Macro Unit Three

Question 1

Demand deposits

Answer 1

Aka checkable deposits
Balances in bank accounts that depositors can access by writing a check or using a debit card
Largest portion of US money supply
Most liquid money is kept in demand deposits

Question 2

Measures of money stock

Answer 2

The money supply typically refers to M1
M1 = most liquid
Checking accounts are basically equal to cash
M1 = checkable deposits, other demand deposits, travelers’ checks, cash
M2 = savings, money market accounts, other

Question 3

Essential bank vocabulary

Answer 3

Assets = items of value in your control
-money you actually have (ex. Stocks, bonds, loans)
Equity = used in economics to account for the capital of a firm
Liabilities = money/debts you owe

Question 4

Reserves

Answer 4

Money a bank cannot lend out
Reserve ratio:
-the percent of deposits a bank must keep as reserves

Question 5

Fractional-reserve banking

Answer 5

A system in which banks only hold a fraction of deposits

Depositing by consumers and lending by the bank creates new money

Question 6

Money multiplier

Answer 6

The amount of money the banking system generates with each dollar of reserves
1/reserve ratio OR 1/(reserve ratio)
The reciprocal of the reserve ratio
-ex. reserve ratio is 10% (1/10), money multiplier is 10, $80 in reserves can then create $800 in total money

Question 7

Numbers on exams

Answer 7

Reserve ratio = 5% 10% 20% 25%

Money multiplier = 20 10 5 4

Question 8

Excess reserves

Answer 8

Any extra money that the bank can lend out, but has decided to keep for the time being
-this reduces the money multiplier

Question 9

Money multiplier (MM)

Answer 9

When the deposit comes from the Fed (new money):
Injection of money x MM
When the deposit comes from a person company (money already in circulation):
Money that is being lent out x MM
OR
(Injection of money x MM) - original deposit

Question 10

Interest rates

Answer 10

The fee paid to borrow money OR
The compensation received for lending money
Usually listed as a percentage
Borrowers prefer lower interest rates
Savers/lenders prefer higher interest rates

Question 11

Bonds

Answer 11

A certificate that represents a loan from a lender to a borrower
Lender: buys the bond. Collects interest
Borrower: sells the bond. Pays out interest
Governments and companies issue bonds to raise money/cover debts

Question 12

IMPORTANT

Answer 12

Bond prices and interest rates are inversely related

Question 13

Federal reserve system (Fed)

Answer 13

Central bank of the United States
Main jobs:
-supervise and ensure the health of commercial banks
•lender of last resort
-control the money supply using the FOMC
•the quantity of money available in the economy

Question 14

Federal open market committee (FOMC)

Answer 14

Made up of:
-7 members of the board of governors
-5 of the 12 regional bank presidents
Enacts monetary policy

Question 15

Monetary policy

Answer 15

Changes in the money supply used to manage demand

Question 16

Monetary policy can be

Answer 16

Contractionary: reduces the money supply
Expansionary: increases the money supply

Question 17

Reserve requirements

Answer 17

Changing banks’ minimum reserve requirements by Fed
Changes the money multiplier
RR down, MS up
RR up, MS down

Question 18

Discount rate

Answer 18

Rate at which the Fed lens to banks. Banks use the discount rate to get short-term liquidity
The Fed raises or lowers its interest rate on loans to banks
DR down, MS up
DR up, MS down

Question 19

Open market operations

Answer 19

Buying and selling US bonds by the Fed
Set the federal funds rate
Sell bonds, MS down
Buy bonds, MS up

Question 20

Federal funds rate

Answer 20

Short term interest rate banks charge each other for overnight loans

Question 21

Three ways Fed can impact money supply

Answer 21

Reserve requirements, discount rate, open market operations

Question 22

Model: money market

Answer 22

Shows the supply of/demand for liquidity
The amount of “money” (reserves) available sets the nominal interest rate (i)
Y axis is interest rate (i)
X axis is quantity of money

Question 23

Supply of money

Answer 23

Aka supply of reserves
The supply of money for loans in the economy is usually a central bank
-it is fixed by the Fed in the US
There is a relationship between price level and money supply
Money supply is a vertical, fixed line

Question 24

The demand for money

Answer 24

The opportunity cost of holding money is the interest rate
As the interest rate rises, people are less likely to hold money
An increase in price level shifts demand for money right
Downward sloping

Question 25

The supply and demand of money: money market

Answer 25

The supply of and demand for money sets the nominal interest rate in the short-run

Question 26

Important

Answer 26

In the short run, real = nominal because there is no inflation

Question 27

Classical theory of inflation

Answer 27

There is a clear connection between the supply of money and prices
Changes in money supply do not affect real GDP
Quantity theory of money

Question 28

Quantity theory of money

Answer 28

Quantity of money available determines the price level

• increase in money supply = increase in price level
• decrease in money supply = decrease in price level

Question 29

Monetarist so (neo-classicalists)

Answer 29

Believed classical theory of inflation
-inflation is caused by printing money
Stated the FED should control the price level by changing the money supply
Assumed the velocity of money is constant

Question 30

Velocity of money

Answer 30

How quickly a dollar is used and reused

-measures how the money supply responds when monetary policy is enacted (i.e. how quickly the money multiplier works)

Question 31

Equation of exchange

Answer 31

Money supply x velocity = price level x quantity
Price level x quantity = nominal GDP
Therefore: velocity of money = (nominal GDP (PL x Q)) / (money supply (MS))

Question 32

Fischer effect (equation)

Answer 32

Interest rates adjust to inflation in the long run

Nominal interest rate = real interest rate + expected inflation rate