Chapter 25 Microeconomics

Fractional reserve banking system

A banking system in which banks keep less than 100 percent of deposits as reserves

When banks gain reserves, they make new loans, and the money supply .....

expands

Commercial Loans

to businesses

Consumer Loans

to households

What is unit of account?

way of measuring value in the economy

What is medium of exchange?

(money) both sides agree on exchange.

What are the 4 functions of money?

- Medium of exchange - Unit of account - Store of value - Standard of deferred payment

The flow of payment on securitized loan

1. Banks collect loan payments from households 2. collect a fee for processing the payments 3. send payments to investors

Securing a loan*** look in book

1. Banks grant loans to households 2. loans are bundled into securities 3. Investors purchase new securities

Past 20 years, 2 most important development on financial systems

1. Banks have begun to resell many of their loans rather than keep them until they are paid off 2. Financial firms other than commercial banks have become sources of credit to businesses

What can serve as money?

1. The good must be ACCEPTABLE to most people. 2. It should be of STANDARDIZED QUALITY so that two units are identical. 3. It should be DURABLE so that value is not lost by spoilage 4. It should be VALUABLE relative to its weight so that amounts large enough to be useful in trade can be easily transported. 5. The medium of exchange should be DIVISIBLE because different goods are valued.

3 monetary policy tools

1. open market operations 2. discount policy 3. reserve requirements

What is M2?

A broader definition of the money supply: It includes M1 plus savings account balances, small denomination time deposits, balances in money market deposit accounts in banks, and the non-institutional money market fund shares.

security

A financial asset- such as a stock or bond- that can be bought and sold in a financial market

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 velocity of money is constant.

What are reserves?

Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve.

The Quantity Theory Explanation of Inflation

Inflation rate = Growth rate of the money supply - growth rate of real output

Discount loans

Loans the Federal Reserve makes to banks

Discount Policy

Lowering the discount rate, encourages banks to take additional loans and increase their reserves. With more reserves, banks make more loans to households and firms, which increases checking account deposits and the money supply. Raising discount rate will have reverse effect.

Excess Reserves

Reserves that banks hold over and above the legal requirement for loans

What is Fiat Money?

Money, such as paper currency, that is authorized by a central bank or governmental body and that does not have to be exchanged by the central bank for gold.

Connection between money and prices?

Quantity equation MxV=PxY Money Supply (M) Velocity of Money (V) Price Level (P) Real Output (Y)

Required Reserves?

Reserves that a bank keeps as cash in its vault or on deposit with the Federal Reserve.

Monetary policy

The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objective

Velocity of money

The average number of times each dollar in the money supply is used to purchase goods and services included in GDP

What is the Federal Reserve?

The central bank of the United States

Federal Open Market Committee (FOMC)

The federal reserve committee responsible for open market operations and managing the money supply in the United States

Discount rate

The interest rate the federal reserve changes on discount loans

Required reserve ratio (RR)

The minimum fraction of deposits banks are required by law to keep as reserves

What is M1?

The narrowest definition of the money supply: the sum of currency in circulation, checking account deposits in banks, and holdings of traveler's 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

Reserve Requirements

The ratio the Fed requires banks to hold in reserves. Banks are able to lend out anything not in the reserve.

Equation for Velocity

V= PxY/M

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

what is an asset?

anything of value owed by a person or firm

definition of money

assets that people are generally willing to accept in exchange for goods and services

How can a central bank help stop a bank panic?

by acting as a lender of last resort, this is making loans to other banks

"why do we need money?"

by making exchanges easier, money allows people to specialize and become more productive

What is the most important part of the money supply?

checking account balance component

when banks lose reserves, they reduce their loans, and the money supply ....

contracts

Open market operations

the buying and selling of treasury securities by the federal reserve in order to control the money supply