Chapter 14 ECON 202

Assembling a pool of loans and selling shares of the pool to investors is called: investment banking. securitization. derivation. deleveraging.

securitization.

currency in circulation

actual cash held by the public

excess reserves

a bank's reserves over and above the reserves required by law or regulation.

How banks create money

1) fraction of deposit held in reserves; 2) Remainder can be loaned (excess reserves); 3) Quantity of money increases with a multiplier effect;

In a famous passage in The Wealth of Nations, Adam Smith described paper money as a

"waggon-way through the air."

M1

, the narrowest definition, contains only currency in circulation (also known as cash), checkable bank deposits, and traveler's checks.

bank regulation

1. deposit insurance 2. capital requirements 3. reserve requirements 4. discount window

The last significant change in reserve requirements was in

1992

Suppose that the reserve ratio is 25%; the money multiplier is: 0.04. 5. 0.25. 4.

4

. Suppose that the reserve ratio is 20%. If Sam deposits $500 in his checking account, his bank can increase loans by: $2,500. $400. $500. $100

400

worlds oldest central bank

Bank of Sweden, Sveriges Riksbank

The monetary base is different from the money supply in two ways.

Bank reserves, which are part of the monetary base, aren't considered part of the money supply. A $1 bill in someone's wallet is considered money because it's available for an individual to spend, but a $1 bill held as bank reserves in a bank vault or deposited at the Federal Reserve isn't considered part of the money supply because it's not available for spending. the ratio of the money supply to the monetary base. Checkable bank deposits, which are part of the money supply because they are available for spending, aren't part of the monetary base.

Banks affect the money supply in two ways:

Banks remove some currency from circulation: dollar bills that are sitting in bank vaults, as opposed to sitting in people's wallets, aren't part of the money supply. banks create money by accepting deposits and making loans—that is, they make the money supply larger than just the value of currency in circulation.

Open market operations are carried out by the Federal Reserve Bank of: San Francisco. Kansas City. New York. Philadelphia.

New York.

Decisions about monetary policy are made by the

Federal Open Market Committee, which consists of the Board of Governors plus five of the regional bank presidents.

WHAT'S NOT IN THE MONEY SUPPLY

Financial assets like stocks and bonds are not part of the money supply under any definition because they're not liquid enough.

Fiat money has two major advantages over commodity-backed money

First, it is even more of a "waggon-way through the air"—creating it doesn't use up any real resources beyond the paper it's printed on. Second, the supply of money can be adjusted based on the needs of the economy, instead of being determined by the amount of gold and silver prospectors happen to discover.

Because currency and checkable deposits are directly usable as a medium of exchange, .

M1 is the most liquid measure of money

M2 consists of

M1 plus other types of assets: two types of bank deposits, known as savings deposits and time deposits, both of which are considered noncheckable, plus money market funds, which are mutual funds that invest only in liquid assets and bear a close resemblance to bank deposits.

The primary difference between M1 and M2 is that: M2 includes checkable deposits, but M1 does not. the dollar amount of M1 is much larger than the dollar amount of M2. M1 includes checkable deposits, but M2 does not. M2 includes savings deposits and time deposits, but M1 does not.

M2 includes savings deposits and time deposits, but M1 does not.

6. The LARGEST monetary aggregate is: the reserves in the vaults of Federal Reserve banks, because they are the money multiplier. the total volume of stocks and bonds, because they store most of the national wealth. M1, because it contains all of the currency in circulation. M2, because it contains currency in circulation, all bank deposits, other deposits, and deposit-like assets.

M2, because it contains currency in circulation, all bank deposits, other deposits, and deposit-like assets.

broader def of money

The broader definition includes three categories just noted plus other assets that are "almost" checkable, such as savings account deposits that can easily be transferred into a checking account with a phone call or a few taps on a smartphone.

narrow def of money

The narrower definition of money considers only the most liquid assets to be money: currency in circulation, checkable bank deposits, and traveler's checks.

Which statement is TRUE regarding shadow banks? They are required to have deposit insurance. They face much less regulation compared to traditional banks. They face much more regulation compared to traditional banks. They are subject to reserve requirements.

They face much less regulation compared to traditional banks.

. The law intended to reform the financial system after the crisis of 2008 was called the: Financial Modernization Act. Wall Street Reform and Consumer Protection Act. Glass-Steagall Act. Camp David Accords.

Wall Street Reform and Consumer Protection Act.

capital requirement

a government regulation specifying a minimum amount of bank capital

deposit insurance

a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account. ($250,000)

unit of account

a measure used to set prices and make economic calculations.

commodity-backed money

a medium of exchange that has no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods on demand.

commodity money

a medium of exchange that is a good, normally gold or silver, that has intrinsic value in other uses.

fiat money

a medium of exchange whose value derives entirely from its official status as a means of payment.

Money plays three main roles in any modern economy: it is

a medium of exchange, a store of value, and a unit of account .

the discount window

a protection against bank runs in which the Federal Reserve stands ready to lend money to banks in trouble.

