ECN 1500 Final exam

Assumptions

20% required reserves all banks "loaned up" banks lend all of excess reserves a 100 bill is found and deposited, multiple deposits can be created

Troubled Asset Relief Program (TARP)

A 2008 federal government program that authorized the U.S. Treasury to loan up to $700 billion to critical financial institutions and other U.S. firms that were in extreme financial trouble and therefore at high risk of failure.

Fractional reserve banking system

A banking system in which banks and thrifts are required to hold less than 100 percent of their checkable deposit liabilities as cash reserves.

Monetary Policy

A central bank's changing of the money supply to influence interest rates and assist the economy in achieving price stability, full employment, and economic growth.

Federal Reserve System

A central component of the U.S. banking system, consisting of the Board of Governors of the Federal Reserve and 12 regional Federal Reserve Banks.

Savings Account

A deposit that is interest-bearing and that the depositor can normally withdraw at any time.

Balance Sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date. assets = liabilites + networth both sides balance out

Commercial Bank

A firm that engages in the business of banking (accepts deposits, offers checking accounts, and makes loans).

Wall Street Reform and Consumer Protection Act of 2010

A law that gave authority to the Federal Reserve to regulate all large financial institutions, created an oversight council to look for growing risk to the financial system, established a process for the federal government to sell off the assets of large failing financial institutions, provided federal regulatory oversight of asset-backed securities, and created a financial consumer protection bureau within the Fed.

Legal Tender

A legal designation of a nation's official currency (bills and coins). Payment of debts must be accepted in this monetary unit, but creditors can specify the form of payment, for example, "cash only" or "check or credit card only."

M2

A more broadly defined money supply, equal to M1 plus noncheckable savings accounts (including money market deposit accounts), small-denominated time deposits (deposits of less than $100,000), and individual money market mutual fund balances. about 8.9 trillion dollars in feb 2011

Who can a bank borrow from

Another bank, federal reserve bank. interest from another bank is federal fund rate. interest from federal reserve bank is called discount rate.

Checkable Deposit

Any deposit in a commercial bank or thrift institution against which a check may be written.

Medium of Exchange

Any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter.

fiat money

money without intrinsic value that is used as money because of government decree. ex: the US dollar, its just paper but the decree of its value is different than what its made up of. money that has value because the government has ordered that it is an acceptable means to pay debts

Quasi-Public Banks

privately owned by the commercial banks within their district, but operated in the public interest. They are non-profit organizations that actually make a sizable profit, which is turned over to the treasury

required reserves formula

required reserve ratio x total/checkable deposits

LO15.4

The advantages of monetary policy include its flexibility and political acceptability. Recently, the Fed has targeted changes in the Federal funds rate as the immediate focus of its monetary policy. When it deems it necessary, the Fed uses open-market operations to change that rate, which is the interest rate banks charge one another on overnight loans of excess reserves. Interest rates in general, including the prime interest rate, rise and fall with the Federal funds rate. The prime interest rate is the benchmark rate that banks use as a reference rate for a wide range of interest rates on short-term loans to businesses and individuals.

Excess Reserves

The amount by which a bank's or thrift's actual reserves exceed its required reserves; actual reserves minus required reserves.

Asset Demand

The amount of money people want to hold as a store of value; this amount varies inversely with the interest rate.

Transactions demand for money

The amount of money people want to hold for use as a medium of exchange (to make payments); varies directly with nominal GDP.

Financial Services industry

The broad category of firms that provide financial products and services to help households and businesses earn interest, receive dividends, obtain capital gains, insure against losses, and plan for retirement.

Open-Market Operations

The buying and selling of U.S. government securities by the Federal Reserve Banks for purposes of carrying out monetary policy.

Liquidity

The ease with which an asset can be converted quickly into cash with little or no loss of purchasing power. Money is said to be perfectly liquid, whereas other assets have a lesser degree of liquidity.

LO14.5

The financial crisis of 2007-2008 consisted of an unprecedented rise in mortgage loan defaults, the collapse or near-collapse of several major financial institutions, and the generalized freezing up of credit availability. The crisis resulted from bad mortgage loans, coupled with declining real estate prices. It also resulted from an underestimation of risk by holders of mortgage-backed securities, as well as faulty insurance securities designed to protect holders of mortgage-backed securities from the risk of default.

Actual Reserves

The funds that a bank has on deposit at the Federal Reserve Bank of its district (plus its vault cash).

