Chapter 4: The Monetary System: What it is and How it Works
100% reserve banking
system where banks hold all deposits as reserves
Bank capital
the resources a bank's owners have put into the bank (financial capital, not physical)
Open market purchases
to increase MB, Fed buys gov bonds, paying the counterparty reserves
non-borrowed reserves
reserves created bc of open market operations by the Fed
Borrowed reserves
reserves created due to fed lending to banks
Reserve deposit ratio formula
rr= R/D
Leverage ratio formula
assets/capital
money multiplier formula
(cr+1)/(cr+rr)
The Fed sees that commercial banks hold adequate reserves by...
paying the banks interest on their reserves
Functions of money
-Medium of exchange -Unit of account -Store of value
How can the Fed change the money multiplier?
-changing reserve requirements -changing the interest rate paid on reserves
Bank capital requirements
-min amount of capital mandated by regulators -intended to ensure banks will be able to pay off depositors and other creditors -higher or banks that hold more risky assets
When does the money multiplier decrease?
-when households decide to hold more of their money as currency and less in the form of demand deposits -when banks decide to hold more excess reserves
How can the Fed change the monetary base?
1. Open market operations 2. discount rate
Total money supply formula
1/rr * amount of money added to econ rr=ratio of reserves to deposits
What do you add up when you are trying to get total change in money supply when you have banks' balance sheet?
Deposits
What does the currency deposit ratio depend on?
Household's preferences
What makes up M2?
M1, retail money market mutual funds, saving deposits, small time deposits
What does the fed do to control the money supply?
Open market operations
Since 2012 the Fed has done what related to bank reserves deposited at the Fed?
Paid interest on them, which discourages the monetary base from turning into money (causing rapid inflation) during expansion
Money
Stock of assets that can be readily used to make transactions
What does the reserve deposit ratio depend on?
regulations and banks preferences
Fractional reserve banking
a system in which banks hold a fraction of their deposits as reserves
If m decreases, M....
also decreases
reserve requirement ratio
banks are required to hold a fraction of deposits as reserves
Currency-deposit ratio formula
cr= C/D
Money supply
currency + demand deposits
What makes up M1?
currency, demand deposits, traveler's checks, and other checkable deposits
Since the 2008 financial crisis, the retorn on equity has ____________ for banks
declined
Banks fund themselves primarily through...
deposits
What enables money creation in addition to that directly created by the central bank?
fractional-reserve banking
money multiplier
increase in the money supply resulting from a one dollar increase in the monetary base
Discount rate
interest rate the fed charges on loans to banks
Commodity money has....
intrinsic value
Fiat money has no...
intrinsic value
What happened to the money multiplier after all the QU due to the financial crisis?
it fell bc even though there was a big increase in the monetary base, banks increased excess reserves a lot too
WHy is money a unit of account?
its a common unit by which everyone measures prices and values
What could the fed do to the discount rate to increase the MB?
lower the discount rate to encourage banks to borrow more reserves from the Fed
A drop in what contributed to the severity of the Great Depression?
money supply
Why is money a store of value?
transfers purchasing power from the present to the future
T/F The system of fractional-reserve banking creates money but not wealth
true
Leverage
use of borrowed money to supplement existing funds for purposes of investment
Reserves
vault cash of banks plus banks deposits at the fed
Being highly leverage makes banks...
vulnerable
Payment system
web of arrangements that facilitate the exchange of goods and services
