Econ201 Exam 2 Chapter 10 Money anything that is generally accepted as a medium of exchange o Means of payment or medium of exchange Barter the direct exchange of goods and services for other goods and services Medium of exchange or means of payment what sellers generally accept and buyers generally use to pay for goods and services o Store of value 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 o Unit of account of quoting prices Unit of account a standard unit that provides a consistent way Commodity monies items used as money that also have intrinsic value in some other use Fiat or token money items designated as money that are intrinsically worthless o Legal tender money that a government has required to be accepted in settlement of debts o Currency debasement the decrease in the value of money that occurs when its supply is increased rapidly M1 or transactions money money that can be directly used for transactions you can buy stuff with it o M1 currency held outside banks demand deposits traveler s checks other checkable deposits o Demand deposits are checking accounts M2 broad definition of money o Near monies close substitutes for transactions money such as savings accounts and money market accounts o M2 or broad money M1 plus savings accounts money market accounts and other near monies Private banking system o 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 Commercial banks savings and loan associations life insurance companies and pension funds Run on a bank occurs when many of those who have claims on a bank deposits present them at the same time Federal Reserve Bank the Fed the central bank of the United States Reserves the deposits that a bank has at the Fed plus its cash on hand Required reserve ratio the percentage of its total deposits that a bank must keep as reserves at the Fed o Required Reserves Deposits x Required Reserve Ratio Excess reserves the difference between a bank s actual reserves and its required reserves Money multiplier o Excess reserves actual reserves required reserves o An increase in bank reserves leads to a greater than one for one increase in the money supply Economists call the relationship between the final change in deposits and the change in reserves that caused this change the money multiplier o Money multiplier the multiple by which deposits can increase for every dollar increase in reserves Money multiplier 1 required reserve ratio Federal Open Market Committee FOMC a group composed of seven members of the Fed s Board of Governors the president of the New York Federal Reserve Bank and four of the other eleven 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 NY Open Market Desk the office in the New York Fed from which the government securities are bought and sold by the Fed From a macro POV the Fed s crucial role is to control the money supply 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 o The Fed also performs several important functions for banks such as clearing interbank payments regulating the banking system and assisting banks in a difficult financial position o The Fed is also responsible for managing exchange rates and the nation s foreign exchange reserves o It is often involved in intercountry negotiations on international economic issues If Fed wants to increase money supply it creates more reserves thereby freeing banks to create additional deposits by making more loans o If it wants to decrease money supply it reduces reserves 3 tools available to the Fed for changing the money supply o Changing the required reserve ratio Decrease in required reserve ratio means increase in money supply o Changing the discount rate Interest rate the banks pay to the Fed to borrow from it Increase the discount rate means decrease in money supply Moral suasion the pressure that in the past the Fed exerted on member banks to discourage them from borrowing heavily from the Fed o Engaging in 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 Two branches of government deal in government securities o The Treasury Department is responsible for collecting taxes and paying the federal government s bills o The Fed is not the Treasury It is a quasi independent agency authorized by Congress to buy and sell outstanding preexisting US government securities on the open market 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 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 Open market operations are the Fed s preferred means of controlling the Through open market operations the Fed can have the money supply be money supply because o They can be used with some precision o Are extremely flexible and o Are fairly predictable whatever value it wants Review Terms o Barter o Commodity monies o Currency debasement o Discount rate o Excess reserves o Federal Open Market Committee o Federal Reserve Bank o Fiat or token money o Financial intermediaries o Legal tender o Lender of last resort o Liquidity property of money o M1 or transactions money o M2 or broad money o Medium of exchange or means of payment o Money multiplier o Moral suasion o Near monies o Open Market Desk o Open market operations o Required reserve ratio o Reserves o Run on a bank o Store of value o Unit of account Chapter 11 Interest rate funds Demand for money o Interest the fee that borrowers pay to lenders for the use of their o Interest rate the annual interest payment on a loan expressed as a percentage of the loan Equal to the amount of interest received paid per year divided by the amount of the loan o Interest rate interest
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