!Exam%#%2%Study%Guide%Lectures:%12%6%20%!Lecture!12!(October!27),!Lecture!13!(October!29),!Lecture!1 4!( N o ve mber!3)!and !L e ctu r e !15 !(Novembe r !5)!!The!Money!Supply!and!the!Federal!Reserve!System!!(Chapter!10)!• An!Overview!of!Money:!!o What!is!Money!o Commodity!and!Fiat!Monies!!o Measuring!the!Supply!of!Money!in!the!United!States!o The!Private!Banking!System!• How!Banks!Create!Money:!o A!Historical!Perspective:!Goldsmiths!o The!Modern!Banking!System!o The!Creation!of!Money!o The!Money!Multiplier!• The!Federal!Reserve!System:!o Functions!of!the!Federal!Reserve!o Expanded!Fed!Activities!Beginning!in!2008!o The!Federal!Reserve!Balance!Sheet!• How!the!Federal!Reserve!Controls!the!Money!Supply!o The!Required!Reserve!Ratio!o The!Discount!Rate!o Open!Market!Operations!o Excess!Reserves!and!the!Supply!Curve!for!Money!!Definitions:!- Money:!A!means!of!payment,!a!store!of!value,!and!a!unit!of!account.!- Barter:!The!direct!exchange!of!goods!and!services!for!other!goods!and!services.!o A!barter!system!requires!a!double'coincidence'of'wants'for!trade!to!take!place.!That!is,!to!effect!a!trade,!you!have!to!find!someone!who!has!what!you!want!and!that!person!must!also!want!what!you!have.!- Medium!of!Exchange:!What!sellers!generally!accept!and!buyers!generally!use!to!pay!for!goods!and!services.!!!- Store!of!Value:!An!asset!that!can!be!used!to!transport!purchasing!power!from!one!time!period!to!another.!!- Liquidity!Property!of!Money:!The!property!of!money!that!makes!it!a!good!medium!of!exchange!as!well!as!a!store!of!value:!It!is!portable!and!readily!accepted!and!thus!easily!exchanged!for!goods.!- Unit!of!Account:!A!standard!unit!that!provides!a!consistent!way!of!quoting!prices.!!- Commodity!Monies:!Items!used!as!money!that!also!have!intrinsic!value!in!some!other!use.!!!!!!!!!!!ECON!104!!!11th!Edition!! !- Fiat!or!Token!Money:!Items!designated!as!money!that!are!intrinsically!worthless.!- Legal!Tender:!Money!that!a!government!has!required!to!be!accepted!in!settlement!of!debts.!!- Currency!Debasement:!The!decrease!in!the!value!of!money!that!occurs!when!its!supply!is!increased!rapidly.!- M1!(Transactions!of!Money):!Money!that!can!be!directly!used!for!transactions.!o M1!≡!currency!held!outside!banks!+!demand!deposits!+!traveler’s!checks!+!other!checkable!deposits!- Near!Monies:!Close!substitutes!for!transactions!money,!such!as!savings!accounts!and!money!market!accounts.!!- M2!(Broad!Money):!M1!plus!savings!accounts,!money!market!accounts,!and!other!near!monies.!!o M2!≡!M1!+!savings!accounts!+!money!market!accounts!+!other!near!monies!- Financial!Intermediaries:!Banks!and!other!institutions!that!act!as!a!link!between!those!who!have!money!to!lend!and!those!who!want!to!borrow!money.!- Federal!Reserve!Bank!(The!Fed):!The!central!bank!of!the!United!States.!- Reserves:!The!deposits!that!a!bank!has!at!the!Federal!Reserve!bank!plus!its!cash!on!hand.!!- Required!Reserve!Ratio:!The!percentage!of!its!total!deposits!that!a!bank!must!keep!as!reserves!at!the!Federal!Reserve.!- Excess!Reserves:!The!difference!between!a!bank’s!actual!reserves!and!its!required!reserves.!o Excess!reserves!≡!actual!reserves!−!required!reserves!