can get a higher interest rate by buying a certificate of deposit, or CD. The difference between a CD and a checking account is that the depositor pays a penalty for withdrawing the money before the CD comes due—a period of months or even years. Small CDs are counted in M2 but not in M1. Explain why they are not part of M1.

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Again, the important characteristic of money is its liquidity: how easily it can be used to purchase g/s. M1, the narrowest definition of the money supply, contains only currency in circulation, traveler's checks, and checkable bank deposits. CDs aren't checkable—and they can't be made checkable w/o incurring a cost because there's a penalty for early withdrawal. This makes them less liquid than the assets counted in M1.

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Explain why a system of commodity-backed money uses resources more efficiently than a system of commodity money.

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Commodity-backed money uses resources more efficiently than simple commodity money, like gold and silver coins, because commodity-backed money ties up fewer valuable resources. Although a bank must keep some of the commodity—generally gold and silver—on hand, it only has to keep enough to satisfy demand for redemptions. It can then lend out the remaining gold and silver, which allows society to use these resources for other purposes, with no loss in the ability to achieve gains from trade.

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bank reserves

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currency banks hold in their vaults plus their deposits at the Federal Reserve

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T-accounts

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a tool for analyzing a business's financial position by showing, in a single table, the business's assets (on the left) and liabilities (on the right).

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reserve ratio

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the fraction of bank deposits that a bank holds as reserves

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problem banks can run into

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bank runs a lot of people try to withdraw money from their accounts in a short amount of time

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bank run

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a phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure.

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deposit insurance

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guarantees that a bank's depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account provided by FDIC

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the system to prevent bank runs from destroying the economy consists of 4 main features...

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1. deposit insurance 2. capital requirements 3. reserve requirements 4. banks have access to the discount window, a source of cash when it's needed

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FDIC currently insures

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$250,000 per person per bank

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reserve requirements

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rules set by the Federal Reserve that determine the minimum reserve ratio for banks.

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discount window

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an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble.

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in the United States, the minimum reserve ratio for checkable bank deposits is

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10%

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excess reserves

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a bank's reserves over and above its required reserves

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monetary base

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the sum of currency in circulation and bank reserve

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money multiplier

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the ratio of the money supply to the monetary base

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The money multiplier in the US normally vs in a recession

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normally: 1.5-3 recession: 0.7

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Assume that total reserves are equal to $200 and total checkable bank deposits are equal to $1,000. Also assume that the public does not hold any currency. Now suppose that the required reserve ratio falls from 20% to 10%. Trace out how this leads to an expansion in bank deposits.

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Since they only have to hold $100 in reserves, instead of $200, banks now lend out $100 of their reserves. Whoever borrows the $100 will deposit it in a bank, which will lend out $100 × (1 − rr) = $100 × 0.9 = $90. Whoever borrows the $90 will put it into a bank, which will lend out $90 × 0.9 = $81, and so on. Overall, deposits will increase by $100/0.1 = $1,000.

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Take the example of Silas depositing his $1,000 in cash into First Street Bank and assume that the required reserve ratio is 10%. But now assume that each time someone receives a bank loan, he or she keeps half the loan in cash. Trace out the resulting expansion in the money supply.

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Silas puts $1,000 in the bank, of which the bank lends out $1,000 × (1 − rr) = $1,000 × 0.9 = $900. Whoever borrows the $900 will keep $450 in cash and deposit $450 in a bank. The bank will lend out $450 × 0.9 = $405. Whoever borrows the $405 will keep $202.50 in cash and deposit $202.50 in a bank. The bank will lend out $202.50 × 0.9 = $182.25, and so on. Overall, this leads to an increase in deposits of $1,000 + $450 + $202.50 +...But it decreases the amount of currency in circulation: the amount of cash is reduced by the $1,000 Silas puts into the bank. This is offset, but not fully, by the amount of cash held by each borrower. The amount of currency in circulation therefore changes by −$1,000 + $450 + $202.50 +...The money supply therefore increases by the sum of the increase in deposits and the change in currency in circulation, which is $1,000 − $1,000 + $450 + $450 + $202.50 + $202.50 +...and so on.

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central bank

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an institution that oversees and regulates the banking system and controls the monetary base

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Fed was created in

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1913

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The Fed has 3 main policy tools at its disposal:

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reserve requirements, the discount rate, and, most importantly, open-market operations.

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federal funds market

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allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves.

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federal funds rate

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the interest rate determined in the federal funds market.

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discount rate

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the rate of interest the Fed charges on loans to banks

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If the Fed reduces reserve requirements

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banks will lend a larger percentage of their deposits, leading to more loans and an increase in the money supply via the money multiplier

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If the Fed reduces the spread between the discount rate and the federal funds rate

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the cost to banks of being short of reserves falls; banks respond by increasing their lending, and the money supply increases via the money multiplier

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open-market operation

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a purchase or sale of government debt by the Fed

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Reconstruction FInance Corporation

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RFC given the authority to make loans to banks in order to stabilize the banking sector

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Glass Steagall Act of 1932

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created federal deposit insurance and increased the ability of banks to borrow from the Federal Reserve system, was passed

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commercial bank

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accepts deposits and is covered by deposit insurance.

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investment bank

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trades in financial assets and is not covered by deposit insurance.

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savings and loan (thrift)

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another type of deposit-taking bank, usually specialized in issuing home loans. institutions designed to accept savings and turn them into long-term mortgages for home-buyers

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A financial institution engages in ______ when it finances its investments with borrowed funds

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leverage = borrowed money

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Hedge funds are virtually unregulated, allowing them to make much riskier investments than mutual funds, which are open to the average investor

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balance sheet effect

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the reduction in a firm's net worth due to falling asset prices.

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vicious cycle of deleveraging

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takes place when asset sales to cover losses produce negative balance sheet effects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset prices

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subprime lending

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lending to home-buyers who don't meet the usual criteria for being able to afford their payments.

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securitization

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a pool of loans is assembled and shares of that pool are sold to investors

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TED spread

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the difference between the interest rate on three-month loans that banks make to each other and the interest rate the federal government pays on three-month bonds

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Wall Street Reform and Consumer Protection Act—generally known as Dodd-Frank, after its sponsors in the Senate and House, respectively—into law. It was the biggest financial reform enacted since the 1930s—not surprising given that the nation had just gone through the worst financial crisis since the 1930s

answer

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Econ. Chapter 14 – Flashcards

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