week 2

Question 1

What is a liquid asset?

Answer 1

An asset that can be rapidly converted into cash while keeping its market value.

Question 2

What are the three types of money in a modern economy?

Answer 2

• Bank deposits: IOUs from commercial banks to consumers
• Central bank reserves: IOUs from the central bank to commercial banks
• Currency (fiat money): IOUs from the central bank to consumers

Question 3

What percentage of the total money in the UK economy does fiat money represent?

Answer 3

About 3%

Question 4

Who creates most of the money in the economy?

Answer 4

Commercial banks

Question 5

Define broad money.

Answer 5

currency + deposits from commercial banks

Question 6

What is base money?

Answer 6

currency + cb reserves
* Currency in Circulation
* Reserves of Commercial Banks

Question 7

what are the deposit accounts?

Answer 7

• liabilities for com bank; asset for consumerts
• current accounts + savings account = deposits
• medium of exchange since the debit card transactions alter bank deposits of seller and buyer
• store of value

Question 8

What are reserves?

Answer 8

• liabillity for central banks and assets for com banks
• electronic record of the amount owed by the central bank to each individual commercial bank
• guarantees to convert reserves into cash since the BoE can always match demand and issue enough cash => commercial banks use reserves as well as as some currency to meet withdrawal from deposit account
• medium of exchange for banks
• banks settle accpunts with each other every day resulting from transactions of their customers => BoE adjusts reserves accordingly

Question 9

What is a reserve requirement? aka Reserves Ratio

Answer 9

A regulation that requires commercial banks to maintain a level of reserves at the central bank corresponding to a specified proportion of their deposits. A bank would be allowed to hold more reserves than this fraction => excess reserves

Question 10

True or False: The Bank of England has a reserve requirement, what about the liquidity coverage ratio?

Answer 10

False, none since 2009, but has liquidity coverage ratio

Question 11

What is the purpose of liquidity coverage ratio (LCR)?

Answer 11

To require banks to hold a large enough stock of highly liquid assets to meet their payment obligations in case of severe short-term stress which is not only reserves

Question 12

What are high-quality liquid assets (HQLA)?

Answer 12

• Notes
• Coins
• Short-term deposits at a UK-authorized credit institution
• UK government bonds
• Short-term UK and some foreign money market funds

Question 13

What does the money multiplier theory describe?

Answer 13

How the stock of broad money is determined and how the central bank can control the stock of money.

Question 14

What is an example of a non-money liability for consumers?

Answer 14

Mortgages (secured loans) and unsecured loans.

Question 15

What does QE stand for?

Answer 15

Quantitative Easing

Question 16

How do commercial banks create money?

Answer 16

By creating deposits corresponding to any loan they make.

Question 17

What does the identity relationship in the quantity theory of money express?

Answer 17

Mv = PY, where M is the amount of money, v is the velocity of money, P is the price level, and Y is the volume of goods and services.

Question 18

What is M4?

Answer 18

A headline broad money measure that excludes deposits of intermediate other financial corporations.

Question 19

What does the repayment of loans do to money supply?

Answer 19

Destroys money.

Question 20

What is the significance of the central bank as the sole issuer of base money?

Answer 20

It allows the central bank to implement monetary policy.

Question 21

What is the difference between secured and unsecured loans?

Answer 21

Secured loans are backed by collateral, while unsecured loans are not.

Question 22

does the fed have reserves requirement?

Answer 22

• used to have 12, now has 0 since 2020

Question 23

what assets are accepted by the bank of england as collateral in providing liquidity?

Answer 23

level A - high-quality soverreign debt trading in very deep markets
level b - soverign debt, private sector debt, highest-quality asset-backed securities
level c - securities, portfolios of loans including mortgages

Question 24

what is the most inaccurate claim for reserve requirements since quantative easing?

Answer 24

that it enables the central bank to control the quantity of money in the economy

Question 25

what are other inaccurate claims for reserve requirements?

Answer 25

- if there is a rise in the reserve requirement will reduce commercial banks funds availability for lending - if a reserve requirement is reduced commercial bank will lend out more money why are they wrong? - these claims imply and require that a commercial bank has a fixed amount of funds that they can lend to the central bank or consumers - modern commercial banks can manipulate their holdings of reserves, currency, gov bonds => this does not determine their choice of consumer lending - since QE reserves are abundant =>suppply matches demand => commerical banks do not face restrictions in obtaining reserves to match any required ratio => they can expand their lending without effective ratio restriction -commercial banks in need of reserves could almost always obtain funds from other commercial banks in the interbank money market

Question 26

why would central banks not restric supply of reserves?

Answer 26

- they pay interest at the interest rate set by monetary polocy - the money market interest rate could deviate from bank rate => example: commercial babks in need of funds asap and unable to get reserves would be willing to pay more than the bank rate => no purpose in the monetary transmission mechanism

Question 27

what is monetary transmission mechanism?

Answer 27

- money market rates remain close to the interest rate set by policymakers

Question 28

how do commercial banks create new money?

Answer 28

- they create new money by creating deposits corresponding to any loan they make - it is much larger than central banks' money creation

Question 29

why are commercial banks not just intermediaries?

Answer 29

- historically they have started just as intermediaries, but this is certainly not true in modern commercial banks - the amount one individual saves as deposits does not affect funds available to lend - commercial banks can just create money by choosing to lend according to their own profit decisions and demand for more loans, but all are affected by central banks' monetary policy

Question 30

what is the money multiplier? and what is the problem with the multiplier?

Answer 30

the reserve ratio is not exogenous since the bank of england supplies reserves on demand - instead of restricting the quantity of R, central banks have some more time to set the interest rate on R, so R responds on D not the other way around - banks first decide how much to lend depending on profitable opportunities which depend on interest rates set by the bank of england => lending decisions determine how many bank deposits are creates => bank deposits influence how much reserves the commercial bank should hold => the cb prepares to supply reserve on demand

Question 31

how to commercial banks create money?

Answer 31

by lending money to the consumers, but when the loan gets repayd the money gets destroyed - the balance sheet of the central bank remains the same, while the balance sheet of the commerial bank and consumer changes

Question 32

what does the reserve ratio tell?

Answer 32

- it is the ratio between reserves and deposits - it is not constant - it is not under control of the CB - it is endogenous in that bank lending will vary with factors determining the non-bank private sector's willingness to borrow.

Question 33

do commercial banks have an unlimited ability to create money?

Answer 33

NO! it is limited by monetary policy, commercial banks' profit motive, actions of houeholds and firms and regulation - policy rate is the rate commercial banks get on central bank reserves - a higher policy rate will reduce consumers and firms willingness to borrow - NBPS can destroy newly created money by using it to repay loand elsewhere - prudential regulation sets limits on bank lending relative to their liquid asset (include gov bonds as they are readily convertible to cb money by selling to the cb in exchnage for reserves