Econonmics 202 Notes Part 1

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set of assets in an economy that people regularly use to buy goods and services from other people

Back 1

Money

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Functions of money

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-Medium of exchange
-Unit of account: yardstick people use to post prices and record debts
-Store of value: item that people can use to transfer purchasing power from present to the future

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the ease with which an asset can be converted into the economy's medium of exhcange

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Liquidity

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Money that takes the form of a commodity with intrinsic value

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Commodity money: Intrinsic value: item would have value even if it were not used as money

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Money without intrinsic value that is used as money because of government decree

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Fiat money

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quantity of money circulating in the economy

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money stock

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the paper bills and coins in the hands of the public

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currency

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Measures of money in stock

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-M1: demand deposits, traveler's checks. Demand deposits: balances in bank accounts that depositors can access on demand by writing a check
-M2:everything in M1 and includes more assets in its measure of money thatn M1

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Federal reserve system (FED)

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central bank of the United states. Designed to oversee the banking system and reuglate the quantity of money in the economy

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Jobs of the FED

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1. regulate banks and ensure the health of the banking system
2. control the quantity of money that is made available

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Money supply

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quantity of money available in the economy

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Monetary policy

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

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FOMC

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Federal Open Market Committee: decides to increase or decrease money supply

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Open Market operation

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Fed's primary tool.
1. FOMC: increase money supply, the feds make an open-market purchase
2. FOMC: decrese the money supply, the feds make an open-market sale

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Deposits that banks have received but have loaned out

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reserves

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Fractional reserve banking

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a banking system in which banks hold only a fraction of deposits as reserves

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Reserve requirement

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FED sets a minimum amount of reserves that banks must hold

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Money multiplier

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amount of money the banking system generates with each dollar of reserves. Reciprocal of the reserve ratio (1/R)

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resources a bank's owners have put into the institution

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bank capital

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the use of borrowed money to supplement existing funds for purposes of investment

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leverage

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Leverage ratio

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the ratio of assets divided by bank capital

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Capital Requirement

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a government regulation specifying a minimum amount of bank capital

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To increase money supply...

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Feds instruct its bond traders to buy bonds from the public

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To reduce money supply...

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Feds selles government bonds to the public in the naiton's bond markets

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interest rate on the loans that the FED makes to banks

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Discount rate

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Increase of discount rate

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reduces the quantity of reserves in the banking system, which reduces the money supply

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Decrease of a discount rate

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encourages banks to borrow ffrom the FED, increasing the quantity of reserves and the money supply

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Increase of reserve requirements..

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decreases the money supply

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Decrease of reserve requirements

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increases the money supply

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Higher the interest rate on reserves

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the more reserves banks will chose to hold

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The lower interest rates on reserves..

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the less reserves banks will choose to hold

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Problems in controlling the money supply

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-FEDs control of the money supply is not precise
-FED does not control the amount of money households choose to hold as deposits in banks
-FED does not control the amount that bankers choose to lend

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Federal Funds rate

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interest rate at which banks make overnight loans to one another

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When the price of a good is $2...

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the value of a dollar is half of the good (1/P(price))

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Quantity of money demanded depends on the...

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interest rate that a person could earn by using the money to buy an interest-bearing bond rather than leaving it in a wallet

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Supply of money is determeind by..

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the fed and the banking system. The supply curve is vertical

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If the price level is above the equilbirum level..

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people will want ot hold more money than the Fed has created, so the price level must fall to balance supply and demand

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If the price level is below the equilbrium level..

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people will want to hold less money than the Fed has created, and the price level must rise to balance supply and demand

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Quantity theory of money

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the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate

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Nominal variables

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variables measured in monetary units (dollar values)

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Real variables

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variables measured in phsyical units

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the theoretical separation of nominal and real variables

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classical dichotomy

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Velocity money

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the rate at which money changes hands

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Inflation tax

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the revenue the government raises by creating money

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Monetary neutrality

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a change in the money supplies affects nominal variables but not real variables

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one-for-one adjustment of the nominal interest rate to the inflation rate

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The fisher effect

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Inflation fallacy

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"inflation robs people of the purchasing power of his hard-earned dollars"

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resrouces wasted when inflation encourages people to reduce their money holdings

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shoeleather costs

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the costs of changing prices

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menu costs

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unintended changes in tax liabilities due to nonindexation of the tax code

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increased variability of relative prices

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Inflation is bad....

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but deflation may be worse