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78 Cards in this Set
- Front
- Back
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What is the definition of money?
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Money is whatever is accepted in exchange for goods or services or to pay debts.
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What is the definition of commodity money and fiat money?
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Commodity money has a value independent of its role as money.
Fiat money has no real value. |
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What are five desirable characteristics about items that serve as money?
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1. It must be accepted by most traders
2. It should be of standard Quality 3. It should be durable 4. It should be valuable relative to its weight 5. It should be divisible |
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What are the four roles that money plays?
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1. Medium of Exchange
2. Unit of Account 3. Store of Value 4. Standard of Deferred Payment |
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Are credit cards money?
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No. Credit cards are a short term loan
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What is the definition of “Liquidity”?
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How quickly and easily can a financial asset be converted into a form
that would allow you to buy groceries. In other words, converted into money or checking account deposits (M1) |
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What are the main components of M1 and M2?
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The main components of M1 are currency and checking account deposits.
The main components of M2 besides M1 are savings deposits, small denomination time deposits and money _________ market fund shares. |
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What has happened to the proportion of M2 made up of checkable deposits since 1960?
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It has ___________________.
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What is the difference between a “Money Market Instrument” and a “Capital Market Instrument”?
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A money market instrument has a maturity of less than a year and a capital market instrument has a maturity of more than a year.
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What is a “Euro Dollar” and what percent of financial assets are held by Depository Institutions?
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A dollar that is held in an account controlled by a foreign bank and which under the banking regulations of a foreign government.
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How is money created?
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Money is created when loans are made.
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What is the definition of assets and liabilities?
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An asset is when you are owed money
A liability is when you owe someone money |
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Are deposits assets or liabilities? What about loan
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Deposits are assets
Loans are liabilities |
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What is the definition of the Reserve Ratio?
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Banks Reserves divided by Bank total deposits
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What is the definition of Excess Reserves?
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The difference between total reserves and required reserves.
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What is the maximum size of the money multiplier?
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1 divided by the required reserve ratio.
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What is included in the monetary base? What is the definition of “high powered money”?
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The monetary bases equals reserves held by the fed
plus currency High Powered Money is another name for the monetary base |
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What level of control does the FED have over the monetary base and over the money supply?
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Precisely control over the monetary base and
indirectly control over the money supply. |
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Which is larger, the M1 multiplier or the M2 multiplier?
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M2 is larger than M1 so M2 is larger because we
divide by the change in investment. |
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What are three constraints on deposit creation?
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1. Willingness of the public to deposit funds in banks
2. Willingness of the public to borrow money from banks 3. Regulatory constraints on lending |
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How much did the Savings and Loan Crisis cost?
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159.2 billion.
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What was the Glass-Steagall Act and what did it try to limit?
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A depression era law which tried to limit bank competition
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What was “Regulation Q”?
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A section of the Glass-Steagall Act which set limits on the
Interest payments which could be paid on deposits |
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What role was envisioned for Savings and Loans? What is disintermediation?
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Savings and Loans were created so that people could pay for houses
over time instead of having to make a huge down payments. Savings and Loans would accept credit and use that money to make _____________ loans. |
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Why did Savings and Loans start to suffer disintermediation in the 1960s?
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Because of Regulation Q people could get a higher interest rate by taking their money out of savings and loans and putting it into money market funds
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Explain the role of deposit insurance and moral hazard in causing the Savings and Loan crisis?
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Moral Hazard means you do something with someone elses money
you would not do with your own money. Because the U.S. Government guaranteed security, depositors did not care if Savings and Loans were being run by crazy people or banks. |
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With regard to the First and Second Banks of the United States, what was the source of tension regarding the need for a National Bank?
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There was a fear that a National Bank would serve federal interests and limit the power of individual investors
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During the 19th Century, who was the lender of last resort in case of a bank panic?
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There was no one.
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Why was the Federal Reserve created in 1913?
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To be a lender of last resort in order to stop
bank panic. Also, to make sure that farmers could get necessary loans. |
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What three Federal Reserve Banks have more that half of all the Federal Reserve deposits?
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San Francisco, Chicago, and New York City
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Who belongs to the Board of Governors?
