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ECON1020

ECON1020 FINAL

TermDefinition
Currency Notes and coins held by the non-bank private sector (i.e. excluding banks, the RBA, the state and federal governments).
M1 Currency and the value of all demand deposits with banks operating in Australia.
Demand Deposits Deposits in financial institutions (FIs) that are transferrable by cheque, by debit card and via electronic transfers between accounts.
M3 M1 + all other deposits (e.g. term deposits) with banks operating in Australia.
Broad Money M3 + deposits into non- bank deposit-taking institutions less holdings of currency and deposits of non- bank depository corporations, such as finance companies, money market corporations and cash management trusts.
Bank's Balance Sheet The five most relevant items on a bank’s balance sheet are: equity, deposits, loans, reserves and securities. You won't find inventory, accounts receivable, or accounts payable.
Reserves The cash that a bank keeps in its vault or its deposits with the central bank (CB).
Reserve Ratio Reserve Ratio: A bank’s reserves to deposits ratio.
Liquidity o Liquidity refers to how easy it is for an asset to be sold for or converted into cash without a price cut. o Cash is, by definition, the most liquid asset. o Saving deposits are highly liquid as people can withdraw them as cash at any time.
Reserves and Liquidity o Banks hold reserves because they are the most liquid assets amongst all bank assets. o a bank does not have enough cash to meet fund outflows, it will be forced to sell its assets quickly o maintaining sufficient reserves - liquidity management.
Bank Vulnerability o Banks are inherently vulnerable to bank run even if they are solvent. o A bank run happens when many of the bank’s depositors want their money back at the same time.
Fractional Banking System Fractional banking system: banks only keep a small fraction of deposits as liquid assets to meet daily withdraw demand.
Banks become insolvent - 3 Options o Bankrupt: e.g. Lehman Brother in 2008. o Bail-out: external investors inject new capital, o Bail-in: banks’ creditors (i.e. bond holders and depositors) convert their loans into shares.
Central Bank and Money Supply Central Banks typically do not have strict controls over money supply, but they can influence it through - open market operations - reserve requirement ratio (but no all CBs impose it on banks)
Reserve to deposit ration If a CB has the power to set a reserve- to-deposit requirement, then it can also influence the amount of bank loans and thus the money supply by changing the reserve-to-deposit ratio, which is also known as reserve requirement ratio (RRR).
Simple Deposit Multiplier o An initial injection of liquidity (i.e. reserves) by a CB into the banking sector will eventually lead to a much larger increase in deposits and thus money supply. o This is called money multiplication. SDM = 1 /Reserve Ratio
Currency Demand and Credit o people = hold less and put the excess cash into their deposit accounts, bank reserves will go up; - banks can increase lending. o people = hold more by withdrawing from their deposit accounts, bank reserves will go down; - banks reduce lending.
Credit Crunch o During economic downturn, typically banks are reluctant to make new loans, as they are concerned about the potential borrowers’ ability to make repayments during difficult economic times.
Quantity Theory of Money o The QTM connects between the quantity of money and the price level, formalised by Irving Fisher in the early twentieth century: M x V = P x Y
The Velocity of Money o V = the average number of times each dollar in the money supply is used to purchase goods and services included in GDP. o V to be constant, due to the turnover rate of money depends on how often workers are paid, how often people pay bills
Inflation and Money Supply Growth o If V is constant, then QTM implies that: o  Inflation rate = growth rate of M – growth rate of Y o If the money supply grows faster than real GDP, there will be inflation. If the money supply grows slower than real GDP, there will be deflation.
The Very Long Run o This is envisioned as taking several years to play out. o This is where growth theory takes centre stage.
The Long Run o In the long run, although capital and technology do not change, all other variables (including, importantly, prices and wages) can change.
The Short Run • In the short run, importantly, wages do not adjust fully to any changes in the economy. However, prices of goods(i.e., the price level) can adjust. • Monetary and fiscal policy can play major roles.
The Aggregate Demand and Aggregate Supply o main analytical framework for understanding macroeconomics in the long run and the short run is the AD‐AS model. o 3 key ingredients 1. aggregate demand” (AD) 2. “long run aggregate supply” (LRAS) 3. “short run aggregate supply” (SRAS)
Aggregate Demand o This shows the relationship between the price level (on the vertical axis) and the quantity of real GDP demanded by households, firms and the government
Why Does Aggregate Demand Curve Slope Downwards - The Wealth Effect - The Interest-rate effect - The International-trade effect
The Wealth Effect o As the price level increases, the real value of wealth decreases. People feel less wealthy, and cut back on consumption, which is a component of AD.
The Interest Rate Effect o As prices rise, the real value of the money supply in financial markets shrinks. This increases interest rates, which increases the cost of investment, and reduces investment, which is a component of AD.
The international-trade effect o As our prices rise, our exports become less competitive o internationally , and our imports increase, reducing NX, which is a component of AD.
Shifts of the AD curve vs. movements - The AD curve shows the relationship between the price level and the quantity of real GDP demanded, holding everything else constant. - Changes in the price level are depicted as movements up or down a stationary aggregate demand curve.
Variables that shift the AD curve - Changes in government policies - Changes in expectations of household and firms - Changes in foreign variables
The Aggregate Supply o Long‐run aggregate supply (LRAS) curve: A curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied. - in the long-run changes in the price level do not affect the level of real GDP supplied
Shifts in the long-run aggregate supply - The LRAS curve shifts because potential GDP increases over time. - Increases in potential GDP (or economic growth) are due to: - An increase in resources. - An increase in machinery and equipment (capital). - Technological improvements.
Shifts of the short-run aggregate supply curve versus movements along it - The SRAS curve shows the short‐run relationship between the price level and the qty of G&S firms are willing to supply, holding everything else constant. - Changes in the price level are depicted as movements up or down a stationary SRAS curve.
Variables that shift the SRAS Curve 1. Expected changes in the future price level. 2. Changes in factor prices, including nominal wages.
Variables that shift both the short‐run and the long‐run aggregate supply curves 1. Increases in the labour force and/or in the capital stock and/or in resources. 2. Technological change.
Changing Wages o An increase in nominal wages W will raise real wages W/P and cause the SRAS to shift to the left. o A decrease in nominal wages W will reduce real wages W/P and cause the SRAS to shift to the right.
Recession 1. The short‐run effect of a decline in aggregate demand. – AD curve shifts left, and real GDP declines. 2. Adjustment back to potential GDP in the long run. - Automatic adjustment mechanism: SRAS curve shifts right (which may take several years).
Expansion 1. The short‐run effect of increase aggregate demand. – AD curve shifts right, and real GDP and the price level rise. 2. Adjustment back to potential GDP in the long run. – Automatic adjustment mechanism: SRAS curve shifts left may take a year or more
Overall Effects of AD changes • In the short run, increases in AD increase output (and unemployment) and prices • In the long run, increases in AD increase only the price level, - decreases in AD decrease only the price level. decreases in AD decrease output= unemployment/prices.
Supply Shock o Supply shock: An unexpected event that causes the SRASto shift left. 1. The short‐run effect – SRAS curve shifts left, real GDP falls and the price level rises. 2. Adjustment back to potential GDP in the long run. – SRAS curve shifts right
Stagflation o Stagflation: A combination of inflation and recession, usually resulting from a supply shock.
Created by: leckersley
 

 



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