8. The Monetary System and Inflation

Question 1

Money

Answer 1

the set of assets in an economy that people regularly use to buy goods and services from other people.

Question 2

functions of money

Answer 2

medium of exchange; anything accepted as a payment

Question 3

medium of exchange benefits

Answer 3

escape complications of barter;

benefits of specialisation (people can specialise)

Question 4

requirements of medium of exchange

Answer 4

acceptable to all, limited supply, readily portable, divisible, durable, stable in value

Question 5

unit of account

Answer 5

yardstick to measure the relative value of goods and services.

Question 6

store of value

Answer 6

transfer purchasing power from present to the future

Question 7

deferred payment

Answer 7

buy now pay later - can acquire things you cannot afford immediately (pay weekly)

Question 8

commodity money

Answer 8

commodity with intrinsic value (gold, food, clothing, EVEN TOILET PAPER etc.)

Question 9

fiat/token money

Answer 9

no intrinsic value, only accepted because reserve bank/government promises money

Question 10

Reserve bank/central bank functions

Answer 10

regulate/supervise activity of banks, make sure they act responsibly

regulate quantity of money

implements monetary policy objectives by the Policy Target Agreement (keep inflation within 1-3%)

issue notes and coins

Question 11

OCR (Official cash rate)

Answer 11

interest rate set by the Governor of the RBNZ every six weeks

Question 12

Settlement cash balance

Answer 12

balance that is the deposit that (commercial) banks keep with the RBNZ as cash reserves (to settle their end of day net transaction)

Question 13

Fractional-reserve banking

Answer 13

holds a fraction of deposits as reserves and lend out the rest

Question 14

Settlement accounts

Answer 14

accounts held by registered/commercial banks and other financial systems to settle the debt between them (ie cheques transactions between ANZ and BNZ, sent to Reserve bank to exchange settlement)

Question 15

who can go into overdraft?

Answer 15

private people, not BANKS

Question 16

liquidity ratio

Answer 16

ratio of settlement cash to bank’s assets that can be used as collateral

Question 17

reserve ratio

Answer 17

fraction of deposits held as reserves

Question 18

primary expansion of money supply

Answer 18

deposit of money

Question 19

secondary expansion of money supply

Answer 19

credit creation (loans)

Question 20

Policy Target Agreement

Answer 20

inflation must be less than 1-3%

Question 21

money multiplier

Answer 21

how much money the banking system generates with each dollar of reserves, MM = 1/RR

Question 22

Tools of the central bank

Answer 22

changing the OCR; changing reserve requirement (none in NZ), open-market operations

Question 23

open-market operations

Answer 23

RBNZ buy government bonds from public, increasing the supply of money

RBNZ sells government bonds to public, the money supply decreases

Question 24

how does selling government bonds to the public reduce the money supply

Answer 24

check is written to the reserve bank from your bank, decreasing the reserves of your bank so that it can’t loan as much

Question 25

how does increasing the OCR affect supply of money

Answer 25

increasing OCR reduces money supply (if banks overlend then they have to pay a lot to the reserve bank for borrowing)

Question 26

target reserve ratio or interest?

Answer 26

target interest, reserve ratio isn’t necessary (banks have to keep reserves for interbank transactions)

Question 27

if the OCR is 2.75%, what will the interest rate be on loans from the NZRB and deposits with the NZRB?

Answer 27

3% interest rate to borrow, 2.5% interest on deposits (+-0.25%) NO LIMIT ON BORROWING

Question 28

Given the OCR basis point addition subtraction, how would banks like to loan their money?

Answer 28

loaning to other banks, as any interest rate between +-0.25 of the OCR will benefit both banks.