In 2008, when the U.S. financial system collapsed, it led to: the Federal Reserve increasing the interest rate, which further destabilized the economy. a severe cycle of deleveraging and a credit crunch for the economy as a whole. very high inflation, and the Federal Reserve followed a strict contractionary monetary policy to bring prices down. the Federal Reserve lowering the interest rate, and the economy revived as businesses and individuals secured low-interest loans.

a severe cycle of deleveraging and a credit crunch for the economy as a whole.

M2

adds several other kinds of assets, often referred to as near-moneys—financial assets that aren't directly usable as a medium of exchange but can be readily converted into cash or checkable bank deposits, such as savings accounts M2 consists of M1 plus various kinds of near-moneys.

4. A bond is considered: M2. M1. a liability for the owner and is part of the money supply. an asset for the owner and is not part of the money supply.

an asset for the owner and is not part of the money supply.

medium of exchange

an asset that individuals use to trade for goods and services rather than for consumption.

store of value

an asset that is a means of holding purchasing power over time.

central bank

an institution that oversees and regulates the banking system and controls the monetary base.

Monetary Aggreagte

an overall measure of the money supply. The most common monetary aggregates in the United States are M1, which includes currency in circulation, traveler's checks, and checkable bank deposits, and M2, which includes M1 as well as near-moneys.

checkable bank deposits

bank accounts that can be accessed by using checks, debit cards, and digital payments.

shadow banking

bank-like activities undertaken by nondepository financial firms such as investment banks and hedge funds, but without regulatory oversight and protection.

A bank run can break a bank because: depositors' panic spreads to borrowers, who want to take additional loans from the bank. borrowers default on their loans, and the bank's assets become worthless. banks cannot quickly convert illiquid loans to liquid assets without facing a large financial loss. the bank's reserves kept with the Federal Reserve are in the form of illiquid U.S. Treasury bonds.

banks cannot quickly convert illiquid loans to liquid assets without facing a large financial loss.

commericial banks

banks that accept deposits and make loans

The Federal Reserve never buys U.S. Treasury bills directly from the federal government because it could: be a route to disastrous inflation. lead to a recession. make the budget deficit worse. reduce the power of the Fed.

be a route to disastrous inflation.

Interest rates were low in the United States in 2003 because of: a decrease in the money supply. increases in tax rates. capital inflows and monetary policy. capital outflows from the United States to China

capital inflows and monetary policy.

federal funds market

market that allows banks that fall short of reserve requirements to borrow funds from banks with excess reserves.

in order to alter the money supply, the Fed can

change reserve requirements, the discount rate, or both.

Historically, money took the form first of __________, then of ______________. Today the dollar is pure _________.

commodity-backed money, commodity money, fiat money

the fed's liabilities

consist of currency in circulation and bank reserves

Fiat money, though, poses some risks.

counterfeiting The larger risk is that governments that can create money whenever they feel like it will be tempted to abuse the privilege

bank reserves

currency held by banks in their vaults plus their deposits at the Federal Reserve.

Which combination of assets is considered to be money? currency in circulation, checkable bank deposits, and credit cards currency in circulation and in bank vaults, checkable bank deposits, and credit cards currency in circulation, checkable bank deposits, and traveler's checks currency in circulation and in bank vaults, checkable bank deposits, and traveler's checks

currency in circulation, checkable bank deposits, and traveler's checks

Loans of reserves from one bank to another are made in the _____ market. federal funds foreign exchange stock commodity

federal funds

nears money

financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits

a bank is a

financial intermediary that uses liquid assets in the form of bank deposits to finance the illiquid investments of borrowers.

A reserve ratio is the: loan-to-deposit ratio in the bank's balance sheet. fraction of deposits that the bank is required to hold as reserves. money belonging to the bank's largest depositors. proportion of cash and security reserves the bank holds.

fraction of deposits that the bank is required to hold as reserves.

The Federal Reserve holds its assets mostly .

in short-term government bonds called U.S. Treasury bills.

financial intermediary

institution that helps channel funds from savers to borrowers

The big advantage of commodity-backed money over simple commodity money

it tied up fewer valuable resources

Banks create money when they

lend out excess reserves, generating a multiplier effect on the money supply

money

money is any asset that can easily be used to purchase goods and services.

The 12 reserve banks

moved under the board of governors (7 members appointed by the president and confirmed by the senate)

Ordinarily, monetary policy is conducted almost exclusively using the Fed's third policy tool:

open-market operations.

To change the money supply, the Federal Reserve most frequently uses: changes in the discount rate. open-market operations. changes in the required reserve ratios. changes in the inflation rate.

open-market operations.

When, in The Wealth of Nations, Adam Smith wrote of "a sort of waggon-way through the air," he was referring to: the invisible hand. mass transit systems of the future. the forces of competition. paper money

paper money

open-market operation

purchase or sale of U.S. Treasury bills by the Federal Reserve, normally through a transaction with a commercial bank.

Capital requirements for banks do NOT serve the purpose of: putting to use the excess of a bank's assets over its deposits and other liabilities. offsetting the change in incentives caused by deposit insurance. reducing deposits. reducing a bank owner's incentive for excessive risk taking.

reducing deposits.

