CH 10: Money and Banking

Commodity Money

An item that serves a useful purpose other than acting as a medium of exchange. Ex: Salt, gold, and other precious metals have been used in the past.

Fractional Reserve Banking System

Depository institutions (banks) that are required to hold only a small fraction of their total deposits on reserve.

Bank Reserves

Deposits that can legally be in the form of cash in a bank's vault or as deposits at a Federal Reserve Bank.

Excess Reserves

ER= Total Bank Reserves - Required Reserves = R-RR

Simple Deposit Multiplier

Equal to one divided by the reserve ratio, or 1/r. Can be used to find the maximum possible amount of total bank deposits that can be created (deposit creation) when bank reserves increase and lending occurs until excess reserves are equal to zero for all banks.

Potential Deposit Creation

Equal to the change in excess reserves times the simple deposit multiplier. (deltaER)(1/r)

M2

Includes both liquid (spendable) assets that are contained in the M1 measure of money plus less liquid assets, or near-monies.

M1

Includes liquid assets, such as cash and checking account deposits, that are immediately spendable.

M2 equation

M1 + savings deposits + small denomination time deposits + retail money funds

Unit of Account (Standard of Value)

Money acts a common denominator for comparing the relative values of goods and services. Money serves this function and increases efficiency because using money values to make decisions, communicate, and keep records reduces transaction costs.

Store of Value (Store of Wealth)

Money serves as a store of value because it stores purchasing power over time and can be used for future purchases. For large sums over long periods of time, most people use stocks, bonds, or real assets to store value.

Fiat Money

Paper currency and coin that have been designated by government as legal tender (it must be accepted as payment for debts) but it is not convertible into a specific precious metal or other commodity.

Required Reserves

RR = the required reserve ratio x Total Deposits = (r)(D)

Required Reserves Ratio

Required reserves expressed as a percentage of total deposits.

Excess Reserves

Reserves held beyond the minimum required. These reserves may be loaned put. Loaned out reserves create money.

Medium of Exchange

Something that is generally accepted in trade for goods and services and settlement of debts. People use money for this purpose when they make purchases.

Barter

The direct exchange of goods and services. Requires that a double coincidence of wants be satisfied.

Liquidity

The ease with which an asset can be converted into a medium of exchange (cash) without loss of value.

Required Reserves

The fraction of deposits that must be held as reserves in a bank. The current required ratio for demand deposits is 10%.

Double Coincidence of Wants

Two people seek the same trading terms and both believe that the exchange is fair.

Deposit Creation

Uses the multiplier process, and continues for some time, with a smaller amount being loaned (created) in each successive round.

Hyperinflation

When the inflation rate is greater than 50% per month. Money loses value so quickly that people may refuse to accept it in exchange for goods and services.

M1 equation

currency held by the public + demand & other checkable deposits + travelers checks