Chapter 10: The Money Supply and the Federal Reserve System

A currency is liquid if ___________ and ___________.

1. It comes in convenient denominations. 2. It is easily exchangeable for goods and services at all times.

functions of the Federal Reserve

1. approves interbank payments 2. regulates the banking system 3. manages the nation's foreign exchange reserves

three ways in which the Federal Reserve controls the money supply

1. changing the required reserve ratio 2. changing the discount rate 3. engaging in open market operations

What are two things that the Federal Open Market Committee does?

1. sets goals regarding money supply and interest rates 2. directs operations of open-market desk in NYC (by selling government securities)

What happens to the money supply if the Treasury issues bonds and sells them to the public to finance the deficit?

The government spends every dollar that it borrows, so there is no change in the money supply.

Calculate the change in the money supply given reserves, an old required reserve ratio, a new required reserve ratio, and the money supply.

[reserves-(new reserve ratio x money supply)] x 1/new RRR

What is an implication of a higher discount rate?

a higher cost of borrowing; less borrowing

unit of account

a standard unit that provides a consistent way of quoting prices

fiat money

a.k.a. token money intrinsically worthless

excess reserves

actual reserves-required reserves

financial intermediaries

banks and other institutions that link those who have excess funds and those who must borrow them

M1: Transaction Money

bills, coins, checks, debit cards, and anything else that can be immediately used as a means of payment M1=currency held outside of banks+demand deposits+ travelers' checks+ other checkable deposits

government security

bond (debt obligation) issued by a government authority, with a promise of repayment upon maturity may be issued by the government itself or by a government agency low-risk; backed by the taxing power of the government.

1/RRR=?

deposits

reserves

deposits made by commercial banks with the Federal Reserve+cash on hand

Which of the three ways in which the Federal Reserve controls the money supply is the most popular?

engaging in open market operations

M2: Broad Money

includes M1 plus all assets that are in accounts at financial institutions that allow the withdrawal of cash, either immediately or after a certain amount of time; considered a better indicator of the money supply than M1 M2=M1+savings accounts+money market accounts

commodity monies

items used as money that have intrinsic value

legal tender

money that a government has required to be accepted in settlement of debts

required reserve ratio (RRR)

percent of a bank's total deposits that it must keep as reserves with the Federal Reserve

required reserves

percent of a banks's total deposits that must be held in the bank's vaults or at the closest Federal Reserve bank=RRR*total deposits

bank run

phenomena in which those who have claims on a bank (deposits) retrieve those claims all at once reflects distrust of institution/fear of financial insecurity

open market operations

the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system Purchases inject money into the banking system and stimulate growth while sales of securities do the opposite.

currency debasement

the decrease in the value of money that occurs when its supply is increased rapidly problematic in nations where raising taxes is politically unpopular and the government is weak

the discount rate

the interest rate paid by banks to the Federal Reserve for borrowing

the money multiplier

the relationship between the final change in deposits and the change in reserves that caused this change the multiple by which deposits can increase for every dollar increase in reserves derived under the assumption that banks hold no excess reserves 1/RRR