test 4

deposit insurance-

- In 1933-34, the FDIC and FSLIC were created by Congress to ensure depositors that their money would be safe -- thus eliminating the motivation for deposit runs.

Stage 2 - the bubble bursts - -when, and why?

-A bubble bursts when people suddenly realize that an increase in perceived financial wealth is an illusion -As everyone rushes to get into safe assets, herding and (de)leveraging work very fast in the opposite direction -It all happens much faster than the inflation of the bubble -Until a bubble bursts you cannot be sure it was a bubble

what happens When Banks Fail;

-A consequence of the fractional reserve system is that no bank can pay off its customers if they all sought to withdraw their deposits at one time. -Occasional "runs" of depositors rushing to withdraw their funds have created panics in the past. -As word spread, it became a self-fulfilling confirmation of a bank's insolvency.

Legal Reserves: Required reserves: Excess Reserves:

-Legal Reserves: Total Reserves -Required reserves: Reserves which must be kept on hand. -Excess Reserves: Reserves which can be loaned out. -Legal Reserves = Required reserves + Excess reserves (new loans) -Banks can have a Federal or State Charter. If a Federal Charter, must belong to Federal Reserve.

In 2008, the world financial system seized up, causeing what to happen?

-banks went bankrupt -the stock market dropped precipitously -the U.S economy fell into a serious recession -the government took extraordinary steps to try and calm the crises -government expenditures went into the trillions of dollars

-Do excess reserves interest?

-no they earn no interest. -banks have tremendous profit incentive to keep their reserves as close to their required reserve level as possible

Rate of Return = Profit/Cost

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what are the 5 stages of a financial crisis?

1-Inflation of a bubble - unsustainable rapidly rising prices of some type of financial asset 2-The bubble bursts, causing a recession 3-The effects of the bursting bubble threaten the entire financial system 4-People cut spending 5-Firms cut back even more, creating a downward spiral that can turn a recession into a depression

Two Types of Money:

1. Commodity (backed by gold or silver) 2. Fiat (backed by confidence in the government that issues it)

Three Reasons for Demanding Money (Also Called Motives for Money)

1.Transactions (to live) 2. Precautionary (emergencies) 2. Speculative (invest, save)

How many Federal Reserve banks act as a central banker for the banks in their region? -what does the federal reserve perform?

12 fed reserve banks -clearing checks between private banks -holding bank reserves -providing currency -providing loans

The Federal Open Market Committee (FOMC) -how many members in the group? -the FOMC oversees the daily activity of the Fed and meets how often to review monetary and policy and outcomes? -Most important committee and a committee worth remembering!*

12 member group ( the 7 governors along with 5 of the 12 regional reserve bank presidents) -every 4-5 weeks

Extrapolative expectations about falling real output can lead to a cycle of shrinking aggregate demand - causeing what on demand curve?

An upward-sloping effective aggregate demand curve

greenbacks we carry around today are not the only for of "money we use. name another explain

Credit cards are another popular medium of exchange but are not money—they are only a payment service with no store of value in and of themselves.

Definition of Money:

Definition of Money: Anything generally acceptable as medium of exchange. It is that simple (e.g., wampum, cigarettes, gold). -Without money, you would have to use barter to get items you want.

Fractional Reserve Banking System

Fractional Reserve Banking System Banks are concerned with safety, liquidity and profitability regarding money., banks keep a fraction of deposits as reserves and use the rest to make loans

Goldsmith Principle:

Goldsmith Principle: Keep a percentage of money on hand and lend out the rest to earn income. The Goldsmith Principle lead to our current banking system.

Monetary policy affects investment.

Higher interest rates cause less investment (there is less return on investment)

If RRR decreases what happens to money supply? same if increases? -if discount rate goes down, money supply what? same if goes up? -if federal reserve buys bonds, money supply will what? what is sells bonds? -When Federal Reserve buys bonds, who receive the money.

