Econ Review - Chapter 14-16
Legal tender
Any form of currency that by law must be accepted by creditors (lenders) for the settlement of a financial debt; a nation's official currency is legal tender within its own borders.
Cyclical asymmetry
the idea that monetary policy may be more successful in slowing expansions and controlling inflation than in extracting the economy from severe recession
Discount rate
the interest rate that the Federal Reserve charges on the loans they make to commercial banks - is paid to the Fed as a source of low-cost liquidity
M1
the narrowest definition of the U.S money supply - currency and checkable deposits
Open-market operations
the purchase and sale of U.S. government securities by the Fed in order to influence interest rates and the money supply
If a company is profitable
the stockholder can earn capital grains and dividends but if it is not it will only lose the amount paid for the stock
Total demand for money
the sum of the transactions demand for money and the asset demand for money
What was the outcome of the 2007-2008 financial crisis?
the system faced serious problems in a rise in mortgage loan defaults, the collapse of several major financial institutions, and a credit freeze
Bonds Versus Stocks
they are issues most frequently by governments and corporations + they are much more predictable any they generate lower average rates of return
Present value
the amount of money you would need to deposit now in order to have a desired amount in the future - X0 = Xt / (1+i)^t
Money market forces determine
the equilibrium interest rate
Transactions demand for money
The amount of money people want to hold for use as a medium of exchange (to make payments); varies directly with nominal GDP.
Thrift Institutions (Thrifts)
a savings and loan association, mutual savings bank, and mainly credit unions
Money supply
guaranteed by the governments ability to keep the value of money relatively stable
When general price level increases
purchasing power of money decreases
Before the financial crisis of 2007-2009, restrictive monetary policy by the Fed involved
raising the target for the federal funds rate and using an open-market sale of bonds to adjust bank reserves and thereby raise the federal funds rate to hit its target.
Investors compare risk by
reviewing the average expected rate of return and the beta statistic
Key functions of the Fed
to conduct monetary policy, regulate financial institutions, maintain the stability of the financial system, and act as the governments fiscal agent - cannot be influenced by politics because it acts as an independent agency
Arbitrage
when investors buy and sell similar investments until the average expected rates of return equalize, removing the ability to profit
Interest paid on reserve balances held at the Fed
will incentivize banks to hold more reserves and reduce riskier lending.
Purchasing Power
( 1 - Previous Price Index / Current Price Index )x 100
Goal federal funds rate
0-.25%
Target inflation rate and the full employment rate of unemployment
2% and between 4-5%
Limited liability rule
A law that limits the potential losses that an investor in a corporation may suffer to the amount that she paid for her shares in the corporation. Encourages financial investment by limiting risk.
Taylor Rule
A monetary rule proposed by economist John Taylor that would stipulate exactly how much the Federal Reserve System should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation.
Liquidity trap
A situation in a severe recession in which the Fed's injection of additional reserves into the banking system has little or no additional positive impact on lending, borrowing, investment, or aggregate demand.
Unit of Account
A standard unit in which prices can be stated and the value of goods and services can be compared; one of the three functions of money.
Open-Market Operations (OMOs)
A tool of monetary policy, it involves the Fed's buying (or selling) of securities from (or to) commercial banks and the general public - tool of monetary policy used by the Fed for altering the interest rates of bonds The Fed can regularly influence and change the risk-free rate of financial investments
Store of Value
An asset set aside for future use; one of the three functions of money.
Time deposit
An interest-earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specified period.
Token money
Bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency still circulating, money for which the face value exceeds the commodity value.
Mortgage-backed securities
Bonds that represent claims to all or part of the monthly mortgage payments from the pools of mortgage loans made by leaders to borrowers to help them purchase residential property.
Restrictive monetary policy
Federal Reserve System actions to reduce the money supply, increase interest rates, and reduce inflation; a tight money policy.
Expansionary monetary policy
Federal Reserve system actions to increase the money supply, lower interest rates, and expand real GDP; an easy money policy.
Near-money
Financial assets that are not themselves a medium of exchange but that have extremely high liquidity and thus can be readily converted into money. Includes noncheckable savings accounts, small time deposits, and short-term U.S. government securities plus savings bonds.
Subprime mortgage loans
High-interest-rate loans to home buyers with above-average credit risk.
Diversifiable risk versus undiversifiable
Investment risk that investors can reduce via diversification; also called idiosyncratic risk versus investment risk that investors are unable to reduce via diversification; also called systemic risk
Advantages versus disadvantages of monetary policy
Its run by the Fed so its isolated from political pressure and is flexible but its recognition and operational lags, cyclical asymmetry, and the liquidity trap
Reverse Repo rate
Rate at which the central bank can borrow money from commercial banks.
