Chapter 13 Money and the Banking System medium of exchange as asset that is used to buy and sell goods or services money is a medium of exchange store of value item people can use to transfer purchasing power from the present to the future money is a store of value inflation causes money to cease being a store of value liquid asset can be easily converted into money without loss of value unit of account the unit of measurement people use to post prices and keep track of revenues and costs money is a unit of account fiat money money that has neither intrinsic value nor the backing of a commodity with intrinsic value has value because we trust that it is valuable and because it is scarce U S currency is fiat money M1 money supply the sum of currency checkable deposits travelers checks o demand deposits noninterest earning checking deposits that depositors can access by writing a check or using debit card M2 money supply includes M1 plus savings deposits time deposits less than 100 000 and money market mutual fund shares o money market and mutual funds interest earning accounts that pol depositors funds and invest them in highly liquid short term securities credit cards aren t money credit is funds acquired by borrowing credit is a liability money is an asset banks match borrowers with savers profitable projects promote economic growth banking system includes savings and loan associations credit unions and commercial banks central bank institution designed to oversee the banking system and regulate the amount of money in the economy the U S central bank is the Federal Reserve System The Fed banking system bank reserves vault cash plus deposits of banks with Federal Reserve banks fractional reserve banking allows banks to hold reserve of less than 100 against deposits increases the money supply required reserves the minimum amount that a bank is required to keep on hand to back up deposits Federal Deposit Insurance Corporation FDIC guarantees deposits up to 250 000 how banks create money required reserve ratio the ration of reserves that banks are required to maintain in their vaults excess reserves actual reserves that exceed the legal requirement deposit expansion multiplier maximum potential increase in the money supply as new reserves are injected the actual multiplier will be smaller than the potential because some people hold currency and banks hold excess reserves potential deposit expansion multiplier 1 required reserve ratio monetary policy control of the money supply by the Fed expansionary money policy increasing the money supply restrictive monetary supply decreasing the money supply tools of monetary policy 1 change reserve requirements 2 open market operations buying a selling of U S bonds and other financial assets 3 extend loans to banks and other institutions and 4 change interest rate on funds held as reserves buying bonds increases the money supply selling bonds decreases the money supply reserve requirements lowering the reserve requirement increases the money supply increasing the reserve requirement decreases the money supply extend loans discount rate the interest rate the Fed charges banks for loans usually short term days or weeks o o o o o o o o o o federal funds rate the interest rate that banks charge banks for loans usually short term days or weeks o lowering these interest rates increases the money supply raising these interest rates decreases the money supply monetary base currency bank reserves
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