Monetary System

Question 1

Define Money

Answer 1

Set of Assets in an Economy, used Regularly to buy G+S

- It is a Liquid Asset

Question 2

What are the 3 main Functions of Money?

Answer 2

1. Medium of Exchange
2. Unit of Account
3. Store of Value

Question 3

Define Medium of Exchange

Answer 3

Item Buyers give to Sellers in exchange for G+S

Question 4

Define Unit of Account

Answer 4

Measure of Economic Value

• Represents Value of G+S
• Records Debts

Question 5

Define Store of Value

Answer 5

Can retain its Purchasing Power

Question 6

Define Liquidity

Answer 6

Ease an Asset can be Converted into the Economy’s Medium of Exchange

Question 7

What is the most Liquid Asset?

Answer 7

Money = Medium of Exchange

Question 8

What is the general relationship between Liquidity + Return

Answer 8

Higher Liquidity –> Lower Return

Question 9

What are the 2 main Kinds of Money?

Answer 9

Commodity Money + Fiat Money

Question 10

What is Commodity Money?

Answer 10

Money in the form of a Commodity with Intrinsic Value

• e.g. Gold, Paper Money convertible to Gold on Demand
• • Cigarettes + Phone cards in Prison

Question 11

What is Fiat Money?

Answer 11

Money with NO Intrinsic Value

• Requires people’s Trust- Loses Value without it
• If Trusted– No Gov. necessary- e.g. Bitcoin

Question 12

What is Money Stock?

Answer 12

Quantity of Money circulating the Economy

- Includes: Paper Bills + Coins in hands of Public + Demand Deposits

Question 13

Define Demand Deposits?

Answer 13

Balances in Bank accounts Depositors can access on Demand

Question 14

What are the 2 main measures of Money Stock?

Answer 14

M1 + M2

Question 15

What is M1?

Answer 15

• Currency in Circulation
• Demand Deposits
• Other checkable deposits

Question 16

What is M2?

Answer 16

• M1
• Savings Deposits (Short term)
• Money Market Mutual Funds
• Other categories

Question 17

What do Central Banks regulate?

Answer 17

Fiat Currencies

- e.g. BoE, Fed. Res., ECB

Question 18

Define Central Bank

Answer 18

Legal Entity with Authority to:

• Oversee Banking System
• Regulate Money Supply

Question 19

What happens if too much money is printed?

Answer 19

Price Levels RISE–> Inflation

Question 20

What do I.R / Money Supply affect?

Answer 20

Economic Activity + Unemployment

Question 21

Why is Monetary Policy Important?

Answer 21

There is a TRADE OFF between Economic Activity / Unemployment + Inflation

Question 22

How does a Fall in I.R affect the Economy?

Answer 22

Inflation- bad

Increased Production–> Lower Unemployment in SR

Question 23

What is QE?

Answer 23

Quantitative Easing
Unconventional Monetary Policy
Jan 2010- MPC authorised purchase of £200 bn worth of Assets
–> Decreases I.R–> Increased C + I –> Increased AD
=> BUT Increased Inflation

Question 24

How do Banks influence the Money Supply?

Answer 24

Reserves

Question 25

What are Reserves?

Answer 25

Deposits Banks have received but NOT Loaned out

Question 26

What is 100% Reserve Banking?

Answer 26

ALL Deposits held as Reserves

Question 27

What is Fractional-Reserve Banking?

Answer 27

Banks holds a Fraction of Deposits as Reserves | --> Loan out remainder + earn Return on their Assets

Question 28

What is the Reserve Ratio?

Answer 28

Fraction of Deposits Banks MUST hold as Reserves | -- In case Depositors want to Withdraw their Cash

Question 29

What is the Reserve Requirement

Answer 29

Minimum amount of Reserves Banks MUST hold in C.B

Question 30

What are Excess Reserves?

Answer 30

Reserves Banks hold above the Legal Minimum

Question 31

What is the Money Multiplier?

Answer 31

Amount of Money Banking System generates from Reserves | 1 / rr

Question 32

How does the Reserve Ratio affect the Money Multiplier?

Answer 32

Increased rr --> Lower m

Question 33

Given the Money Multiplier, how do you find the Final level of Money?

Answer 33

Initial Deposit x 1/rr = Initial Deposit x m New Money Created = Final level of Money - Initial Deposit

Question 34

What are the 3 main tools C.B uses for Monetary Control?

Answer 34

1. Open Market Operations 2. Refinancing Rate 3. Reserve Requirement

Question 35

What are Open Market Operations?

Answer 35

Purchase + Sale of Gov. Bonds by the C.B

Question 36

How does the C.B Increase M.S using OMOs?

Answer 36

C.B buys Gov. Bonds from Public--> Increased Money in hands of Public

Question 37

How does the C.B Decrease M.S using OMOs?

Answer 37

C.B sells Gov. Bonds to Public--> Decreased Money in hands of Public

Question 38

What is the Refinancing Rate?

Answer 38

I.R at which C.B lends to Commercial Banks on a Short-Term basis - C.B controls I.R in Money Market--> Affects Retail I.R

Question 39

How does the C.B Increase M.S using Ref. Rate?

Answer 39

Decrease Ref. Rate--> Increased Borrowing

Question 40

How does the C.B Decrease M.S using Ref. Rate?

Answer 40

Increase Ref. Rate--> Decreased Borrowing

Question 41

What is the Reserve Requirement?

Answer 41

Regulations on Min amount of Reserves banks MUST hold against Deposits

Question 42

How does C.B Decrease M.S using Reserve Requirement?

Answer 42

Increase Reserve Requirement--> Lower Multiplier--> Lower M.S

Question 43

How does C.B Increase M.S using Reserve Requirement?

Answer 43

Decrease Reserve Requirement--> Higher Multiplier--> Higher M.S

Question 44

What are the main problems with Monetary Policy?

Answer 44

- C.Bs control of M.S NOT Precise- Fractional Reserve Banking affects Money Multiplier - C.Bs do NOT choose how much Households deposit in Banks - Unable to control how much Banks lend than keep as Reserves