Taylor Rule Formula
Target = 2% + current rate of inflation + .5 x inflation gap - 1 x unemployment gap
Compound Interest
The accumulation of money that builds over time in an investment or interest-bearing account as new interest is earned on previous interest that is not withdrawn - Xt = (1+i)^t x X0
Zero lower bound problem
The constraint placed on the ability of a central bank to stimulate the economy through lower interest rates by the fact that nominal interest rates cannot be driven lower than zero (because if interest rates were negative, people would be unwilling to put their money into banks due to the fact that deposit balances would decrease over time due to the negative interest rate.)
Liquidity
The degree to which an asset can be converted quickly into cash with little or no loss of purchasing power. Money is said to be perfectly liquid, whereas other assets have lesser degrees of liquidity.
Risk premium
The interest rate above the risk-free interest rate that must be paid and received to compensate a lender or investor for risk.
Average expected rate of return
The probability-weighted average of an investment's possible future returns.
Financial Investment
The purchase of a financial asset (such as a stock, bond, or mutual fund) or real asset (such as a house, land, or factories) or the building of such assets in the expectation of financial gain.
What policies adjusted the Recession of 2008?
Wall Street Reform and Consumer Protection Act
Medium of Exhcange
What sellers generally accept and buyers generally use to pay for goods and services without exchanging in barter
Mutual funds
actively or passively managed portfolios of stocks and bonds selected and purchased by mutual fund companies
The Federal Open Market Committee (FOMC)
aids the Board of Governors in conducting monetary policy
Security Market Line
an upward-sloping line that shows how the average expected rates of return on assets and portfolios varies with their respective levels of non-diversifiable risk a measured by their beta statistic - if investors dislike risk the SML will be steep but if they don't mind risk it will be flat
Checkable deposit
any deposit in a commercial bank or thrift institution against which a check may be written
Money is
anything that serves as a medium of exchange, a unit of account, and a store of value
The major problem facing the economy is high unemployment and weak economic growth. The inflation rate is low and stable. Therefore, the Federal Reserve decides to pursue a policy to increase the rate of economic growth. Which policy changes by the Fed would tend to offset each other in trying to achieve that objective?
buying government securities and raising the discount rate
How does the Fed lower or raise interest rates?
by changing the money supply to promote full employment, price stability, and economic growth
M2
consists of M1 plus saving deposits i.e money market deposit accounts, time deposits, and money market mutual fund balances held by individuals
U.S. Banking System
consists of the Board of Governors of the Federal Reserve System, the 12 Federal Reserve Banks, and commercial banks and thrift institutions
Interest rate
determines by the intersection of money demand and money supply
Board of Governors
directs the activities of the 12 Federal Reserve Banks
Investors can reduce risk by
diversifying their portfolios but there is always some risk as investors are anticipating future payouts
Arbitrage ensures
every asset in the economy plots onto the SML. If the risk-free interest rate increases, the vertical intercept of the SML increases.
The price of an asset should
exactly equal the total present value of all of the asset's future payments.
Bankrupt
individual or firm finds that it cannot make timely interest payment on money it has borrowed. A bankruptcy judge can order the individual or form to liquidate its assets in order to pay lenders at least some portion of the amount owed.
Money market deposit accounts
interest-bearing accounts offered by commercial banks and thrift institutions that invest deposited funds into a variety of short-term securities
In 2020, the Fed began to
let banks decide for themselves how big their reserves against withdrawals should be.
Beta Statistic
measures how the non-diversifiable risk of a given asset or portfolio of assets compares with that of the market portfolio which is considered the most diverse portfolio possible
When the Fed undertakes "reverse repo" transactions with nonbank financial firms, it is trying to influence the behavior of the
nonbanks that operate in the money market.
The three main tools of monetary policy are
open-market operations, forward guidance, and changing the administered interest rates.
Defaults
situations in which borrowers stop making payments on their loans
Economic investment
spending for the production and accumulation of capital and additions to inventories, or the research and development of new goods or service's
When the economy is producing more than its potential and inflation increases
the Fed uses contractionary monetary policy
When the economy is in a recession
the Fed uses expansionary monetary policy
The value of money is determined by
the amount of goods and services it can buy
Asset demand for money
the amount of money people want to hold as a store of value, this amount varies inversely with the interest rate
Reserve ratio
the fraction of checkable deposits that each commercial bank or thirst institution mist hold as reserves at its local Fed Bank