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7 members appointed by the president . Chairman and Vice Chairman are confirmed by the president.
They serve staggered 14 year terms. |
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Who belongs to the Federal Open Market Committee (FOMC)?
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The 7 members of the board of governors plus 5
Federal Reserve Bank always including the President of the New York Federal Reserve Bank. |
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What part of the Federal Reserve most actively conducts monetary policy?
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The FOMC
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What are the four goals of monetary policy?
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1. Price stability
2. High employment 3. Economic growth 4. Stability of Financial Markets and Institutions |
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What are the three tools of monetary policy?
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1. The Required Reserve Ratio
2. The Discount Rate 3. Open Market Operations |
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How does a change in Required Reserve Ratio affect the lending capacity of the banking system?
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A change in the Required Reserve Ratio causes a change in:
Excess reserves which changes the lending multiplier thereby changing the lending capacity of the banking system. |
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Why does the FED not use changes in the reserve requirement to conduct monetary policy?
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It would be very ________________ to the financial system because it is such a ______________ tool.
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What is the discount rate and how is it used by the FED? Why is the discount rate potentially an extremely powerful instrument of monetary policy?
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The discount rate is the interest rate that the Federal Reserve charges depository institutions for very short term loans.
The FED has the authority to make loans to any entity whose collapse might endanger the stability of the financial system. The FED can determine the loan ___________ and __________ ___________ charged on such loans based on the situation. |
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The Federal Funds rate is the interest rate that one bank charges another bank for a very short term loan. The Federal Funds Rate and the Discount Rate are very similar to each other because the funds borrowed are used for the same reason.
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The reason is to meet the reserve ratio requirement of the Fed.
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When did the FED start paying interest on required reserves and what is the consequence of that policy?
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__________ of ________. The policy sets a lower floor to the Federal Funds Rate.
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Where does the FED get the money to buy bonds?
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From investments and loans made in the course of conducting
Monetary policy. |
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What is the relationship between bond prices and interest rates?
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When bond prices go up, the effective interest rate on the bond goes
down |
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What is the effect on the money supply when the FED buys or sells bonds?
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When the FED buys bonds, the money they are using to buy the bonds was not previously available to the market. The FED writes a check for the bonds and those checks are deposited at the _____________ __________ into accounts owned by the U.S. treasury or by private financial institutions. This directly increases the size of the monetary base. Money has been created
When the FED sells bonds, the accounts of private financial institutions at the __________________ __________________ are ________________ for the amount of the check received. The _________________ ______________ _____________. Money has been ____________. |
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What is the opportunity cost of holding money?
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The interest which could be earned if you held bonds instead.
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What are the five determinants of the demand for money?
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1. Transactions demand
2. Precautionary demand 3. Speculative demand 4. The level of real GDP ( the higher Y the more money demanded) 5. The Price level. |
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An increase in real GDP will shift the money demand curve how?
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To the right.
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An increase in the price level will shift the money demand curve how?
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To the right
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What is the effect on the money supply when the Treasury sells bonds to the public?
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When the Treasury sells bonds to the public, the money supply stays the same.
When the Treasury sells bonds to the FED, the money supply increases. Money is created |
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With regard to reserve requirements, the discount rate, and the bond market – what would the FED do if they wanted to increase the money supply?
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1. Lower reserve requirements
2. Lower the discount rate 3. Buy bonds |
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Does the FED focus on money supply targets or interest rate targets?
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No
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Does the FED in concentrate on changing short term or long run interest rates? Why?
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Short term interest rates. Long term interest rates are more affected by Long run expectations and other factors which are more slowly affected by changes in monetary policy
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Explain how would decreases in interest rates affect consumption spending, investment spending and net exports.
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1. ________________ consumption spending because credit card and other borrowing would become ___________.
2. ________________ investment spending because everything else the same, more projects would be profitable if the opportunity cost of investment funds is ______________. 3. ___________________ Net Exports because lower interest rates would cause the U.S. dollar to ____________ making our exports __________ to foreigners. |
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What will happen to the AD curve is interest rates drop?
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At a given price level, spending will be greater so the AD curve will shift to the right.
