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06 - Monetary Systems Flashcards

1
Q

What are the three functions of money?

USM

1.
2.
3.

A
  • unit of account; universal yardstick used to express relative prices
  • medium of exchange; can be traded for goods and services and allows circumventing the double coincidence of wants
  • store of value; allows transferring purchasing power into the future (you worked last year and can get food for that today)
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2
Q

What are the types of money?

1.
2.

What is it backed by?

A

paper money
1. convertible money (used as legal tender by government decree; backed by governments promise to be exchangeable into valuable commodity like gold at any time) and
2. fiat money (used as legal tender by government decree; NOT backed by any physical commodity)

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3
Q

What is the Bretton Woods System?

1.
2.
3.

A
  • promise to convert US dollars into physical gold any time
  • failed bc fight with france
  • USA stupid as always; printed too much money to finance vietnam war; only 22% of dollars were actually backed by gold reserves
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4
Q

How can the trust in fiat money be kept for it to work?

1.
2.

A

Government and or central bank

  1. create money that is difficult and illegal to counterfeit (fälschen)
  2. manage money supply and keep it limited
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5
Q

Money Supply | Definition

1.
2.
3.

Most of the money supply is in form of…

A
  • sum of currency in circulation + deposits (e.g checking accounts, saving accounts)
  • many different exact definitions (names are M1,M2,M3 etc….) with different liquidity requirements
  • most money supply in form of bank accounts; e.g. M2 in US was 12 trillion, but actual cash in circulation was 1 trillion
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6
Q

The change in nominal GDP over time can be split into…..

A

…. change in real GDP and change in prices (inflation)

Split can be described by nominal GDP growth equation:

Growth rate nominal GDP = Growth rate real GDP + inflation rate

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7
Q

What does the Quantitiy Theory of Money state?

A
  • in the long run it holds that

Growth rate of Money supply = growth rate of nominal GDP

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8
Q

What casues inflation?
What’s the equation?

A
  • inflation is generated when money supply grows at a faster rate than GDP
  • inflation rate = money supply growth rate - real GDP growth rate
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9
Q

Inflation and Consequences

For real prices one should not….

A

…. change inflation needs all prices in an economy (including wages) to increase by the same rate simultaneously

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10
Q

Prices adjusting differently: Winners and Losers

  1. Lower real wages/ pensions (if amounts are nominally fixed or slowly to adjust)…
  2. Lower real interest rate payment for loans (if nominal rate is fixed)….
A
  1. harm receivers and benefit payers
  2. harms creditors and benefits borrowers
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11
Q

In the short run, inflation can on the other hand also…

A

… stimulate economic activity.

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12
Q

The real wage is the…

A

…. nominal wage divided by the price index (such as CPI)

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13
Q

If inflation causes prices to increase and nominal wage are fixed, then…

Following, firms may hire more workers and

A

… real wages drop.
…. unemployment may vanish

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14
Q

What are some negative consequences from inflation for everyone?

1.
2.
3.

A
  • menu costs
  • counterproductive policies (such as price controls implemented in response to rising prices (usually leading to supply disruptions, waiting lines, a rising undergound economy)
  • potential to lose trust in the currency completely, i.e. losing the currencys functions
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15
Q

What was the reason for the german hyperinflation?

A
  • after WW “, to pay financial needs, they printed more money
  • GDP did not grow at the same rate
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16
Q

The central bank of a country is responsible for the monetary policy, which means it….

IMLR

1.
2.
3.
4.

In US, its…
in Euro area, its….

A
  1. controls certain key interest rates
  2. indirectly controls the money supply
  3. acts as a lender of last resort, i.e. can provide short term loans to banks who are short of liquidity
  4. has responsibilities in monitoring financial insitiutions (in most cases)

Fed, the Federal Reserve Bank
European Central Bank (ECB)

17
Q

The Fed (Federal Reserve Bank) has a dual mandate, which means…

1.
2.

A
  • it shall achieve low and predictable levels of inflation
  • it shall achieve maximum (sustainable) levels of employment
18
Q

The ECB is…. and its primary objective is to….

A
  • independent from national governments and EU insitutitons
  • ensure price stability, thus it aims to maintain inflation rates below but close to 2% over the mdeium term
19
Q

What are the Tools of a Central Bank?

1.
2.
3.
4.

OFQR

A
  • open market operations: purchase and sale of non monetary assets from and to the bank sector (usually with a repurchase agreement)
  • refinancing rate (ECB)/ federal funds rate (fed): interest rate at which the central bank lends money on a short term basis to private banks (i.e. price differential in open market operations)
  • quantitative easing: special type of open market peration where the central banks also buys longer term and potentially riskier assets
  • minimum reserve requirement: regulations regarding the minimum reserves the central bank expects the private banks to hold
20
Q

How can private banks create money?

One thing that affect money creation?

A
  • you deposit 100 euro at a bank, so it now has 100 euro in reserves
  • now bank takes 50 and lends to other people
  • it now has created money
  • not everyone wants their money back at the same time, so there is no need to hold 100% of reserves

In order to affect money creation by private banks, central banks can set a minimum reserve requirement (or change it)

21
Q

What is the money market / federal funds market? What happens if there is a problem?

1.
2.
3.

A
  • someone wants their deposit back, and a bank then might be in need of liquidity or reserves
  • so, banks lend money to each other on a short term basis
  • if a net shortage of liquidity happens, the central bank steps in
22
Q

The amount that reserves that banks demand from the central bank depend on…..

A

…. the price (refinancing rate / federal funds rate)

23
Q

Banks demanding reserves from the central bank | Why does the demand curve for bank reserves shift?

1.
2.
3.
4.

A
  • economic expansion or contraction (banks need more liquidity during boom)
  • banks run (requiring more liquidity)
  • changing deposit base (more deposits meand the bank needs more reserves)
  • changing reserve requirement set by the central bank
24
Q

Banks demanding money from the Central Bank | What are the two key strategies of the Central bank here?

1.
2.

A
  • can keep reserves fixed, even when demand curve shifts, and so allow federal funds rate to fluctuate when reserves demand shifts
  • or, can supply more or less reserves to target a certain federal funds rate
  • more favourable is Strategy 2
25
Q

How does the Central Bank control inflation?
Keep in mind the formula for long run inflation rate!

1.
2.
3.
4.

A
  • it needs to control it so that in the long run, inflation rate = money supply growth rate - real GDP growth rate
  • so if it fears inflation, it needs to reduce the growth rate of money supply
  • money supply can be affected by: open market operations or federal funds rate targeting (influence short term interest rates (higher interest rate = less credit = slower money growth))
  • or it can change minimum reserve requirement to influence how much money private banks will create (higher requirement = slower money growth)
26
Q

Suppose the deposit base at private banks increases.

  1. How does this affect the federal funds market?
  2. How does this affect the federal funds market equilibrium?
A
  1. demand to right
  2. depends on the feds reaction!
27
Q

Suppose the fed sells some of the governments bonds it holds to private banks.

  1. How will this affect the federal funds market?
  2. “” Federal Funds Market Equilibrium?
A
  1. supply to left
  2. higher Federal funds rate; lower quantity of reserves
28
Q

What would be an explanation to why expansionary monetary policy sustained over long periods of time might lead to inflation?

A
  • quantity theory of money and nominal GDP growth equation combined

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