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Assets that people are generally willing to accept in exchange for goods and services or for payment of debts

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Money

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Anything of value owned by a person or a firm

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Asset

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A good used as money that also has value independent of its use as money

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Commodity money

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The central bank of United States

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Federal Reserve

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Money, such as paper currency, that is authorized by a central bank or governmental body and that does not have to be exchanged by the central bank for gold or some other commodity money

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Fiat money

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The narrowest definition of the money supply: The sum of currency in circulation, checking account deposits in banks, and holdings of traveler's checks

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M1

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A broader definition of the money supply: It includes M1 plus savings account balances, small denomination time deposits, balances in money market deposit accounts in banks, and noninstitutional money market fund shares

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M2

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Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve

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Reserves

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Reserves that a bank is legally required to hold, based on its checking account deposits

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Required reserves

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The minimum fraction of deposits banks are required by law to keep as reserves

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Required reserve ratio

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Reserves that banks hold over and above the legal requirement

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Excess reserves

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The ratio of the amount of deposits created by banks to the amount of new reserves

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Simple deposit multiplier

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A banking system in which banks keep less than 100 percent of deposits as reserves

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Fractional reserves banking system

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•Medium of exchange • Unit of account • Store of value • Standard of deferred payment

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Functions of Money

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each good has many prices

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Unit of Account

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Money serves as a_________ when sellers are willing to accept it in exchange for goods or services

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Medium of Exchange

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Money allows value to be stored easily: If you do not use all your dollars to buy goods and services today, you can hold the rest to use in the future.

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Store of Value

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Money is useful because it can serve as a _________in borrowing and lending

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Standard of Deferred Payment

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The value of money as a medium of exchange is determined primarily by

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The willingness of people to accept it.

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1.The good must be acceptableto (that is, usable by) most people. 2.It should be of standardized qualityso that any two units are identical. 3.It should be durableso that value is not lost by spoilage. 4.It should be valuablerelative to its weight so that amounts large enough to be useful in trade can be easily transported. 5.The medium of exchange should be divisiblebecause different goods are valued differently.

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What Can Serve as Money?

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If prisoners of war use cigarettes as money, then cigarettes are:

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commodity money.

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Money that is authorized by a central bank and that does not have to be exchanged for gold or some other commodity money

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What is fiat money?

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1.Currency, which is all the paper money and coins thatare in circulation, where "in circulation" means not heldby banks or the government 2.The value of all checking account deposits at banks 3.The value of traveler's checks

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M1 includes:

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The sum of currency in circulation, checking account balances in banks, and holdings of traveler's checks equals:

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M1.

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Saving account balances, small-denomination time deposits, and noninstitutional money market fund shares are a component of:

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M2.

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Many people buy goods and services with credit cards, yet credit cards are not included in definitions of the money supply.

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What about Credit Cards and Debit Cards?

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In the definition of the money supply, where do credit cards belong

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None of the above.

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refers to the minimum fraction of deposits banks are required by law to keep as reserves

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The required reserve ratio.

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The largest liability for most banks is

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deposits.

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A situation in which many depositors simultaneously decide to withdraw money from a bank.

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Bank run

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A situation in which many banks experience runs at the same time.

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Bank panic

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Loans the Federal Reserve makes to banks.

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Discount loans

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The interest rate the Federal Reserve charges on discount loans.

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Discount rate

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The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic objectives.

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Monetary policy

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1. Open market operations 2. Discount policy 3. Reserve requirements

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To manage the money supply, the Fed uses three monetary policy tools:

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The Federal Reserve committee responsible for open market operations and managing the money supply in the United States.

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Federal Open Market Committee (FOMC)

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The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply.

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Open market operations

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By lowering the discount rate, the Fed can encourage banks to take additional loans and thereby increase their reserves. With more reserves, banks will make more loans to households and firms, which will increase checking account deposits and the money supply.

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Discount Policy

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When the Fed reduces the required reserve ratio, it converts required reserves into excess reserves.

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Reserve Requirements

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A financial asset—such as a stock or a bond—that can be bought and sold in a financial market

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Security

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The process of transforming loans or other financial assets into securities.

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Securitization

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As banks and other financial firms sold assets and cut back on lending to shore up their financial positions, the flow of funds from savers to borrowers was disrupted. The resulting credit crunch significantly worsened the recession that had begun in December 2007.

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The Financial Crisis of 2007-2009

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In the early twentieth century, Irving Fisher, an economist at Yale, formalized the connection between money and prices using the quantity equation: M ×V = P ×Y

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The Quantity Equation

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The average number of times each dollar in the money supply is used to purchase goods and services included in GDP. V =P*Y/M

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Velocity of money

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A theory about the connection between money and prices that assumes that the velocity of money is constant.

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Quantity theory of money

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1.Price stability 2.High employment 3.Stability of financial markets and institutions 4.Economic growth

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The Goals of Monetary Policy

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The interest rate banks charge each other for overnight loans.Determined by the demand and supply of reserves in the federal funds market

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Federal funds rate (FFR)

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•Consumption (especially on durables) •Investment •Net exports

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How Interest Rates Affect Aggregate Demand

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The Federal Reserve's increasing the money supply and decreasing interest rates to increase real GDP.

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Expansionary monetary policy

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The Federal Reserve's adjusting the money supply to increase interest rates to reduce inflation

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Contractionary monetary policy

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A rule developed by John Taylor that links the Fed's target for the federal funds rate to economic variables.

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Taylor rule

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Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives

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Fiscal policy

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Government spending and taxes that automatically increase or decrease along with the business cycle

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Automatic stabilizers

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1.purchases (about 33%) 2.Others (67%) •intereston the national debt •grants to state and local governments •transfer payments (TP). Which rose from about 25 percent of federal government expenditures in the 1960s to nearly 45 percent in 2008.

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Federal government Expenditure/Spending made up of

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A decline in private expenditures as a result of an increase in government purchases

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Crowding out

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The situation in which the government's expenditures are greater than its tax revenue

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Budget deficit

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The situation in which the government's expenditures are less than its tax revenue

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Budget surplus

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The deficit or surplus in the federal government's budget if the economy were at potential GDP.

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Cyclically adjusted budget deficit or surplus

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The difference between the pretax and posttax return to an economic activity

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Tax wedge

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Effects on aggregate supply of cutting each of the following taxes: •Individual income tax •Corporate income tax •Taxes on dividends and capital gains

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The Long-Run Effects of Tax Policy

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