CH 14 Money and Banking
1. Barter – describe a barter situation
Trading one good or service for another without money.I trade sewing services to someone to trim my trees.
2. Double coincidence of wants -- a major disadvantage of the Barter System
Situation in which two people each want some good or service that the other one has. Give an example: if I trade accounting services to trim my trees, then both of our double coincidence of wants will be satisfied
3. What are the four functions of money and define each
a. Medium of exchange – widely accepted as a method of payment
b. Store of value – serves to preserve economic value and can be spent in the future. Valid criticism as a store of value – annual inflationary loss of purchasing power
c. Unit of account – the common way in which market values are measured
d. Standard of deferred payment – acceptable to make purchases today that will be paid in the future
4. Commodity money – an item used as money, but also has value for its use as something other than money. Example: gold and silver coins
5. Fiat money – has no intrinsic value, but is declared by a government to be legal tender. The US dollar is Fiat money.
6. What is an asset? Give an example from Bank Balance Sheet
a. Item of value owned by an individual or firm
Bank assets include Cash Reserves, Loans Receivable, US Bonds
7. What is a liability? Any amount or debt owed by a firm or individual
Bank liabilities include Customer Checking accounts, Loans Payable
8. Asset-liability time mismatch – a bank’s liabilities can be withdrawn in the short-run, while its assets are repaid in the long-run
9. Balance sheet – What are the account classifications listed on a Balance Sheet?
Assets, Liabilities and Equity
10. What are reserves? Excess reserves? Required Reserves?
a. Reserves are the funds that a bank keeps on hand and that are not loaned out or invested in bonds.
b. Excess reserves are the amount of reserves in excess of required reserves. Excess reserves can be loaned out.
c. Required reserves are the portion of reserves which must be held in the bank’s vault or on deposit with the Federal Reserve Bank.
11. What does M1 money supply include?
Currency, Checking accounts, and Traveler’s checks
12. What does M2 money supply include?
M1 money supply plus savings deposits, money market funds, and certificates of deposit.
13. Money multiplier- In a multi-bank system, institutions determine the amount of money that the system can create by using the money multiplier.
14. Money multiplier formula = 1/reserve requirement
Multiplier = 1/reserve requirement
If reserve requirement is 10%, What is the Multiplier?
1/.10 = 10 The multiplier is 10
a. By multiplying the money multiplier by the excess reserves, we can determine the total amount of M1 money supply created in the banking system.
15. What is money?Anything that can be used in exchange for goods and services.
CH 15 Monetary Policy and Bank Regulation
16.Bank run – when depositors race to the bank to withdraw their deposits out of fear they will be lost.
17. Deposit Insurance-FDIC (Federal Deposit Insurance Corporation) Insurance for bank deposits up to $250,000 per individual in case the bank goes bankrupt.
18. Federal funds rate/ federal funds market –
Federal Funds Rate - interest rate at which one bank lends funds to another bank overnight or for a very short period.
Federal Funds Market is a market where banks lend reserves to one another for very short periods.
19. Target federal funds rate - the Fed cannot change the Federal Funds Rate, so it sets a target federal funds rate and uses open market operations to change the supply of loanable funds and change the interest rate in the federal funds market.
20. Discount rate/discount loan –
Discount Rate -The interest rate the central bank charges banks that borrow reserves from it.
A discount loan is a loan the Fed (central bank) makes to a commercial bank
21. Reserve requirement - the percentage of its total deposits that a bank must hold in its vault or on deposit at a Federal Reserve Bank. Currently it is 0 % for the US
22. Excess reserve – reserves banks hold that exceed the legally mandated limit. Excess reserves can be used to make loans such as car loans or home mortgages.
23. Federal Reserve Banking System – the central bank of the United States
24. Central Bank – institution which conducts a nation’s monetary policy and regulates its banking system and the supply of money.
25. Federal Open Market Committee (FOMC) – makes the decisions regarding open market operations. Is comprised of the Board of Governors, 5 Federal Reserve’s Bank Presidents from the regional Federal Reserve (The president of the Federal Reserve Bank of New York holds a permanent seat on the FOMC because the New York Fed is responsible for executing open market operations.
26. Open market operations – the central bank selling or buying Treasury bonds to influence the quantity of money and the level of interest rates.
27. Expansionary monetary policy is used during a recession. It increases the supply of money. Increasing the supply of money will decrease interest rates, which in turn will increase business investment and consumer spending which will lead to an increase in aggregate demand. (shift right of the aggregate demand curve) When faced with a recession, the Fed could Buy Bonds, Decrease the Discount Rate, Decrease the Required Reserve Ratio or Decrease the Interest on Reserve Balances (IORB)
28. Contractionary monetary policy is used during an inflationary gap. –it decreases the supply of money. Decreasing the supply of money will increase interest rates, which in turn will decrease business investment and consumer spending leading to a decrease in aggregate demand. (shift left of the aggregate demand curve). When face with an inflationary gap, the Fed could Sell Bonds, Increase the Discount Rate, Increase the Required Reserve Ratio or Increase the Interest on Reserve Balances (IORB)
29. Quantitative easing is a non-traditional action in which the central bank purchases long-term government and mortgage-backed securities to make credit available in hopes to stimulate aggregate demand. This was an emergency measure taken by the Federal Reserve during the Great Recession and during Covid. Currently, the Fed is decreasing its investment in long-term government securities and mortgage backed securities.
