Module: 16.1: Money and Inflation Flashcards
What is fiscal policy?
government’s use of spending and taxation to influence the economy
What is a budget surplus? budget deficit?
surplus occurs when government revenues exceed expenditures
deficit is when government expenditures exceed tax revenues
What is monetary policy?
refers to the central bank’s actions that affect the quantity of money and credit in an economy in order to influence economic activity.
What is expansionary monetary policy vs. contractionary?
expansionary - when the central bank increases the quantity of money and credit in an economy.
contractionary - when the central bank is reducing the quantity of money and credit in an economy.
What are the three primary functions of money?
1) Medium of exchange - accepted as payment for goods and services
2) Unit of account - all goods and services are expressed in units of money
3) Store of value - because money received for work or goods now can be saved to purchase something later
What is narrow money vs. broad money?
narrow money is the amount of notes and coins in circulation in an economy plus balances in checkable bank deposits
broad money includes narrow money plus any amount available in liquid assets, which can be used to make purchases.
What is fractional reserve banking?
a bank holds a proportion of deposits in reserve, and lends the remaining out to earn interest.
What’s the formula for how much money is created by fractional reserve banking?
money created = new deposit / reserve requirement
What is the quantity theory of money? What is the quantity equation of exchange?
states that the quantity of money is some proportion of the total spending in an economy and implies the quantity equation of exchange:
money supply x velocity = price x real output (MV = PY)
velocity = average number of times per year each unit of money is used to buy goods and services.
What is money neutrality?
the belief that real variables (real GDP and velocity) are not affected by monetary variables (money supply and prices)
What are three reasons for holding money? (demand for money)
1) Transaction demand - money held to meet the need for undertaking transactions.
2) precautionary demand - money held for unforeseen future needs.
3) speculative demand - money that is available to take advantage of investment opportunities that arise in the future.
What is the relationship between short term interest rates and the quantity of money that firms and households demand to hold?
At lower interest rates, firms and households choose to hold more money and vice versa and nvice versa.
What is the supply of money?
determined by the central bank and is independent of the interest rate (perfectly inelastic curve).
How are short-term interest rates determined?
the equilibrium between money supply and money demand. If the interest rate is above the equilibrium, then there is excess supply of real money. if the interest rate is below, then there is excess demand for real money balances.
How does an increase in money supply in the short term affect short-term interest rates?
an increase in the money supply will but downward pressure on interest rates, if the central bank decreases money supply, excess demand for money balances results in sales of securities and an increase in the interest rate.