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What are the three policy constraints which could limit the ability of monetary policy to affect the economy?
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1. Reluctant Lenders
2. Liquidity Trap 3. Reluctant Borrowers (Low expectations) |
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How did the lack of deposit insurance during the Great Depression lead to the money supply dropping in half?
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The currency to deposit ratio increased which dropped
the money multiplier in half which dropped the money supply in half. |
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Explain graphically what we mean by “Validating Inflation
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Whenever we use monetary policy to shift the AD curve to the right instead of waiting for the economy to self _____________ the result will be a _______________ price level. Inflation has been validated because otherwise it would have gone away.
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How do we calculate velocity?
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V= PY divided by M = Nominal GDP / money supply
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What two assumptions do Monetarists make?
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1. Although V does change, the changes are predictable
2. Y is stable at YFE as argued by the classical school. |
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According to Monetarists, if we doubled the money supply what would happen in the long run to the level of Y, real interest rates, and the real money supply?
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Prices would double but everything else would end up unchanged.
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A contribution of the New Classical Model to economics is that it has focused on the importance of what to the economy?
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_____________
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Why did Milton Friedman say that “Inflation is always and everywhere a monetary phenomena”?
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Episodes of sustained and high inflation are invariably associated with an increase in the money supply which is too great.
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How independent is the Federal Reserve from political pressure? What is the relationship between the political independence of a country’s Central Bank and inflation?
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The U.S. Federal Reserve is more independent compared to other central banks.
Generally, the more independent, the less the chance of severe inflation. |
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With reference to the Fisher Equation, why did Paul Volker warn in 1979 that nominal interest rates would have to go even higher before they could come down?
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Nominal interest rates were high because expected inflation was high. In order to bring down nominal interest rates it was necessary to decrease real estate of inflation which could only be done by decreasing expected inflation .∆MV=∆Y
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Why were real interest rates so high in the 1980s?
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Decreases in _____________ inflation were ________________ decreases in ________________ inflation.
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What are three problems with following a strict monetary rule?
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1. Is Velocity predictable?
2. Is the growth rate of Y predictable? 3. What about exogenous shocks to the economy? |
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Why did subsequent events prove that following a monetary rule as suggested by Milton Friedman would be difficult?
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Velocity became much more difficult to predict
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What are 3 points about velocity?
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1. Velocity is inversely related to money demand.
2. If interest rates go up, the quantity of money demanded goes down and velocity increases. 3. If Income increases and money demand increases less than proportionately, velocity increases |
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Contrast the inside and outside lags for monetary policy.
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The inside lag for monetary policy is very short while the outside lag is very long
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What is the definition of a bubble?
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When asset prices increase just because they are expected to increase in the future. The price increase is not based on fundamental factors
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How could the FED create a bubble?
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The FED could create a bubble by keeping interest rates too low for too long.
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Should the FED try to deflate bubbles?
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Old Answer No
New Answer Yes |
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What is “credit easing”, what is the result of credit easing, and what is the worry about credit easing?
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Credit easing means making credit more available. The result of credit easing is that the monetary base increases
The worry is that the increase in the monetary supply will cause Inflation. |
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What has happened recently to the monetary base, the multiplier, the money supply, velocity, and inflation?
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The monetary base has increased
The money multiplier has decreased The money supply has remained steady Velocity has decreased The price level has increased |
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How did the U.S. trade deficit contribute to the current financial crisis?
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It put ______________ pressure on interest rates which encouraged
_______________ mortgage loans. |
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How did securities based upon pools of mortgages create a moral hazard problem?
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The institutions that created the mortgages were not at risk
if borrowers failed to pay them back. The reason is that the mortgages had been ___________. |
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What was the role of Freddie Mac and Fannie Mae in the current crisis?
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They bought and sold many of the risky mortgages and then they securitized those Mortgages and sold them as CMO’s.
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Why did regulators fail to prevent all the risk taking which occurred?
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The assumed that house prices would never go down.
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How did the rating agencies contribute to the financial crisis?
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Many securities buyers such as pension funds are prohibited from buying risky securities but securities based on pooled mortgages were rated very high. (AAA)
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