- Money!Multiplier:!The!multiple!by!which!deposits!can!increase!for!every!dollar!increase!in!reserves;!equal!to!1!divided!by!the!required!reserve!ratio.!!!o !- Federal!Open!Market!Committee!(FOMC):!A!group!composed!of!the!seven!members!of!the!Fed’s!Board!of!Governors,!the!president!of!the!New!York!Federal!Reserve!Bank,!and!four!of!the!other!11!district!bank!presidents!on!a!rotating!basis;!it!sets!goals!concerning!the!money!supply!and!interest!rates!and!directs!the!operation!of!the!Open!Market!Desk!in!New!York.!o The!United!States!is!divided!into!12!Federal!Reserve!districts,!each!with!its!own!Federal!Reserve!bank.!The!district!banks!are!like!branch!offices!of!the!Fed!in!that!they!carry!out!the!rules,!regulations,!and!functions!of!the!central!system!in!their!districts!and!report!to!the!Board!of!Governors!on!local!economic!conditions.!- Open!Market!Desk:!The!office!in!the!New!York!Federal!Reserve!Bank!from!which!government!securities!are!bought!and!sold!by!the!Fed.!!- Lender!of!Last!Resort:!One!of!the!functions!of!the!Fed:!It!provides!funds!to!troubled!banks!that!cannot!find!any!other!sources!of!funds.!!ratio reserve required1 multiplier money ≡! !- Open!Market!Operations:!The!purchase!and!sale!by!the!Fed!of!government!securities!in!the!open!market;!a!tool!used!to!expand!or!contract!the!amount!of!reserves!in!the!system!and!thus!the!money!supply.!o When!the!Fed!purchases!a!security,!it!pays!for!it!by!writing!a!check!that,!when!cleared,!expands'the!quantity!of!reserves!in!the!system,!increasing!the!money!supply.!When!the!Fed!sells!a!bond,!private!citizens!or!institutions!pay!for!it!with!their!bank!deposits,!which!reduce'the!quantity!of!reserves!in!the!system.!o The!Treasury!Department!is!responsible!for!collecting!taxes!and!paying!the!federal!government’s!bills.!!To!finance!the!deficit,!(G'\!T)!is!the!amount!the!Treasury!must!borrow!each!year.!This!means!that!the!Treasury!cannot'print!money!to!finance!the!deficit.!o The!Fed!is!not!the!Treasury.!It!is!a!quasi\independent!agency!authorized!by!Congress!to!buy!and!sell!outstanding!(preexisting)!U.S.!government!securities!on!the!open!market.!- We!can!sum!up!the!effect!of!these!Open!Market!Operations!this!way:!o An!open!market!purchase!of!securities!by!the!Fed!results!in!an!increase!in!reserves!and!an!increase!in!the!supply!of!money!by!an!amount!equal!to!the!money!multiplier!times!the!change!in!reserves.!o An!open!market!sale!of!securities!by!the!Fed!results!in!a!decrease!in!reserves!and!a!decrease!in!the!supply!of!money!by!an!amount!equal!to!the!money!multiplier!times!the!change!in!reserves.!!!Diagrams:!The!Supply!of!Money!!!Summary!(From!the!Lectures):!!Lets!Think!About!the!Debt!!a. Debt!Servicing:!The!interest!required!to!be!paid!each!year!on!outstanding!debt.!!b. Opportunity!Cost:!The!cost!of!an!alternative!that!must!be!forgone!in!order!to!!pursue!a!certain!action.!Put!another!way,!the!benefits!you!could!have!received!by!!taking!an!alternative!action.!!Bonds!and!Interest!Rates!!c. Bond:!A!debt!investment!in!which!an!investor!loans!money!to!an!entity!(corporate!or!governmental)!that!borrows!the!funds!for!a!defined!period!of!time!at!a!fixed!interest!! !rate.!!d.
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