Ch 22 Flashcards
(24 cards)
Money
is any asset that can be used in making purchases
Examples include coins and currency, checking account balances, and traveler’s checks
Shares of stock are not money
Money has three principal uses
Medium of exchange
Unit of account
Store of value
Money makes barter unnecessary
Barter is trading goods directly; double coincidence of wants
Commodity money
when money takes the form of a commodity with intrinsic value. E.g. gold, cigarettes
Fiat money
money without intrinsic value that is used as money because of government decree. E.g. paper dollars printed by the U.S. government vs. paper dollars from a game in Monopoly
Cash in a bank’s vault is not part of the money supply
Unavailable for payments, not circulated
Bank deposits available for use in transactions are part of the money supply
Depositing a $100 bill in your checking account does not change the money supply, M1 does not change only its composition changes (currency in circulation and deposits).
Bankers realize that inflows and outflows from vaults leave some guilders unused
Only 10% of deposits are needed for transactions
90% can be lent to borrowers for a fee – interest
Deposits in the banking system satisfy this relationship
bank reserves/ bank deposits = desired reserve-deposit ratio
Solving for bank deposits we get
bank deposits = bank reserves / desired reserve- deposit ratio
Gorgonzola residents hold 500,000 guilders as currency
Deposit 500,000 guilders in the banks
Reserve-deposit ratio = 10%
Bank deposits = 500,000 / 0.10 = 5,000,000 guilders
Money supply = 500,000 cash + 5,000,000 deposits = 5,500,000 guilders
The Federal Reserve
Central bank of the United States
Responsibilities of the Federal Reserve:
Conduct monetary policy
Oversee and regulate financial markets
Central to solving financial crises
The Federal Reserve System began operations in 1914
Does not attempt to maximize profit as a private bank
Promotes public goals such as economic growth, low inflation, and smoothly functioning financial markets
12 Federal Reserve Bank districts
Assess economic conditions in their region
Provide services to commercial banks in their region
At the national level leadership is provided by the Board of Governors
Seven governors are appointed by the President to 14-year terms
President selects one of the seven as chairman for a four-year term (current president Jerome Powell)
The Federal Open Market Committee (FOMC) reviews economic conditions and sets monetary policy
12 members who meet eight times a year
The Fed is the central bank of the US
Responsible for monetary policy and the oversight and regulation of financial markets
Monetary policy is deciding and managing the size of the nation’s money supply
Money supply is controlled indirectly
Open-market purchase of government bonds from the pubic by the Fed increases bank reserves and the money supply
Open-market sale of government bonds by the Fed to the public decreases reserves and money supply
When the Fed purchases a bond from the public
Fed pays bond holder with new money
The new money enters the economy
The bond, which wasn’t money, leaves the economy
Receipts are deposited and this leads to a multiple expansion of the money supply
When the Fed sells a bond to the public
Bondholder pays with checking funds
The checking funds, which were money, leave the economy
The bond, which is not money, enters the economy
Bank reserves decrease and this leads to a multiple contraction of the money supply
Fed prevents bank panics by
Supervising and regulating banks
Loaning banks funds if needed
Fed did not prevent the bank panics of 1930 – 1933
The Fed was more effective at preventing later panics
Velocity
a measure of the speed at which money changes hands in transactions for final goods and services
velocity = nominal GDP / Money stock
Nominal GDP is the price level (P) times real GDP (Y)
P*Y = Nom GDP
M is the money stock