Required Reserves

The funds that banks and thrifts must deposit with the Federal Reserve Bank (or hold as vault cash) to meet the legal reserve requirement; a fixed percentage of the bank's or thrift's checkable deposits.

LO15.2

The goal of monetary policy is to help the economy achieve price stability, full employment, and economic growth. The four main instruments of monetary policy are (a) open-market operations, (b) the reserve ratio, (c) the discount rate, and (d) the interest rate on excess reserves. The Fed's most often used monetary policy tool is its open-market operations. The Fed injects reserves into the banking system (and reduces interest rates) by buying securities from commercial banks and the general public, or through repos, where the Fed loans money to banks that provide securities for collateral. The Fed withdraws reserves from the banking system (and increases interest rates) by selling securities to commercial banks and the general public, or through reverse repos, where the Fed borrows money from banks using securities as collateral.

Discount Rate

The interest rate that the Federal Reserve Banks charge on the loans they make to commercial banks and thrift institutions.

LO14.7

The main categories of the U.S. financial services industry are commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, securities firms, and investment banks. The reassembly of the wreckage from the financial crisis of 2007-2008 has further consolidated the already consolidating financial services industry and has further blurred some of the lines between the subsets of the industry. In response to the financial crisis, Congress passed the Wall Street Reform and Consumer Financial Protection Act of 2010.

LO14.4

The major functions of the Fed are to (a) issue Federal Reserve Notes, (b) set reserve requirements and hold reserves deposited by banks and thrifts, (c) lend money to financial institutions and serve as a lender of last resort in national financial emergencies, (d) provide for the rapid collection of checks, (e) act as the fiscal agent for the federal government, (f) supervise the operations of the banks, and (g) control the supply of money in the best interests of the economy. The Fed is essentially an independent institution, controlled neither by the president of the United States nor by Congress. This independence shields the Fed from political pressure and allows it to raise and lower interest rates (via changes in the money supply) as needed to promote full employment, price stability, and economic growth.

Money Market

The market in which the demand for and the supply of money determine the interest rate (or the level of interest rates) in the economy.

M1

The most narrowly defined money supply, equal to currency in the hands of the public and the checkable deposits of commercial banks and thrift institutions. about 1.9 trillion dollars in feb. 2011

Moral Hazard

The possibility that individuals or institutions will change their behavior as the result of a contract or agreement.

Securitization

The process of aggregating many individual financial debts into a pool and then issuing new securities (financial instruments) backed by the pool. The holders of the new securities are entitled to receive debt payments made on the individual financial debts in the pool.

Board of Governors

The seven-member group that supervises and controls the money and banking system of the United States; also called the Board of Governors of the Federal Reserve System and the Federal Reserve Board.

Reserve Ratio

The specified minimum percentage of its checkable deposits that a bank or thrift must keep on deposit at the Federal Reserve Bank in its district or hold as vault cash.

Total Demand for Money

The sum of the transactions demand for money and the asset demand for money.

LO15.1

There is a set of interest rates that vary by loan purpose, size, risk, maturity, and taxability. Nevertheless, economists often speak of a single interest rate in order to simplify their analysis. The total demand for money consists of the transactions demand and asset demand for money. The amount of money demanded for transactions varies directly with the nominal GDP; the amount of money demanded as an asset varies inversely with the interest rate. The money market combines the total demand for money with the money supply to determine equilibrium interest rates.

The fiscal agent of the U.S. government is the

U.S. Treasury

excess reserves formula

actual reserves - required reserves

fiscal agent

an entity, such as a bank, that handles financial matters for another party an entity, such as a bank, that handles financial matters for another party

Central Banks

an institution that oversees the banking system and regulates the money supply

store of value

an item that people can use to transfer purchasing power from the present to the future

money

anything that serves as a medium of exchange, a unit of account, and a store of value, searching for a double coincidence of wants is not needed with this.

commodity money

takes the form of a commodity with intrinsic value Examples: gold coins, cigarettes in POW camps

Federal reserve

the central bank of the United States

reserve ratio

the fraction of bank deposits that a bank holds as reserves

Demand Deposits

balances in bank accounts that depositors can access on demand by writing a check

financial intermediaries

financial institutions through which savers can indirectly provide funds to borrowers - banks mutual funds: institutions that sell shares to the public and use the proceed to buy portfolios of stocks and bonds

main job of fed reserve bank

issue currency set reserve requirements lend money to banks set discount rate, interest rate, banks pay when they borrow money from fed reserve bank Check collection and/or clearing fed reserve act as a fiscal agent for US gov supervise bankes control money supply in economy

