Chapter 10: The Money Supply and the Federal Reserve System
A currency is liquid if ___________ and ___________.
1. It comes in convenient denominations. 2. It is easily exchangeable for goods and services at all times.
functions of the Federal Reserve
1. approves interbank payments 2. regulates the banking system 3. manages the nation's foreign exchange reserves
three ways in which the Federal Reserve controls the money supply
1. changing the required reserve ratio 2. changing the discount rate 3. engaging in open market operations
What are two things that the Federal Open Market Committee does?
1. sets goals regarding money supply and interest rates 2. directs operations of open-market desk in NYC (by selling government securities)
What happens to the money supply if the Treasury issues bonds and sells them to the public to finance the deficit?
The government spends every dollar that it borrows, so there is no change in the money supply.
Calculate the change in the money supply given reserves, an old required reserve ratio, a new required reserve ratio, and the money supply.
[reserves-(new reserve ratio x money supply)] x 1/new RRR
What is an implication of a higher discount rate?
a higher cost of borrowing; less borrowing
unit of account
a standard unit that provides a consistent way of quoting prices
fiat money
a.k.a. token money intrinsically worthless
excess reserves
actual reserves-required reserves
financial intermediaries
banks and other institutions that link those who have excess funds and those who must borrow them
M1: Transaction Money
bills, coins, checks, debit cards, and anything else that can be immediately used as a means of payment M1=currency held outside of banks+demand deposits+ travelers' checks+ other checkable deposits
government security
bond (debt obligation) issued by a government authority, with a promise of repayment upon maturity may be issued by the government itself or by a government agency low-risk; backed by the taxing power of the government.
1/RRR=?
deposits
reserves
deposits made by commercial banks with the Federal Reserve+cash on hand
Which of the three ways in which the Federal Reserve controls the money supply is the most popular?
engaging in open market operations
M2: Broad Money
includes M1 plus all assets that are in accounts at financial institutions that allow the withdrawal of cash, either immediately or after a certain amount of time; considered a better indicator of the money supply than M1 M2=M1+savings accounts+money market accounts
commodity monies
items used as money that have intrinsic value
legal tender
money that a government has required to be accepted in settlement of debts
required reserve ratio (RRR)
percent of a bank's total deposits that it must keep as reserves with the Federal Reserve
required reserves
percent of a banks's total deposits that must be held in the bank's vaults or at the closest Federal Reserve bank=RRR*total deposits
bank run
phenomena in which those who have claims on a bank (deposits) retrieve those claims all at once reflects distrust of institution/fear of financial insecurity
open market operations
the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system Purchases inject money into the banking system and stimulate growth while sales of securities do the opposite.
currency debasement
the decrease in the value of money that occurs when its supply is increased rapidly problematic in nations where raising taxes is politically unpopular and the government is weak
the discount rate
the interest rate paid by banks to the Federal Reserve for borrowing
the money multiplier
the relationship between the final change in deposits and the change in reserves that caused this change the multiple by which deposits can increase for every dollar increase in reserves derived under the assumption that banks hold no excess reserves 1/RRR