If RRR decreases, money supply increases If RRR increases, money supply decreases If discount rate goes down, money supply increases If discount rate goes up, money supply decreases If Federal Reserve buys bonds, money supply will increase. If Federal Reserve sells bonds, money supply will decrease When Federal Reserve buys bonds, banks and public receive the money.

Liquidity is the degree to which you can convert something to money. are checks? is real estate?

Liquidity is the degree to which you can convert something to money. Checks are very liquid Real estate is not.

Measure of Money: M1 to M15 (M1 being the most liquid)

M1: Currency and demand deposits (checks) M2: M1 and time deposits (savings accounts) M15: Last, measure of money, however for our purposes we are only interested in Ma and M2.

money multiplier

Money Multiplier - The number of deposit (loan) dollars that the banking system can create from $1 of excess reserves. -money multiplier = 1/required reserve requirement

The Federal Reserve System requires banks to maintain some minimum reserve ratio. The ability of a bank to hold fractional reserves is based on two facts:

The ability of a bank to hold fractional reserves is based on two facts: -People use checks for most transactions. -There is no other bank.

The ability of banks to make loans depends on what? Example:

The ability of banks to make loans depends on access to excess reserves. Example: If a bank is required to hold $20 in reserves but has $100 currently, it can lend out the $80 excess.

The money multiplier explained...

When a new deposit enters the banking system, it creates both excess and required reserves. The required reserves represent leakage from the flow of money, since they cannot be used to create new loans. Excess reserve can be used for new loans. Once those loans are made, they typically become transactions deposits elsewhere in the banking system

Wild Cat Banking: Grasham's Law - FDIC: FSLIC:

Wild Cat Banking: Banks would set up in remote sites and float their own money and hope it never got back to the issuing bank. Grasham's Law "Cheap money drives out dear money." FDIC: Commercial banks FSLIC: Savings banks

Transactions Account

a bank account that permits direct payment to a third party (e.g. with a check) -transaction-account balances are the largest component of the money supply

the long 14 year term for governors is intended to give the fed a strong measure of what? the president selects one of the advisors to serve as chairman for how many years at a time?

a strong measure of political independence -4 years at a time

based on their excess reserves the money multiplier determines how much in what the banking system can make

additional loans -available lending capacity of the banking system = excess reserves x money multiplier

bank reserves

assets held by a bank to fulfill its deposit obligations. -Bank reserves are only a fraction of total transaction deposits.

in making a loan, a bank effectively creates money because why?

because transactions-account balances are counted as part of the money supply.

bond- bond yields -people buy bonds because

bond-a certificate acknowledging a debt and the amount of interest to be paid each year until repayment, an IOU -like other markets, the bond market exists whenever and however bond buyers and sellers get together -people buy bonds because bonds pay interest -bond yields- the rate of return on a bond, the annual interest payment divided by the bond's price.

by changing the what?, the fed can directly alter the lending capacity of the banking system by affecting the amount of excess reserves.

by changing the reserve requirement, the fed can directly alter the lending capacity of the banking system by affecting the amount of excess reserves. -think of excess reserves as new loans -excess reserves = total reserves - required reserves

Money Supply (M1)

currency held by the public, plus balances in transactions accounts. M1 includes currency in circulation, transaction account balances, and traveler's checks.

when the fed buys bonds from the public it increases the flow of what to the banking system -bond sales by the fed reduce

deposits (reserves) -bond sales by the fed reduce the flow

people preferred to be paid in what rather than uncertain paper currency.

gold, silver or other commodities.

Transactions demand for money -

money held for the purpose of making everyday market purchases -people hold money so they can buy goods and services.