Financial Systems

the group of institutions in the economy that help to match one person's saving with another person's investment

Currency

the paper bills and coins in the hands of the (non-bank) public

money supply

the quantity of money available in the economy

monetary policy

the setting of the money supply by policymakers in the central bank

double coincidence of wants

the unlikely occurrence that two people each have a good the other wants

unit of account

the yardstick people use to post prices and record debts

LO14.6

In 2008, Congress passed the Troubled Asset Relief Program (TARP), which authorized the U.S. Treasury to spend up to $700 billion to make emergency loans and guarantees to failing financial firms. The TARP loans intensified the moral hazard problem. This is the tendency of financial investors and financial firms to take on greater risk when they assume they are at least partially insured against loss.

Money Market Deposit Account (MMDA)

An interest-earning account (at a bank or thrift) consisting of short-term securities and on which a limited number of checks may be written each year.

Time Deposit

An interest-earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specified period.

subprime mortgage

High-interest-rate loans to home buyers with above-average credit risk.

financial markets

-savers can directly provide funds to borrowers -the bond market -the stock market

Repo

A repurchase agreement (or "repo") is a short-term money loan made by a lender to a borrower that is collateralized with bonds pledged by the borrower. The name repo refers to how the lender would view the transaction. The same transaction when viewed from the perspective of the borrower would be called a reverse repo.

Reverse Repo

A reverse repurchase agreement (or "reverse repo") is a short-term money loan that the borrower obtains by pledging bonds as collateral. The name reverse repo refers to how the borrower would view the transaction. The same transaction when viewed by the lender would be called a repo.

Thrift institution

A savings and loan association, mutual savings bank, or credit union.

Unit of Account

A standard unit in which prices can be stated and the value of goods and services can be compared; one of the three functions of money.

Balance sheet

A statement of the assets, liabilities, and net worth of a firm or individual at some given time.

Store of value

An asset set aside for future use; one of the three functions of money.

Characteristics?

Banks create money through lending banks are subject to panics which means bankrupt could occur? after great depression we have a bank insurance that can guarantee about 200k back in each bank if the bank shuts down

Token Money

Bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency still circulating, money for which the face value exceeds the commodity value.

Mortgage Backed Securities (MBS)

Bonds that represent claims to all or part of the monthly mortgage payments from the pools of mortgage loans made by lenders to borrowers to help them purchase residential property.

Bond and stocls can...

Both be traded in the financial market

What fed reserve is michigan under?

Chicago fed reserve

LO14.1

Conceptually, money is any item that society accepts as (a) a medium of exchange, (b) a unit of monetary account, and (c) a store of value. In the United States, two "official" definitions of money are M1, consisting of currency (outside banks) and checkable deposits, and M2, consisting of M1 plus savings deposits, including money market deposit accounts, small-denominated (less than $100,000) time deposits, and money market mutual fund balances.

Necessary Transactions

Create a bank accept deposits lend excess reserves

barter

Exchange goods without involving money.

Reserve Requirements (RR)

FED can establish and vary reserve ratio within limits set by congress required reserve help fed control lending abilities of commercial bank regulations on the minimum amount of reserves that banks must hold against deposits

Near-Money

Financial assets, the most important of which are noncheckable savings accounts, time deposits, and U.S. short-term securities and savings bonds, which are not a medium of exchange but can be readily converted into money.

LO15.5

In response to the financial crisis of 2007-2009, the Fed pursued a number of expansionary monetary policies, including lowering the discount rate and Federal funds rate. In December 2008, it embarked on a zero interest rate policy (ZIRP) in an effort to stimulate economic recovery and growth. When lowering interest rates to nearly zero failed to have the desired stimulatory effect, the Fed implemented quantitative easing. Because of the severity of the financial crisis, including the possible failure of several major banks, the Federal Reserve provided lender-of-last-resort loans to financial institutions through a series of newly established Fed facilities. Most of these facilities closed in 2010 but could be reestablished in the event of another financial crisis. Monetary policy has two major limitations and potential problems: (a) Recognition and operation lags complicate the timing of monetary policy. (b) In a severe recession, the reluctance of banks to lend excess reserves and firms to borrow money to spend on capital goods may contribute to a liquidity trap that limits the effectiveness of an expansionary monetary policy. In 2015, the Fed began to take steps to raise interest rates back to historically normal levels. That has not yet been achieved, causing some to question what actions the Fed might take if the U.S. economy suffers another recession. Some central banks in Europe have adopted negative interest rates in an effort to stimulate borrowing, spending, and growth.

