Chapter 14

Front 1

Money

Back 1

any assetthat can easily be used to purchase goods and services.

Front 2

Currencyin circulation

Back 2

cash held by the public

Front 3

Checkablebank deposits

Back 3

bank accountson which people can write checks.

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moneysupply

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is the total value of financialassets in the economy that are considered money.

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Money must function as

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a medium of exchange, a store of value, a unit of account.

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Mediumof exchange

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Something people accept as paymentfor goods and services

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Storeof value

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Money is a means of holding purchasingpower over time

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Unitof account

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Money provides a yardstick formeasuring and comparing the values of a wide variety of goods and services.

Front 9

Commoditymoney

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a goodusedas a medium of exchange that has intrinsic value in other uses.

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Commodity-backedmoney

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a medium ofexchange with no intrinsic value whose ultimate value isguaranteed by a promise that it canbe converted into valuable goods.

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Fiatmoney

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money whose value derives entirelyfrom its official status as a means of payment.

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Monetary aggregate

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an overallmeasure of the money supply.

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M1

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includes only the most liquid forms ofmoney

Front 14

M2

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includes near-moneys: financialassets that can’t be directly used as a medium of exchange but can readily beconverted into cash or checkable bank deposits

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What do banks do?

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Banks are financial intermediaries thatuseliquid assets(in the form of bank deposits)to finance the illiquid investmentsof borrowers.

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T-account

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a tool for analyzing a business’sfinancial position by showing the business’s assets and liabilities.

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Bankreserves

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the currencythat banks holdin their vaults plus their deposits at the Federal Reserve.

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Thereserve ratio

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the fractionof bank deposits that a bank holds as reserves

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Bankrun

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a phenomenon in which many of abank’s depositors try to withdraw their funds becausethey fear a bank failure

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Depositinsurance

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aguarantee that a bank’s depositors will be paideven if the bank can’t come up with the funds. (The FDICcurrently guarantees the first $250,000 of each account.)

(Depositinsurance creates a well-known incentive problem: Banks can take more risks, sincethey are insured.)

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Capitalrequirements

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requirementthatthe owners of banks hold substantially more assets than the value of bank deposits.

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Reserverequirements

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rules set by the Federal Reserve thatdetermine the minimum reserve ratio for a bank.

(UnitedStates, the minimum reserve ratio for checkable bankdeposits is 10%.)

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Thediscount window

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anarrangementin which the Federal Reserve stands ready to lend money to banks in trouble.

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Excessreserves

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abank’sreservesover and above its required reserves.

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monetarybase

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is the sum of currency incirculation and bank reserves.

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FederalReserve

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is a centralbank; it oversees and regulates the banking system and controlsthe monetary base.

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federalfunds market

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allows banks that fall short of thereserve requirement to borrow funds from banks with excess reserves.

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federalfunds rate

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is the interest rate determined inthe federal funds market

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discountrate

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is the rate of interest the Fedcharges on loans to banks.

*Normally, thediscount rate is set 1 percentage point above the federal funds rate in orderto discourage banks from turning to the Fed when they are in need of reserves.

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How do reserves incase?

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When the Fed buys anything (evenapples), reserves increase

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What kind of asset does the Fed trade in?

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The Fed usually buys and sellsshort-term bonds called Treasury bills, orT-bills

Because government bonds can be stored indefinitelyand are easy to buy and sell on the open market, the Fed chooses this commodity to buy and selldaily

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What are central banks (NOT the Fed) doing when they buy government bonds?

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it is lendingdirectly to the government—in effectprinting money tofinance the government’s budget deficit.

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When was the federal reserve created and why?

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1913. The panicof 1907 convinced many that the time for centralcontrolofbank reserves had come.

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Glass-Steagall Act

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created federaldeposit insurance and increased the ability of banksto borrow from the Federal Reserve system. Also separated banks into commercial and investment banks.

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Commercial banks

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depository banksthat accepted deposits and were covered by deposit insurance

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Investment banks

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banks whichengaged in creating and trading financial assets (stocksand corporate bonds) but were not covered by deposit insurancebecause their activities were considered riskier

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Leverage

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financing an investment withborrowed funds

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Balancesheet effect

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the reduction ina firm’s net worth due to falling assetprices.

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Viciouscircle of deleveraging

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asset sales tocover losses forcingcreditorsto call in their loans,forcing sales of more assets and causingfurther declines in asset prices

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Subprimelending

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lending to home buyers whodon’t meet the usual criteriafor being able to make the payments.

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Securitization

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a pool of loans assembledandshares of it sold toinvestors