After the colonies became an independent nation, the US constitution prohibited the federal government from issuing what? -and who then issued it?

paper money- -it was then issued by state chartered banks.

the 3 major monetary policy instruments are

serve requirements, discount rates, and open market operations.

the 1st paper money issued by the federal government was called what? and was printed when to finance the civil war.

the 1st paper money issued by the federal government was called "greenbacks" and was printed in 1861 to finance the civil war.

deposit creation-

the creation of transactions deposits by bank lending. -when a bank lends someone money, it simply credits that individual's bank account. -The creation of transaction-accounts balances by giving loans increases the money supply because the new balance is created rather than transferred from another source.

Goldsmith principle

the deposit of funds into a bank does not change the size of the money supply, but it does change the composition of the money supply (transfer from cash to transaction deposits)

lowering the discount rate has what effect?

the effectiveness of lowering the discount rate depends primarily on the difference in the new discount rate and the rate that banks charge their loan customers.

what act and date gave the federal government permanent authority to issue money?

the national banking act of 1863

reserve ratio

the ratio of a banks reserves to its total deposits. -reserve ratio = bank reserves/total deposits

Stage 3- Financial Meltdown and Possible Depression. -explain how and y

-A financial meltdown results when a bursting bubble undermines confidence in the entire financial sector -Excess leveraging and the leveraging needed in the normal functioning of a market economy disappears -As credit disappears, the economy seizes up and consumer and investor confidence evaporates -The effectiveness of the standard monetary and fiscal policy tools is also compromised, making the problems extremely difficult to solve

Crashes are made up of a combination of what? - In 1929 the stock market crashed how much did it fall by? -most economists expected the economy to recover how?

-Crashes are made up of a combination of small events, each of which makes the economy worse -In 1929, the stock market crashed (fell by 50%) -Most economists expected the economy to recover on its own "Prosperity is just around the corner"

-Deposits - -Borrowers - -Regulation -

-Deposits - Consumers must be willing to use and accept checks rather than cash. -Borrowers - Consumers must be willing to borrow the money that banks provide. -Regulation - The Federal Reserve sets the ceiling on deposit creation.

-Federal Reserve has a Board of Governors with how many members, with how many terms? One is up every how many years. -Who is the Chairman that was formerly the department chair of economics at Princeton University. -Approximately how many banks belong to the Federal Reserve.

-Federal Reserve has a Board of Governors with 7 members, each have 14-year terms appointed by the president with confirmation by the U.S Senate. One is up every 2 years. -Ben Bernacke is the Chairman was formerly the department chair of economics at Princeton University. -Approximately 6,000 banks belong to the Federal Reserve.

how the government responded to the Great depression - -Financial Triage was? -Monetary policy was ? -fiscal stimulus was ? New financial regulation was established - deposit insurance- -glass-steagall Act - ^define

-Financial triage was reasonably successful -Monetary policy was ineffective during the crisis -Fiscal stimulus was limited -Deposit insurance is a system under which the federal government promised to stand by an individual's bank deposits -Glass-Steagall Act was passed in 1933 that created deposit insurance and a number of banking regulations

The 1920s stock market bubble and the 2000s housing bubble were both formed because of what 2 things? name and define.

-Herding is the human tendency to follow the crowd -Leverage which is borrowing to make financial investments

money-multiplier process

-In a multibank system, deposits created by one bank invariably end up as reserves in another bank. -This process can theoretically continue until all banks have zero excess reserves (no more loans can be made).

Stage 1-The bubble forms -give examples of how in 2000s

-Loose lending standards allowed families to borrow to buy houses, and home values were increasing rapidly -In 2006, housing prices started to level off and by 2007 housing prices began to fall precipitously

-medium of exchange - store of value- standard of value- standard for deferred payments-

-Medium of exchange - Is accepted as payment for goods and services (and debts). -Store of value - Can be held for future purchases. -Standard of value - Serves as a measurement for the prices of goods and services. -Standard for deferred payments - Loans

what are Two Qualitative Tools

-Moral Suasion (Can't hire or fire but can apply pressure) -Margin Requirements (Buy stocks by only paying for a portion at the time of purchase).

what were somethings that occured because and to cause the financial meltdown of the 1930s?

