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