30. Velocity of money –the speed at which money circulates in an economy.
31. Federal Reserve (Central Bank) and its most important task is to control the supply of money by conducting Monetary Policy.
32. The current chairman of the board of governors of the Federal Reserve-
Jerome Powell
33. The Federal Open Market Committee (FOMC) is made up of
the 7 member board of governors & 5 federal reserve district bank presidents (NY president has a permanent seat) They decide on Open Market Operations
34. The Federal Reserve traditional tools used in a banking system with scarce reservesinclude:
Open market operations, the discount rate, and the required reserve ratio
35. Where do banks keep their required reserves? In their vault or on deposit at a Federal Reserve District Bank.
36. The tools now being used by the Federal Reserve System because we currently have a banking system with Ample Reserves are:
▪ Open Market Operations ▪ Administered Rates ▪ Discount Rate ▪ Interest on Reserve Balances (IORB)
❖ The Interest On Reserve Balances (IORB rate) is the rate of interest that the Federal Reserve pays on balances deposited at Federal Reserve Banks. The interest rate is set by the Board of Governors, and it is an important tool of monetary policy at this time..
❖ A decrease in IORB will decrease the interest rate which increases Investment and increases Aggregate Demand. (Expansionary Monetary Policy used during a recessionary gap)
❖ An increase in IORB will increase the interest rate which decreases Investment and decreases Aggregate Demand. (Contractionary Monetary Policy used during an inflationary gap.)
We are currently dealing with Inflation, so the Fed is slowly raising the Interest on Reserve Balances (IORB) and raising the Target Federal Funds Rate. The Fed (central bank) is taking these actions in order to decrease the supply of money, increase interest rates and slow down the economy by decreasing consumption spending and business investment which will lead to a decrease in aggregate demand (shift leftward of the AD curve)
CH 17 Government Budgets and Fiscal Policy
37. Balanced budget - when government spending and tax revenue are equal
38. Budget surplus – when the government receives more tax revenue than it spends in a year.
39. Budget deficit - when the government receives less tax revenue that it spends in a given year.
40. National debt – the total accumulated amount the government has borrowed, over time, and not yet paid back.
41. Discretionary Fiscal Policy –when the government passes a new law that explicitly changes taxes or government spending with the intent of influencing the level of economic activity. Expansionary and Contractionary Fiscal Policy
42. Automatic stabilizers – tax and spending rules that change economic activity without any additional change in legislation. Example:unemployment insurance increases government spending in a recession when we have high unemployment.
43. What can cause Fiscal Policy not to work as well as planned?
a. Crowding out – gov’t borrowing causes increased interest rates leading to a decrease in consumption and investment.
b. Lags
i. -Recognition lag – time it takes to determine economy is in a recession
ii. Legislative lag – time it takes to get fiscal policy bill passed
iii. -Implementation lag – time it takes for funds to be dispersed and new programs implemented.
44. Contractionary fiscal policy – what is it and when should it be used? A decrease in government spending or an increase in taxes used during an inflationary gap.
45. Expansionary fiscal policy - what is it and when should it be used? An increase in government spending or decrease in taxes used during a recessionary gap.
46. Progressive tax (used for federal income tax in the US) -a tax that collects a greater share of income from those with high incomes than from those with low incomes
47. Regressive tax – a tax in which people with higher incomes pay a smaller share of their income in tax
48. Proportional tax - a tax that is a flat percentage of income earned, regardless of level of income.
49. Excise tax – a tax on a specific good like gasoline, tobacco, or alcohol.
50. Marginal tax rates and how they work – the tax rate an individual would pay on one additional dollar of income.
Only the portion of income that falls into the new marginal rate is taxed at the new rate. Even millionaires get to take advantage of lower marginal rates on their income at lower tax bracket levels.
Explain Fiscal and Monetary Policy:
Fiscal Policy is managed by Congress and the President. It consists of changes in Government Spending and/or changes in Taxes.
Monetary Policy refers to the tools used by the Federal Reserve System (Central Bank) in order to control the money supply. The traditional tools used by the Fed(when we have scarce reserves) are Open Market Operations, the Discount Rate,and the Required Reserve Ratio.
IF we have ample Reserves, the Fed will use Interest on Reserve Balances(IORB), the Discount Rate and Open Market Operations to control the Money Supply.