-People had borrowed from banks to invest in the stock market boom of the 1920s -When the stock market crashed, banks began to have trouble collecting on those loans -If a rumor began to fly about a bank failing, people would withdraw all the money they had deposited before the bank closed (bank runs) -The U.S. government acted to prevent an even greater financial breakdown, but the economy didn't recover until World War II

There are different interest rates but they all tend to move together. Other interest rates are?

-Prime Rate = rate banks charge their best corporate customers -Fed Funds Rate = What banks charge each other for inter bank loans.

Three Quantitative Tools are -

-Required Reserve Ration (3 RRRs) If RRR decreases, money supply increases If RRR increases, money supply decreases -Discount Rate (Rate which Federal Reserve changes member banks) If discount rate goes down, money supply increases If discount rate goes up, money supply decreases -Open Market Operations (buying and selling government securities) If Federal Reserve buys bonds, money supply will increase. When Federal Reserve buys bonds, banks and public receive the money. If Federal Reserve sells bonds, money supply will decrease

How did the Government respond to the 2008 crises? -Stonger and quicker financial triage using ? -expansive fiscal and monetary stimulus - explain

-Stronger and quicker financial triage using -Quantitative easing is nonstandard monetary policy designed to expand credit in the economy -Troubled Asset Relief Program (TARP) -Expansive fiscal and monetary stimulus -The Fed funds target rate was slashed to near zero and lending was expanded dramatically -Fiscal stimulus packages in early 2008 and 2009

Stage 1 bubble forming - explain how this happens - 4 things

-The key to a bubble is extrapolative expectations which are expectations that a trend will continue -Inflating a bubble depends on the ability of demanders to finance the increase in demand: leverage -The process through which leverage creates credit is similar to the money creation process -That creation process allows the endogenous expectations (expectations determined within the model) of rising prices to be met, and price increases to continue

Potential deposit creation

-The money supply can be increased through the process of deposit creation to this limit: -Potential deposit creation = Excess reserves of banking system X Money multiplier

How do economies get out of a financial crises? 3 stages - list and define

-The triage stage in 2008 involved a $700 billion financial bailout of banks in an attempt to prevent the entire financial system from collapsing -The treatment stage involves expansionary monetary and fiscal policy -The rehabilitation stage involves the development of regulatory rules that prevent future harmful economic bubbles

-a bank that is low on reserves can also sell what? -banks use some of their excess reserves to purchase what?

-a bank that is low on reserves can also sell securities? -banks use some of their excess reserves to purchase government bonds. -these may be converted to reserves instantly if necessary - however, this usually forfeits any interest-earning potential it might have had.

A change in the reserve requirement causes what?

-a change in excess reserves -a change in the money multiplier -a change in the lending capacity of the banking system.

Why are Financial Panics Scary?

-a financial sector collapse would bring all other sectors crashing down -all the other sectors rely on a functioning financial sector -the fear in October 2008 was that the financial crisis on Wall Street would spread from Wall Street (the financial sector) to Main Street (the real secor) creating not a recession but a depression.

when someone deposits cash or coins in a bank, they are changing the composition of the money supply, not its size. -give an example

-a student deposits $100 from their piggy bank into the monopoly bank and receives a new checking account -the monopoly bank then loans $100 to the Campus Pub and issues a checking account

open-market operations

-are the principal mechanism for directly altering the reserves of the banking system -the open-market operation of the Fed focus on one of the portfolio choices people make - whether to deposit idle funds in bank accounts or to purchase government bonds. -the fed attempts to influence this choice by making bonds more or less attractive, as circumstances warrant.

explain the structure of the Fed. -a series of bank failures resulted in a sever financial panic in 1907 - millions of depositors lost their savings. What was the result?

-as a result, the National Monetary Commission was established to examine ways of restructuring the banking system. -to address the problem of restructuring the banking system, Congress passed the Federal Reserve Act in 1913.

open market operations- -do bonds have to be bought at face value?

