Macroeconomic Money and the Financial System
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Money
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Is anything that is accepted in exchange for other goods and services or for the payment of debt. First, for a commodity to be used as money, its value must be easy to determine. Second, it must be divisible, so that people can make change. Third, money must be durable. Fourth, a commodity must be widely accepted in exchange if it is to act as money
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fiat money
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Used in our current financial system. It has no intrinsic value, but is recognized as legal tender. Money without intrinsic value that is used as money because of government decree
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barter system
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Goods and services are traded directly. This arrangement requires a double coincidence of wants, a system of exchange in which goods or services are traded directly for other goods or services without the use of money.
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Money must function as
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A medium of exchange This saves time in process of conducting transactions A unit of account Currency prices allow us to compare values of two different commodities A store of value This allows for the process of saving
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M1 equals Currency
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+ Travelers checks + Demand deposits + Other checkable deposits
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M2 equals M1
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+ Savings deposits + Money market deposit accounts + Small-denomination time deposits + Shares in retail money market mutual funds net of retirement accounts
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M1
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Currency represents roughly half of M1, with paper money constituting over 90% of currency; coins form only a small part of M1. Checking accounts represent the other half of the money supply, narrowly defined. Currently, M1 is equal to roughly $1.7 trillion. It is the most liquid part of the money suppl
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M2
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A broader definition of money, M2, includes the \"near moneys\"; funds that cannot be drawn on instantaneously but are nonetheless accessible. This includes deposits in savings accounts, money market deposit accounts, and money market mutual fund accounts. Many of these accounts have check writing features similar to demand deposits.
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What is the benefits to a dollar coin
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Coins last much longer than dollar bills, which tend to deteriorate within 18 months. This is why the Treasury has tried twice recently to introduce one-dollar coins. Production costs are higher, but coins circulate longer than bills, making total costs less for coins
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What is the reward for not spending today?
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Is the interest received on savings, enabling people to spend more in the future.
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The supply of funds to the loanable funds market is directly related to?
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Interest rates because of higher rates of interest, savers are rewarded more and are willing to supply more funds.
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The demand for loanable funds comes from people who want to?
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purchase goods and services, such as taking out a home mortgage, or starting a business
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Are Firms borrowers?
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Firms may want to invest in new plants, facilities, or research
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The demand for loanable funds slopes?
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Downward, reflecting the fact that when the real interest rate is high, only a few projects will have a rate of return high enough to justify the investment.
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As interest rates fall?
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More projects become profitable and the more funds are demanded
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Financial System
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Our financial system is a complex arrangement of institutions that serve to channel funds from savers to borrowers.
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Financial intermediaries facilitate the flow of ?
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funds throughout the economy by reducing transactions and information costs and by risk sharing.
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Bond
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A bond is a contract between a seller and a buyer that determines the following items: Coupon rate of the bond Maturity date of the bond Face value of the bond
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Once a bond is issued
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it is subject to the forces of the marketplace. The yield on a bond is the percentage return earned over the life of the bond. Yields change when bond prices change.
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The yield on a bond is equal to?
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its annual interest payment divided by the bond price
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What is the formula to calculate a Bond price?
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Bond price = Interest payment / yield
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What happen hen the Federal Reserve decides to reduce the money supply?
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An initial shortage of money will lead individuals and institutions to want more money in their portfolios. The supply of bonds will rise, creating a lower bond price and a higher interest rate.
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What is the primary purpose of financial markets and institutions?
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Is to act as conduits for transferring funds from lenders to borrowers.
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By accepting deposits and making loans, banks and other financial institutions are also able to create?
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money
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Financial institutions operate as part of?
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Of a fractional reserve banking system.
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How much money a bank is required to hold?
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When someone deposits money into a bank account, the bank is required to hold a part of this deposit—usually around 20%—in its vault as cash, or else in an account with the regional Federal Reserve Bank
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Banks create money by?
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Loaning out their excess reserves.
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Each new loan created adds to the money supply?
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M1
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The money multiplier measures?
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The potential or maximum amount the money supply can increase when new deposits enter the system.
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The money multiplier is defined as
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Money Multiplier = 1/Reserve Requirement.
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What is the Federal Reserve System?
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Is the central bank of the United States.
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The Federal Reserve Act of 1913
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Was a compromise between proposals for a huge central bank and for no central bank at all.
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The Federal Reserve is considered
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to be an independent central bank, in that its actions are not subject to executive branch control
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The Fed is composed of
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A central governing agency, the Board of Governors, located in Washington, D.C., and twelve regional Federal Reserve Banks in major cities around the nation.
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The Fed's Board of Governors consists of
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Seven members who are appointed by the President and confirmed by the Senate.
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What are the functions performed by th Twelve Federal Reserve Banks and their branches?
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They perform a variety of functions, including providing a nationwide payments system, distributing coins and currency, regulating and supervising member banks, and serving as the banker for the U.S. Treasury
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What are the three primary tools in the conduct of monetary policy used by The Federal Reserve?
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Reserve Requirements The Discount Rate Open Market Operations
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What is the reserve requirement?
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is the required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits
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What is the discount rate?
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Is the rate regional Federal Reserve Banks charge depository institutions for short-term loans to shore up reserves.
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The discount rate also serves as:
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The discount window also serves as a backup source of liquidity
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The Federal Open Market Committee oversees
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open market operations, the main tool of monetary policy
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Open market operations involve
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The buying and selling of government securities.
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What happens when the Fed buys bonds?
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Its demand raises the price of bonds, lowering nominal interest rates in the market. The opposite occurs when the Fed sells bonds
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Money has three primary functions in our economic system
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As a medium of exchange, as a unit of account, and as a store of value.
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An asset's liquidity is determined by
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How easily and reliably it can be converted into cash.
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Bond prices and interest rates are?
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Inversely related.
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Banks operate under a fractional reserve system that?
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Allows them to create money
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The potential money multiplier measures?
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The potential or maximum amount the money
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When supply can increase or decrease?
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When new deposits enter (exit) the system. It is defined by the formula: Money multiplier = 1/reserve requirement.