The Fed has three main policy tools at its disposal:

reserve requirements, the discount rate, and, most importantly, open-market operations.

Most of the interest on the Fed's assets is: returned to the U.S. taxpayers. used to maintain the buildings and grounds of the 12 regional banks. used to purchase currency in the foreign exchange market. shared with banks that are members of the Federal Reserve System.

returned to the U.S. taxpayers.

reserve requirement

rules set by the Federal Reserve that set the minimum reserve ratio for banks. For checkable bank deposits in the United States, the minimum reserve ratio is set at 10%.

In return for injecting capital into banks, the U.S. government received: shares of stock in the bank. deposits at the bank. bonds issued by the bank. loans at an interest rate below the prime rate.

shares of stock in the bank.

T account

simple tool that summarizes a business's financial position by showing, in a single table, the business's assets and liabilities, with assets on the left and liabilities on the right.

A major problem with bank runs is that they: drive down interest rates. spread to other banks. drive down both inflation and interest rates. cause inflation because the money moves so fast.

spread to other banks.

Any asset that holds its purchasing power over time is a

store of value

When we keep part of our wealth in a savings account, money is playing the role mainly of: barter. medium of exchange. unit of account. store of value.

store of value.

The Wall Street Reform and Consumer Protection Act, or Dodd-Frank: requires all banks to become members of the Federal Reserve. decreases regulation of commercial banks and investment banks. subjects "systemically important" institutions to high capital requirements and limits the risks they can take. makes securitization illegal.

subjects "systemically important" institutions to high capital requirements and limits the risks they can take..

t/f A U.S. dollar bill isn't commodity money, and it isn't even commodity-backed

t

investment banks

that create and trade assets but don't accept deposits

You might wonder where the Fed gets the funds to purchase U.S. Treasury bills from banks. The answer is

that it simply creates them with a mouse click—or the stroke of a pen—that credits the banks' accounts with extra reserves. (The Fed prints money to pay for Treasury bills only when banks want the additional reserves in the form of currency.)

the Federal Reserve system consists of two parts:

the Board of Governors and the 12 regional Federal Reserve Banks.

The supply of euros is controlled by: the foreign exchange markets. the European Central Bank. the U.S. Federal Reserve System. the Bank of England

the European Central Bank.

The Panic of 1907 began when: the Federal Reserve was established. national banks were allowed to issue their own bank notes. the Knickerbocker Trust failed. Teddy Roosevelt signed the Sherman Antitrust Act.

the Knickerbocker Trust failed.

7. Prior to the Civil War: all private money issued by banks was of equal value. the U.S. government did not issue paper money. the U.S. government did not allow banks to issue private money. the U.S. government issued paper money but only in small quantities.

the U.S. government did not issue paper money.

bank failure

the bank would be unable to pay off its depositors in full.

reserve ratio

the fraction of bank deposits that a bank holds as reserves. In the United States, the minimum required reserve ratio is set by the Federal Reserve.

federal funds rate

the interest rate at which funds are borrowed and lent in the federal funds market

Bank runs in the United States during the 1930s damaged the economy because: capital requirements prevented bank managers from taking additional lending risks. the Federal Reserve system did not exist at the time. the loss of confidence at one bank quickly extended to other banks. the reserve ratio was set too high

the loss of confidence at one bank quickly extended to other banks.

. If the Federal Reserve increases the discount rate: the federal funds rate must decrease. the money supply is not likely to change. the money supply is likely to decrease. the money supply is likely to increase.

the money supply is likely to decrease.

discount rate

the rate of interest the Federal Reserve charges on loans to banks that fall short of reserve requirements.

money multiplier

the ratio of the money supply to the monetary base. is equal to the money supply divided by the monetary base. It is smaller than $1/rr because people hold some funds as cash.

Board of Governors

the seven-member board that oversees the Federal Reserve System 14 yr terms

monetary base

the sum of currency in circulation and bank reserves

money supply

the total value of financial assets in the economy that are considered money.

double coincidence of wants

the unlikely occurrence that two people each have a good the other wants

Banks can lend money because: they have so much to lend. they don't know how much cash they have in their vault. there is a high demand for commodity money. they know not everyone wants their deposits back at the same time.

they know not everyone wants their deposits back at the same time.

Subprime loans are made: on houses that are below average value. with very short maturities. to buyers who don't meet the usual criteria for getting a mortgage. with interest rates that are below the prime rate.

to buyers who don't meet the usual criteria for getting a mortgage.

ranking of world currencies

u.s, euro, china, japan

The Fed never buys U.S. Treasury bills directly from the federal government. There's a good reason for this:

when a central bank buys government debt directly from the government, it is lending directly to the government—in effect, the central bank is printing money to finance the government's budget deficit. This has historically been a formula for disastrously high levels of inflation.

bank run

widespread panic in which great numbers of people try to redeem their paper money they have often proved contagious, with a run on one bank leading to a loss of faith in other banks, causing additional bank runs