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.