Econ Ch. 14
To increase the money supply, the FOMC directs the trading desk, located at the Federal Reserve Bank of New York, to
buy US Treasury securities from the public
A higher required reserve ratio _________ the value of the simple deposit multiplier.
decreases
What is not a function of money
open market operation
Money serves as a standard of deferred payment when
payments agreed to today but made in the future are in terms of money
When the federal reserve sells Treasury securities in the open market,
the buyers of these securities pay for them with checks and bank reserves fall
Required reserve ratio is
the minimum fraction of deposits banks are required by law to keep as reserves
When the Federal Reserve decreases the discount rate,
the money supply will increase
The central bank of a country controls the money supply, which equals the currency held by
the public plus their checking account balances
When the Federal Reserve purchases Treasury securities in the open market,
the sellers of such securities deposit the funds in their banks and bank reserves increase
define M1
the sum of currency in circulation, checking account deposits in banks, and holdings of travelers checks.
The quantity theory of money is better able
to explain the inflation rate in the long run
Governments sometimes allow hyperinflation to occur because
when governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation
Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio from 10% to 12%. What actions would you need to take?
you would have to reduce loans to make up of the necessary increase in reserves
What are the largest asset and the largest liability of a typical bank?
Loans are the largest asset and deposits are the largest liability of a typical bank
Why do most depositors seem to be unworried that banks loan out must of the deposits they receive?
The FDIC insures deposits up to $250,000
The use of money
eliminates the double coincidence of wants, reduces the transaction costs of exchange, allows for greater specialization
Congress passed legislation to create the Federal Reserve System in 1913 in order to
end the instability created by bank panics by acting as a lender of last resort
Very high rates of inflation are called
hyperinflation
Change in checking account deposits
1/RR {reserve ratio} X change in bank reserves
Suppose you have $2000 in currency in a shoebox in your closet. One day, you decide to deposit the money in a checking account. How will this action affect the M1 & M2 definitions of the money supply?
Both M1 & M2 will remain unchanged
In addition to the Federal Reserve Bank, what other economic actors influence the money supply?
households, firms, & banks
Credit cards are
included in neither the M1 definition of the money supply nor in the M2 definition
define M2
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
Simple deposit multiplier formula
1/RR the ratio of the amount of deposits created by banks to the amount of new reserves; used to calculate the total increase in checking account deposits from an increase in bank reserves; the inverse, or reciprocal, of the required reserve ratio
Distinguish among money, income, and wealth
A persons money is the currency held and the checking account balance, income is the earning and wealth is equal to value of assets minus all debts
The federal reserve uses two definitions of the money supply, M1 and M2, because
M1 is a narrow definition focusing more on liquidity, whereas M2 is a broader definition of the money supply
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 or some other commodity money
How do banks "create money"?
When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands
Fractional Reserve banking system
a banking system in which banks keep less than 100% of deposits as reserves
Commodity Money
a good used as money that also has value independent of its use as money
Quantity theory of money
a theory of the connection between money and prices that assumes that the velocity of money is constant
Reserve requirements are changed infrequently because
banks set long-term policy decision, loan decisions, and deposit decisions based on the reserve requirement
the most important role of the Federal Reserve in today's US economy is
controlling the money supply to pursue economic objectives
Reserves are
deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve
By raising the discount rate, the Fed leads banks to make ________ loans to households and firms, which will _______ checking account deposits & the money supply
fewer; decrease
The FOMC (Federal Open Market Committee)
includes the Board of Governors and the presidents of the 12 Federal Reserve regional banks (though not all are voting members), determines the target federal funds rate and the direction of open market operation policies, & makes decisions that are voted on by all 7 members of the board of governors but only 5/12 regional bank presidents
What monetary policy tool is used by the Federal Reserve Bank?
increasing the reserve requirement from 10% to 12.5%; buying $500 million worth of government securities, such as Treasury bills' and decreasing the rate at which banks can borrow money from the federal reserve.
The real-world multiplier
is smaller than the simple deposit multiplier because banks keep excess reserves and households hold excess cash
What is true with respect to hyperinflation?
it can be hundreds- even thousands- of percentage points per year, it is caused by central banks increasing the money supply at a rate much greater than the growth rate of real GDP, and firms & households avoid holding money
The Federal Reserve Bank of New York is always voting member of the FOMC because
it carries out the policy directives of the FOMC
Quantity equation=
m X v = p X y
Money serves as a unit of account when
prices of goods and services are stated in terms of money
What is the least likely tool used by the Federal Reserve in order to actively change the money supply?
reserve requirements
Required reserves are
reserves that a bank is legally required to hold, based on its checking account deposits = required reserve ratio X the amount of deposits
Excess reserves are
reserves that banks hold over and above the label requirement = total reserves - required reserves