Financial Institution

Institution which collects funds from the public and places them in financial assets such as deposits, loans, and bonds in financial markets, and financial intermediaries

interest on excess reserves (IOER)

Interest rate paid by the Federal Reserve on bank excess reserves.

Money Market Mutual Funds (MMMFs)

Interest-bearing accounts offered by investment companies, which pool depositors' funds for the purchase of short-term securities. Depositors may write checks in minimum amounts or more against their accounts.

LO14.8

Modern banking systems are fractional reserve systems: Only a fraction of checkable deposits is backed by currency. Commercial banks keep required reserves on deposit in a Federal Reserve Bank or as vault cash. These required reserves are equal to a specified percentage of the commercial bank's checkable-deposit liabilities. Excess reserves are equal to actual reserves minus required reserves. Commercial banks create money—checkable deposits, or checkable-deposit money—when they make loans. The ability of a single commercial bank to create money by lending depends on the size of its excess reserves. Generally, a commercial bank can lend only an amount equal to its excess reserves. Money creation is thus limited because, in all likelihood, checks drawn by borrowers will be deposited in other banks, causing a loss of reserves and deposits to the lending bank equal to the amount of money lent. The commercial banking system as a whole can lend by a multiple of its excess reserves because the system as a whole cannot lose reserves. Individual banks, however, can lose reserves to other banks in the system. The multiple by which the banking system can lend on the basis of each dollar of excess reserves is the reciprocal of the reserve ratio. The bank panics of 1930-1933 resulted in a significant contraction of the U.S. money supply, contributed to the Great Depression, and gave rise to federal deposit insurance.

Monetary Multiplier

Monetary multiplier is maximum amount of new money created by a single dollar of excess reserves formula: 1/r = 1/requred reserve ratio = m higher R, Lower M reversibaility The multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1 divided by the reserve requirement.

LO15.3

Monetary policy affects the economy through a complex cause-effect chain: (a) Policy decisions affect commercial bank reserves; (b) changes in reserves affect the money supply; (c) changes in the money supply alter the interest rate; (d) changes in the interest rate affect investment; (e) changes in investment affect aggregate demand; and (f) changes in aggregate demand affect the equilibrium real GDP and the price level.

LO14.2

Money has value because of the goods, services, and resources it will command in the market. Maintaining the purchasing power of money depends largely on the government's effectiveness in managing the money supply to prevent inflation.

Federal Reserve Note

Paper money issued by the Federal Reserve Banks.

Federal Reserve Banks

The 12 banks chartered by the U.S. government to control the money supply and perform other functions.

Federal open market committee

The 12-member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for U.S. government securities.

LO14.3

The U.S. banking system consists of (a) the Board of Governors of the Federal Reserve System, (b) the 12 Federal Reserve Banks, and (c) some 6,200 commercial banks and 8,700 thrift institutions (mainly credit unions). The Board of Governors is the basic policymaking body for the entire banking system. The directives of the Board and the Federal Open Market Committee (FOMC) are made effective through the 12 Federal Reserve Banks, which are simultaneously (a) central banks, (b) quasi-public banks, and (c) bankers' banks.

Fractional reserve banking

a banking system that keeps only a fraction of funds on hand and lends out the remainder a banking system that keeps only a fraction of its funds on hand and lends out the remainder

bond

a certificate of indebtedness - rated AAA bond = no risk, strong credibility - A+ A B C ... A financial security that represents a promise to repay a fixed amount of funds a formal contract to repay borrowed money with interest at fixed intervals

Stock

a claim to partial ownership in a firm when company makes profit, you have a right to be compensated also in form of dividends to whoever holds the stocks and this will depend on what type as not all do.

in a 100% reserve banking system....

banks do not affect size of money supply.

reserve ratio equation

commercial bank's required reserves / commercial bank's checkable-deposit liabilities

money supply formula

currency + deposits money multiplier x bank reserves

two assets considered in the money supply

currency and demand deposits

commercial banks

earn profits - make loans and earn interest - buy securities to earn interest maintain liquidty alterate - overnight bank loans - federal funds rate if bank is short one day they borrow from another bank to cover for that day. interest on bank to bank loans is federal fund rate, very short term loans 1-3 days

credit crunch

when banks stop lending problem in economy is not enough increase in money supply, impacts interests rates, money supply in economy is less to no money to spend by people and businesses occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing, and leads to a rise in the cost of borrowing