Chapter 25: Money, Banks, and the Federal Reserve System
Fractional Reserve Banking System
A banking system in which banks keep less than 100 percent of deposits as reserves
M2
A broader definition of the money supply; It includes M1 plus savings account deposits, small-denomination time deposits, balances in money market deposit accounts in banks, and non-institutional money market fund shares
Security
A financial asset—such as a stock or a bond—that can be bought and sold in a financial market
Commodity Money
A good used as money that also has value independent of its use as money
Bank Panic
A situation in which many banks experience runs at the same time
Bank Run
A situation in which many depositors simultaneously decide to withdraw money from a bank
Quantity Theory of Money
A theory about the connection between money and prices that assumes that the velocity of money is constant
Asset
Anything of value owned by a person or firm
Money
Assets that people are generally willing to accept in exchange for goods and services or for payments of debts
Reserves
Deposits that a bank keeps as cash in its vault or on deposit with the federal reserve
Why did shadow banks experience such great losses in the financial crisis of 2007-2009?
Highly leveraged; subjected to large gains and large losses
store of value
If you do not use all of your dollars to buy goods and services today, you can hold the rest to use in the future
Federal Deposit Insurance Corporation (FDIC)
Insures deposits in most banks up to a limit ($250,000); Greatly reduced bank runs because it reassured all but the largest depositors that their deposits are safe, even if their bank goes out of business
What are the three parts of the shadow banking system?
Investment banks, money market mutual funds, hedge funds
Discount Loans
Loans the Federal Reserve makes to banks
What are the 4 functions of money?
Medium of Exchange, Unit of account, store of value, standard of deferred payment
M X V = P X Y
Money Supply X Velocity of Money = Price Level X Real Output
standard of deferred payment
Money allows people to borrow and lend, Value of money depends on its purchasing power
Fiat Money
Money, such as paper currency, that is authorized by a central bank or government body and that does not have to be exchanged by the central bank for gold or some other commodity money
Required Reserves
Reserves that a bank is legally required to hold, based on its checking account deposits
Excess Reserves
Reserves that banks hold over the legal requirement
Federal Open Market Committee (FOMC)
The Federal Reserve committee responsible for open market operations and managing the money supply of the United States
Monetary Policy
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives
Velocity of Money
The average number of times each dollar in the money supply is used to purchase goods and services included in the GDP
Open Market Operations
The buying and selling of treasury securities by the Federal Reserve in order to control the money supply
Federal Reserve
The central bank of the United States
Discount Rate
The interest rate the Federal Reserve charges on discount loans
Required Reserve Ratio
The minimum fraction of deposits banks are required by law to keep as reserves
M1
The narrow definition of the money supply; the sum of currency in circulation, checking account deposits in banks, and holdings in travelers checks
Securitization
The process of transforming loans or other financial assets into securities
Simple Deposit Multiplier
The ratio of the amount of deposits created by banks to the amount of new reserves
What happens when banks lose reserves?
They make less loans and money supply contracts
What happens when banks gain reserves?
They make more loans and money supply expands
4 qualities of money
acceptable, standardized quantity, durable, valuable, divisible
unit of account
each good has a single price instead of many; a way of measuring value in the economy
Federal Reserve Act of 1913
intended to put an end to bank panics
Shadow banking
non-bank financial firms that raise money from investors and lend it directly or indirectly to firms and households—a function that at one time was exclusively the domain of commercial banks
Hedge Funds
raise money from wealthy investors and use sophisticated investment strategies that often involve significant risk
Investment banks
rarely accept deposits, provide advice to firms issuing stocks or bonds or considering mergers, buys mortgage bundles and resell them to investors
Medium of exchange
sellers are willing to accept it for goods or services
Money Market Mutual Funds
sells shares to investors and use the money to buy short term securities such as Treasury bills and commercial paper issued by corporations
Why do governments sometimes expand money rapidly?
they want to spend more than they've raised through taxes
