ch 15-16

What is the Taylor rule and how is it used?

The Taylor Rule is the conditions for raising and lowering the Federal Funds rate based on the current rate of inflation and the relationship between potential and real GDP. It was designed to provide recommendations for how a central bank like the Federal Reserve should shet short-term interest rates as economic conditions change to achieve short-run goals for stabilizing the economy and long-run goal for inflation. -Fed. Funds = between banks (interest rates)

Describe the multiple expansion of loans and money by the entire banking system.

The ability of a banking system composed of many banks to lend a create money is a multiple (greater than 1) of its excess reserves and is equal to the excess reserves of the banking system multiplied by the checkable deposit or multiplier. -when one bank increases its money supply, it goes to another bank

Define the money multiplier, explain how to calculate it, and demonstrate its relevance.

The ability of a system with many banks to lend and create money is a multiple (greater than 1) of its excess reserves, and is equal to the excess reserves multiplied by the checkable deposit or multiplier.

What are the major strengths of monetary policy compared with fiscal policy?

The major strengths of monetary policy compared with fiscal policy are quite simple: it involves speed and flexibility, along with isolation from political pressure. Fiscal policy does not involve control by central government, which is important in national operations, as well. -Monetary = central government, interest rate, money in economy (expansion and restriction) -Fiscal = no central authority (transfer payments); contractionary and expansionary

What is the monetary multiplier? How does it work?

The monetary multiplier is the amount of money that banks are able to generate with each dollar of reserves. In order to find, or solve for, the monetary multiplier, you would divide 1 by the required reserve ratio.

Explain the basics of a bank's balance sheet and discuss why the U.S. banking system is called a "fractional reserve" system.

A balance sheet is used to explain commercial banking operations and money creations. The major components of a bank's balance sheet are assets, liabilities, and net worth. The U.S. banking system is called a "fractional reserve" system because financial institutions set aside a fraction of their deposits in the form of reserves.

Why does a bank's balance sheet balance?

A bank's balance sheet states loans and investments on the assets side and deposits and borrowings on the liabilities side. -even if its equity, it will always balance out

Explain the effectiveness (advantages) of monetary policy and its shortcomings (disadvantages).

Advantages: Expansionary monetary policy makes it possible for more investments come in and consumers spend more. Lowered interest rates also lower mortgage payment rates. It allows the Central Bank to apply quantitative easing. It promotes predictability and transparency. Fast, not as political Disadvantages: Despite expansionary monetary policy, there is still no guaranteed economy recovery. Cutting interest rates is not a guarantee. It will not be useful during global recession. Contractionary monetary policy can discourage businesses from expansion.

Describe how a bank can create money.

Banks can create money in a system. The money creating ability of many commercial banks is multiplied and influences the money creating ability of the banking system as a whole. -Fractional reserve system - put some in to save it; send some out to create multiplier effect

Why are changes in the rate of interest more likely to affect investment spending than consumption and saving?

Changes in interest rate directly affects the outcome of investments rather than that of spending/consumption. If interest rate goes up, people will invest more and if it drops, people will invest less. While interest rate changes do affect spending, consumption, and saving, it is a less direct effect on those compared to investments. -Determine long-term things for capital purposes

Identify the mechanisms by which monetary policy affects GDP and the price level.

Expansionary Monetary Policy: (easy money policy) lowers the interest rate to bolster borrowing and spending which will increase aggregate demand and expand real output. Restrictive Monetary Policy: (tight money policy) in periods of rising inflation the fed will increase the interest rate to reduce borrowing and spending which will hold price-level increases.

How did the early goldsmiths come to issue paper money and then become bankers?

Goldsmiths became the first bankers when they originally took in other people's gold and stored it for them. The goldsmiths issued warehouse receipts to their customers and these receipts stated the amount deposited. Soon, people began trading the warehouse receipts as a form of money and represented the gold the goldsmiths held. Furthermore, the money receipts were backed by gold creating the gold standard.

Discuss how monetary policy has been used to counter recession and limit inflation since 2000.

Monetary policy: Higher interest rates. This increases the cost of borrowing and discourages spending. This leads to lower economic growth and lower inflation.

What are the important assets and liabilities of the Federal Reserve Banks?

U.S. government securities and loans to commercial banks & outstanding notes, reserve deposits of commercial banks, and U.S. Treasury deposits.

Explain what happens to the money supply when a bank accepts deposits of cash.

When a bank accepts deposits of cash, the cash becomes an asset to the bank, and checkable deposit accounts that are created are a liability. The deposit of cash in the bank does not affect the total money supply. It only changes its composition by substituting checkable deposits for currency (cash) in circulation. -cash becomes an asset to the bank

Explain the distinction between a bank's actual reserves and its required reserves.

actual reserves: a bank's deposits at the Federal Reserve Bank (plus vault cash). Required reserves: when a bank must maintain at its Federal Reserve Bank (vault cash at the bank). It equals the reserve ratio multiplied by the checkable deposit liabilities of the commercial bank.

Explain why the granting of a loan by a commercial bank increases the supply of money.

because of old loans being paid back and with interest, which then becomes the basis of a new loan. -Money multiplier

Define the meaning of excess reserves. How are they calculated?

capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors, or internal controls. -measured against standard reserve requirement amounts that are put into place by central banking authorities (The Federal Reserve System).

What is the basic goal of monetary policy?

put money into the economy and to focus on interest rates. -Keep it stable through interest rates - output/input, etc.

Describe the Federal funds rate and how the Fed directly influences it.

the interest rate at which depository institutions (banks and credit union) lend reserve balances to other depository institutions overnight, on an uncollateralized basis. -Interest rates between banks