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ECON1020
ECON1020 FINAL
| Term | Definition |
|---|---|
| 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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