-federal reserve purchases and sales of government bonds for the purpose of altering bank reserves. -bonds do not have to be (and frequently are not) bought at the bond's face value. -it is possible for example to buy a $1000 bond for $900 - making the bonds yield higher. -a principle objective of Federal Reserve open-market activity is to alter the price of bonds and their yields -by doing so, the Fed makes bonds a more or less attractive alternative to holding money.

explain the structure of the Federal reserve system

in a triangle starting from bottom up- -bottom - private banks (depository institutions) -middle - Federal Reserve banks (12 banks, 24 branches) -top - board of Governors (7 members) -off the top to the right - Federal Advisory Council and other committees -off the top to the left - federal open market committee (12 members)

The fed can - explain each -lower reserve requirements- -reduce the discount rate- -buy bonds-

-lower reserve requirements- this will increase the banking system's excess reserves with which they will increase the money supply through deposit creation (loans) -reduce the discount rate- this makes the cost of borrowing reserves from the federal reserve cheaper for banks. the new borrowed (excess) reserves will be used to make more loans - thus increasing the money supply. -buy bonds- by purchasing bonds, the fed places money in bank reserves (via bond sellers). the banks will then increase the obey supply even more through additional loans.

Money Conepts - -money market- capital market- interest rate- monetary policy-

-money market- less than one year -capital market- one year or longer -interest rate- the price paid for the use of money -monetary policy- the use of money and credit controls to influence macroeconomic activity.

to reduce the money supply the feds can what

-raise reserve requirements -increase the discount rate -sell bonds

The fed requires banks to keep a minimum amount of what? and define.

-required reserves - the minimum amount of reserves a bank is required to hold, equal to required reserve ratio times transactions deposits. - required reserves = required reserve ratio x total deposits.

Monetary Tools- -the federal reserve is able to alter the money supply and does so using what 3 policy instruments?

-reserve requirements -discount rates -open-market operations

The Federal Funds Market - Federal Funds Rate-

-the federal funds market - a bank that finds itself short of reserves can turn to other banks for help. -reserves borrowed in this manner are called "federal funds" and are lent for short periods usually overnight. -Federal funds rate - the interest rate for inter-bank reserve loans.

-Demand for money -

-the quantities of money people are willing and able to hold at alternative interest rates, ceteris paribus. -although holding money provides little or no interest, there are reasons for doing so.

what are 2 basic principles of the money supply?

-transactions-account balances are a large portion of our money supply -banks can create transactions-account balances by making loans

-Before 1980, the Fed's control of the money supply was not only incomplete - it was what? -Only one-third of all commercial banks were members of the what? and subject to its regulations. -Congress passed the what? which subjected all commercial banks, S&Ls, savings banks and most credit unions to Fed regulation.

-weakening -Only one-third of all commercial banks were members of the Federal Reserve System and subject to its regulations. -Congress passed the Depository Institutions Deregulation and Monetary Control Act of 1980. The Monetary Control Act subjected all commercial banks, S&Ls, savings banks and most credit unions to Fed regulation.

If you are wealthy you need more for transactions and precautionary. Major function of interest rates is investment.

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Legal Reserves100%=Required Reserves20%+Excess Reserves*80% Example: $1,000 = $200 + $800 Legal Reserves Required Reserve Ratio* Excess Reserves $1,000 = $200+ $800 $800=$160+$640 * Required Reserve Ratio is 1/RRR Money Multiplier = 1/RRR = 1/.2 = 5 To increase the money supply, cut RRR. Legal limit is 7 - 22%. Example: 1/(0.10) = 10/1 = 10

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Short and Long term markets : Usually denote by one year or longer Capital Market is everything one year and over Bond Market Money Market is one day to one year

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When none wants to borrow the excess reserves are high and visa versa

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by buying bonds, the fed increases bank reserves- -by selling bonds, the fed reduces bank reserves

