Macro Midterm #5 (Ch 15,16,17, & 18) NOTES

Poor monetary policy

-can decrease the stability of GDP

Means of payment, but not currency

-debit/credit cards -checks

The Fed does:

-regulates other banks -lends money to these banks -manages the nations payment system

The Federal Reserve

-the central bank of the United States, both the government's bank and the bankers bank -has the power to create money -the Fed manages the issuing, transferring, and redeeming if US treasury bonds, bills, and notes

The most important assets that serve as means of payment in the United States today are:

1. Currency- paper bills and coins 2. Total reserves held by banks at the Fed 3. Checkable deposits- your checking or debit account 4. Saving deposits, money market mutual funds, and small-time deposits

How the Fed Controls the Money Supply

1. Open Market Operations- the buying and selling of U.S gov't bonds on the open market 2. Discount rate lending and the term auction facility- Fed Reserve lending to banks and other financial institutions 3. Paying interest on reserves held by banks at the Fed

Three most important definitions of the money supply:

1. The Monetary base (MB): currency and total reserves held at the Fed 2. M1: currency plus checkable deposits 3. M2: M1 + savings deposits, money market mutual funds, and small time deposits

With a negative real shock the bank faces two dilemmas, and must choose between:

1. too low a rate of growth (with a high rate of unemployment) 2. or too high a rate of inflation

When the Fed wants to increase AD and they choose to buy bonds results in:

1.the bond purchases increases the monetary base 2. which decreases the short term interest rates 3. an increase in deposits and loans through the multiplier process (via the increase in the base) 4. stimulation of investment (via the lower interest rates) and therefore consumption borrowing 5. AD then increases, which influences the economy

Ultimately, the Fed uses it tools to influence:

Aggregate Demand

Why don't banks want to hold to many reserves?

Because money being held in reserve isn't being lent, and lending is where banks earn most of their profits

change in money supply equation

Change in Money Supply= Change in reserves X Money Multiplier

MM equation

MM= 1/RR -if one dollar is held in reserve for every 10$ deposit, the reserve ratio is 1/10

Market Confidence

One of the Feds most powerful tools is its influence over expectations, not its influence over the money supply

The Fed has influence on real interest rates only in the

Short Run

The most important and influential part of the Fed:

The Federal Open Market Committee

The world's largest bank customer, who borrows more than any one else

The US Treasury

Lender of last resort

a lender of last resort loans money to banks and other financial institutions when no one else will i.e JP Morgan, Ben Bernanke (chairman of the Federal Reserve)

fractional reserve banking

banks hold only a fraction of deposits in reserve, lending the rest

What reduces inflation

decrease in the money velocity

When faced with a negative shock to AD, the central bank can restore aggregate demand through: expansionary or contractionary?

expansionary monetary policy

An insolvent bank

has liabilities that are greater than its assets

The increase in the money supply:

increases the supply of loans and the lower interest rates increase the quantity of loans demanded

Money

is a widely accepted means of payment

Liquid asset

is an asset that can be used for payments or, quickly and without loss of value, be converted into an asset that can be used for payments -the more liquid the asset, the more it can serve as money (money is most liquid, followed by checkable deposits and reserves)

The Money Multiplier

is the amount the money supply expands with each dollar increase in reserves

Discount Rate

is the interest rate banks pay when they borrow directly from the Fed

The Federal Funds Rate

is the overnight lending rate from one major bank to another

Systematic risk

is the risk that the failure of one financial institution can bring down other institutions as well -domino effect

Quantitative easing

is when the Fed buys longer term government bonds or other securities

Quantitative tightening

is when the Fed sells longer-term government bonds or other securities

When the Fed buys bonds:

it increases the demand for bonds, which pushes up the price of bonds, thus lowering the interest rate

Ch 16: Monetary policy -a monetary policy is credible when:

it is expected that a central bank will stick with its policy

Open Market Operations

occur when the the Fed buys or sells government bonds -the purchase of bonds leads to a ripple effect of increasing deposits, loans, deposits, loans and so forth

Moral hazard

occurs when banks and other financial institutions take on too much risk, hoping that the Fed and regulators will later bail them out

Liquidity crisis

occurs when banks are illiquid

Solvency crisis

occurs when banks become insolvent

Disinflation, or the reduction of inflation, usually results in:

recession

When the Fed sells bonds:

reduces the money supply as people give up their reserves to buy the bonds -selling bonds also lowers the price, making interest rates increase

The Fed has some influence over the growth rate of GDP through its influence over:

the money supply, and thus AD

The Reserve Ratio (RR)

the ratio of reserves to deposits

If the money multiplier is ten then

then an increase in reserves of $1,000 will lead to an increase in deposits of $10,000.

When banks are confident and eager to lend

they will want to keep their reserves relatively low so the money multiplier will be large.