Money and Monetary Policy Flashcards
(38 cards)
what is money?
Money is the set of assets in an economy that people regularly use to buy goods
and services from other people.
What is the relationship between money and trades
Trade doesn’t require the existence of money.
Barter trades can occur.
But money removes the problem of ‘double coincidence of wants’.
Money makes trade easier, and helps gains from specialization to occur and
improve social welfare.
what are the functions of money
- Medium of exchange
- Unit of account
- Store of value
- Standard of deferred payment
what are the types of money
▸ Commodity Money
▸ Fiat Money
how do we measure money?
▸ Currency: Notes and coins held by the private non-bank sector.
▸ M1: The narrowest definition of the money supply which is comprised of
currency plus the value of all demand deposits with banks.
▸ M3: M1, plus all other deposits of the private non-bank sector with
domestic and foreign-owned banks operating in Australia.
▸ Broad money: M3, plus deposits into non-bank deposit-taking
institutions minus holdings of currency and deposits of non-bank
depository corporations.
what is RBA
▸ The RBA is the central bank of Australia.
▸ The RBA has two major roles:
▹ To maintain the financial integrity and stability of the Australian
financial system
▹ To implement monetary policy
▸ Monetary policy: The actions taken by the RBA to manage interest rates
in the pursuit of macroeconomic objectives.
how do we create money?
▸ Money can be created by the central bank
▸ In Australia this is the Reserve Bank of Australia (RBA)
▸ But also, money is ‘created’ by a fractional reserve banking
system
what are reserves?
Money that banks keep as cash (or in their account at the RBA)
to cover their deposits
what is a fractional reserve
Banks keep only a fraction of deposits as reserves
▸ The reserve ratio might be for example 0.1 (10%)
▸ This would mean that if you deposit $100 cash at the bank, they would
keep $10 aside as reserves, and can loan out the other $90
▸ This works because not all customers will withdraw at the same time
▸ The cash not kept as reserves is used to make profitable loans
what is the simple deposit multiplier
The ratio of the amount of deposits created by
banks to the amount of new reserves
what is the actual deposit multiplier
▸ The real-world deposit multiplier is smaller than the simple deposit
multiplier due to factors such as:
▹ Banks may hold excess reserves.
▹ People do not deposit all their money
what is monetary policy
Monetary policy: The actions taken by the Reserve Bank of Australia to
manage interest rates in the pursuit of macroeconomic objectives
what are the objectives of a monetary policy
- price stability in Australia; and
- the maintenance of full employment in Australia
what are exchange settlement accounts
▸ Exchange settlement accounts (ESAs): Accounts held with the RBA by
banks and other financial institutions to enable the overnight transfer of
funds (cash) between financial institutions, and between the RBA and
financial institutions.
▸ ESA’s enable real-time gross settlement (RTGS) through the RBA
information and transfer system (RITS).
▸ Balances held in ESAs are called exchange settlement funds.
what is the cash rate
the interest rate that banks charge each other for overnight loans
What is money and why is it important in an economy?
Money is the set of assets regularly used to buy goods and services. It replaces barter, solving the issue of the double coincidence of wants, making trade easier and enabling the benefits of specialisation, which improves social welfare.
What are the four main functions of money?
Medium of exchange – used to buy goods and services.
Unit of account – a common standard for measuring prices.
Store of value – retains value over time.
Standard of deferred payment – used to settle debts.
What are the main types of money?
Commodity money: Has intrinsic value (e.g., gold).
Fiat money: Value by government decree (e.g., Australian dollars).
Modern money is fiat money backed by trust in the issuer.
What are the definitions of currency, M1, M3, and Broad Money?
Currency: Notes and coins held by the public.
M1: Currency + demand deposits.
M3: M1 + all other private sector deposits in Australian banks.
Broad money: M3 + non-bank institution deposits – holdings of currency/deposits by those institutions.
What are the two main roles of the RBA?
Maintain financial system stability and integrity.
Implement monetary policy (managing interest rates to achieve macroeconomic goals).
How does a fractional reserve banking system create money?
Banks only hold a fraction of deposits as reserves and lend out the rest. This creates new deposits and expands the money supply through the process of lending.
What is the simple deposit multiplier and how is it calculated?
Simple deposit multiplier = 1 / Reserve Ratio
If RR = 10%, multiplier = 1 / 0.10 = 10
This means $1 of new reserves can support $10 of deposits (in theory).
Why is the actual deposit multiplier smaller than the simple multiplier?
Banks may hold excess reserves.
People may hold cash instead of depositing it.
What is the cash rate and how is it determined?
The cash rate is the interest rate on overnight loans between banks. It is determined in the overnight money market by supply and demand for funds.
