Week 19 - Money and Prices - unfinished Flashcards
Chapter 22 (24 cards)
Money
An asset that can be used in making purchases.
It is not a measure of wealth but part of wealth.
Reason for money
Makes bartering easier as people can trade for money rather than trading an amount of one item for an amount of another.
Allows people to specialise in producing different goods/services and use money to buy what they don’t make. This increases economic efficiency.
Wealth
The value of all property including money and assets such as bonds, stocks, land, houses, furniture, cars, art etc.
3 principle uses of money
Medium of exchange: money can be used as an asset in purchasing goods and services
Unit of account: money can be used as a basic measure of economic value for a variety of things. E.g., measuring stocks, wages, current accounts, financial assets, goods, services.
Store of value: money as an asset can be used as a means of holding wealth – it allows you to retain purchasing power into the future as it is a store of a value. E.g., you can keep money in a banking account for spending later.
Liquidity
The ease and speed at which an asset can be converted into a medium of exchange.
Liquidity of money
Money is the most liquid asset of all as it is the medium of exchange – it doesn’t need to be converted into anything else to make purchases.
Moneys liquidity is the reason it is often used for purchase - using other assets requires transaction costs when they are converted to money.
Reasons for holding money
- Illegal activities – drug/arms trafficking, tax evasion – cash is harder to trace than banking transactions.
- Corruption.
- Fear of political and economic instability, banking crises – if the banks or economy is unstable, it is safer to hold cash rather than keep money in banks in case they collapse.
- Fear of deflation and negative interest rates – prices will be lower in the future so keeping hold of cash will increase its value over time.
Measuring the US money supply
M1 money supply: sum of currency outstanding and balances held in chequing accounts.
M2 money supply: all assets in M1 but including some assets that can be used in making payments but at a greater cost/inconvenience than using currency or cheques.
Portfolio allocation decision
The decision about the forms to hold your wealth in.
Demand for money
The amount of wealth an individual chooses to hold in the form of money
Opportunity cost of holding wealth as money
The nominal interest rate i - the money you would earn if the wealth was not in the form of money.
Money demand curve
Shows the relationship between aggregate quantity of money demanded (M) and the nominal interest rate (i).
The demand curve slopes down as increased nominal interest rate increases opportunity cost for holding money which reduces quantity of money demanded.
An increase in GDP or the price level will increase the amount of money that people want to hold.
Bank reserves
Cash/similar assets held by commercial banks for meeting depositor withdrawals and payments.
Fractional-reserve banking
A banking system where banks reserves are less than its deposits.
Fractional banking leads to the money multiplier effect - banks can lend more money than it physically has through cycles of lending and borrowing.
Desired reserve ratio
Desired reserve ratio = bank reserves / bank deposits
Can be re-arranged to find deposits from initial reserves and desired reserve ratio: deposits = initial reserves / desired reserve ratio
Currency value
The total amount of money held outside of banks.
Money supply
currency value + total deposits
or
currency value + bank reserves/reserve deposit ratio
Securitisation
Banks can pool similar illiquid assets such as loans and sell them to another financial institution in the form of securities like bonds.
It allows illiquid assets to be sold in the form of a liquid asset.
It can reduce risk as it spreads credit risk among various investors.
The Federal Reserve
The central bank of the US.
It is responsible for conducting monetary policy and overseeing and regulating financial markets.
Monetary policy
Deciding and manging the size of the nations money supply.
Indirectly increasing money supply
Money supply and bank reserves can be increased by open market purchases of government bonds by the federal reserve from the public.
When the fed does on open market purchase of a bond from the public, the fed pays the bond holder with new money which then enters the economy and the bond which was not money, leaves the economy.
Receipts are deposited which leads to a multiple expansion of the money supply.
Indirectly decreasing money supply
Money supply and bank reserves can be decreased by open market sales of government bonds by the federal reserve to the public.
When the fed does an open market sell of a bond to the public, the bondholder pays with checking funds (which was money) which then leaves the economy. The bond which is not money then enters the economy.
Bank reserves decrease which leads to a multiple contraction of the money supply.
Money supply curve
The initial money supply set is not affected by nominal interest rate meaning the money supply curve is a vertical line.
Open market sales/purchases to/from the public causes the money supply curve to shift left/right.
Money market equilibrium
Equilibrium interest rate where Money demand = money supply.
The central bank can decrease/increase nominal interest rate by increasing/decreasing money supply.
At the equilibrium interest rate the amount of money the public wants to hold is equal to the money supply.
