Financial Markets Flashcards
currency
coins and bills
deposit accounts
bank deposits on which you can write cheques or use a debit card
bonds
pay positive interest rate but cannot be used for transactions
agents in market
households and firms demand financial assets
central bank manages the supply of money
government issues bonds
commercial banks intermediate
money market funds
pool together the funds of many people; funds then used to buy bonds (typically government bonds); pays an interest rate close to but slightly below the interest rate on the bonds they hold (difference coming from admin costs of running funds and from their profit margins)
money
used to pay for transactions
functions:
- medium of exchange: money is a commodity used in purchasing other g&s, to make transactions more efficient, in constant to barter
- unit of account: measures economic value; emerges when payments are denominated in terms of another currency or when the currency itself changes
- reserve of value: asset that serves as a means of storing wealth depending on its stability, money can be a financial asset like bonds but money is liquid
income
what you earn from working plus interest and dividends
saving
part of after-tax income that you do not spend
financial wealth
value of all your financial assets minus all your financial liabilities (stock variable) cannot change your wealth at a given time but you can change the composition of your wealth
demand for money
sum of all the individual demands for money by the people and firms in the economy
depends on overall level of transactions in economy and interest rate
overall level of transactions is hard to measure but is roughly proportional to nominal income
negatively affected on interest rate (decreases demand for money if IR increases as people put more of their wealth into bonds)
how do central banks typically change the supply of money?
by buying or selling bonds in the bond market. if a central bank wants to increase amount of money in economy, it buys bonds and pays for them by creating money.
financial intermediaries
institutions that receive funds from people and firms and use these funds to but financial assets or to make loans to other people and firms
reasons why banks have reserves
- on any given day, some depositors withdraw cash from their banks accounts and others deposit cash into their accounts. no reason for the inflows and outflows to be equal, so bank must keep some cash on hand
- people with bank accounts can write cheques to other ppl at diff banks and people with accounts at other banks write cheques to people with accounts at the bank. as a result, what the bank owes the others banks can be larger or smaller than what the other banks owe to it
- subject to reserve requirements, required to hold reserves in some proportion of deposit accounts
- pays interest on reserves. higher IR on reserves, less unattractive it is for banks to hold reserves rather than to buy bonds or make loans thus higher the reserves they are willing to hold.
demand and supply for central bank money
demand is equal to demand for currency by people plus the demand for reserves by banks
supply is under the direct control of the central bank
monetary policy
process by which central bank controls the supply of money in economy
goals: price/output stabilisation
instruments: policy can be undertaken through setting the base rate, reserve requirements, or through open market operations that affect the money stock.
new instruments: QE and forward guidance