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federal open market committee - step 1" FOMC purchases government bonds; pays for bonds with federal reserve check -> public - step 2: bond seller deposits fed check -> private bank - step 3: bank deposits check at fed bank, as a reserve credit -> regional federal reserve bank

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the fed funds rate- -fed funds rate act as a market signal of the changing reserve flows. -if the fed is pumping more serves into the banking system, the federal funds rate will decline. -if the fed is reducing bank reserve by selling bonds, the federal funds rate will increase

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the volume of trading in the US gov. securities exceeds $100 billion per day

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Characteristics of Money

1. Stores its value 2. Medium of exchange 3. Standard for deferred payments 4. Unit of account

Barter:

Barter: - The direct exchange of one good for another, without the use of money -Before money there was barter. The problem with barter is what economists call the double coincidence of wants. For example, you may have what I want, but I do not have anything you want. Therefore, I have to find out what you want, and then find someone with that good that also wants what I have. This may incur multiple trades in order to get what the person wants that I want to trade with. Sounds like an Abbott and Costello "who's on first dilemma." Most students traditional say it is because it is not easily divisible, bulky, etc. -

Size of deficit depends what?

Size of deficit depends on the amount of government securities.

To make interest rates go up, would you increase or decrease money supply.

To make interest rates go up, decrease money supply.

M2 Money Supply

M1 plus balances in most savings accounts and money market mutual funds. -savings-account balances are almost as good a substitute as transaction-account balances. -the official measures of the money supply (particularly M1 and M2) are fairly reliable benchmarks for gauging how much purchasing power market participants have.

The Fed's control over the supply of money is the Key mechanism of what policy? -and define

Monetary - the use of money and credit controls to influence microeconomic activity.

between what, were paper bills issued by state banks? and how many different paper bills were issued by 1600 banks in how many states?

1789-1863 -30,000 different paper bills in 34 states

The resulting bank closing wiped out customer deposits, curtailed bank lending, and often pushed the economy into recession. in the early part of the great depression 1930-1933 how many banks failed?

9000

Discounting- Discount Rate-

Discounting - federal reserve lending of reserves to private banks. (a 3rd option for avoiding a reserve shortage is to go to the Fed's "discount window" and borrow reserves directly from a Federal reserve bank. -discount rate-the rate of interest charged by the federal reserve banks for lending reserves to private banks -by raising or lowering the discount rate, the fed changes the cost of money for banks and the incentive to borrow reserves.

Excess Reserves -

Excess Reserves - Bank reserves in excess of required reserves. -Excess reserves = Total reserves - Required reserves -So long as a bank has excess reserves, it can make loans. -Excess reserves are reserves a bank is not required to hold. -The creation of transaction deposits via new loans is the same thing as creating money -As the excess reserves are loaned out again, more deposits are created and thus more money is created.

FOMC - determine what? -What would they do in a recessionary gap? -What would the FOMC do when there is an Inflation gap?

FOMC (Federal Open Market Committee, which is part of the Federal Reserve) determines monetary policy. -The answer is that they would increase money supply, driving down interest rates and increasing Investment. -Lower interest rates increase investment because there is a higher rate of return. If Investment goes up by $50 billion, demand goes up. -If money supply (MS) is decreased, interest rates go up and investment goes down. When interest rates go down, investment goes up. When interest rates go up, investment goes down.

the S&L failures cost the fed government how much? -then what happened?

The S & L failures cost the federal government billions—over $60 billion in 1992 alone—as the FSLIC and FDIC paid off depositors. The cost was so great that the FSLIC ran out of money. The Resolution Trust Corporation was created in 1989 to manage the outstanding loans of banks the federal government had to bail out. Parts of the bailout funds were recouped from this effort.

The entire banking system can increase the volume of loans by what?

The entire banking system can increase the volume of loans by the amount of excess reserves multiplied by the money multiplier