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chapter 11
| Question | Answer |
|---|---|
| money functions, 3 | medium of exchange, unit of account (measure of relative value), a store of value |
| medium of exchange | money can be traded for goods and services, therefore facilitating trade. |
| unit of account | money is a universal yardstick that is used to express relative prices of goods and services. |
| store of value | money is an asset that enables people to transfer purchasing power into the future. |
| fiat money | an asset that is used as legal tender by government decree and is not backed by a physical commodity like gold. Any object in limited supply can act as fiat money |
| 2 main official measures of money | monetary aggregates, M1 and M2 |
| M1 | the most narrow definition, includes mainly currency in circulation, traveler's checks, and balances held in checking accounts. |
| M2 | includes everything in M1 plus saving deposits, small time deposits (<1$00,000) and money market deposit accounts |
| velocity | the circulation rate of money |
| quantity theory of money | assumes the circulation of money (velocity) is constant in the long run |
| real wage | inflation adjusted wage |
| wage spiral | when workers demand higher wages and firms raise price to absorb the change and the cycle repeats |
| demand curve for reserves | plots the total quantity of reserves demanded by private banks for each level of the federal funds rate |
| open market operation | an exchange between a private bank and the Federal reserve where the fed buys or sells gov. bonds to private banks |
| open market purchase | fed buy gov bonds from private banks and in return the banks give more reserves |
| open market sale | fed sells gov. bonds to private banks and in return the private banks give some of their reserves. |
| central bank (Federal reserve bank/Fed) | government institution that runs a country's monetary system. manipulates quantity of bank reserves |
| why central bank MANIPULATES BANK RESERVES | 1. influence short term interest rates, especially the federal funds rate 2. influence the money supply and inflation rate 3. influence long term real interest rates |
| central bank functions (MONETARY POLICY) | indirectly control money supply, control certain key interest rates, monitor financial institutions |
| bank reserves | combination of deposits that private banks hold at the central bank and cash in their vaults. provide liquidity to private banks |
| liquidity | funds (and assets) that are available for immediate payment |
| federal funds rate | the overnight interest rate charges in the federal funds market |
| federal funds market | the market where banks borrow and lend reserves to one another |
| real gdp | total value of production (final goods and services), using fixed prices taken from a particular base year (which may or may not be the year the output was produced) |
| nominal gdp | total value of production (goods and services) using the prices from the same year the output was produced |
| GDP | market value of the final goods and services produced within the borders of a country during a particular time period. |
| inflation | a situation of rising prices |
| deflation | a situation of falling prices (negative inflation) |
| hyperinflation | a situation of extreme inflation where prices double within three years. |
| real interest rate (r) | the annual real or inflation adjusted cost of a $1 loan. solve w/ fisher equation |
| seignoriage | government revenue from printing currency |
| inflation benefits | seignoriage, sometimes stimulating an economy (i.e. fall in real wage increases firms willingness to employ workers, increases in price of output shifts labor demand to right) |
| inflation social costs | inflation tax (decline in value of cash holdings due to inflation), raising logistical costs (frequent price changes AKA menu costs), distorting relative prices |
| inflation negatives | can lead to counter productive policies such as price controls (higher prices in underground economy) |
| deflation costs | 1. high real interest rates that cant be offset by lowering the nominal interest rate 2. real burden of debt, which is fixed in nominal terms and rises when prices fall |
| dual mandate | goals or objectives of the Fed done through monetary policy. 1. low and predictable levels of inflation. 2. maximum (sustainable) levels of employment. |
| how central bank achieves dual mandate | regulation, interbank transfers, management of macroeconomic fluctuations by manipulating the quantity of bank reserves |
| How Fed regulates banks (3) | 1. audits the financial statements of large banks 2. monitors amount of shareholder's equity of large private banks 3. requires banks to perform stress test" periodically |
| interbank transfers | central bank oversees these which are money from one bank to another. these transactions are processed by using bank reserves held at the central bank. |
| supply curve for reserves | quantity of reserves supplied by the Fed through open market operations. vertical because Fed supplies reserves not to earn profit but to pursue monetary policy |
| supply shift and FFR same time? | Fed cant control the supply of reserved and the FFR at the same time. individually they can. |
| long term expected real interest rates | what investment decisions depend on. 10yrs or more investment. fed's management of bank reserves influences this by altering inflationary expectations. |
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