The Money Supply And The Federal Reserve System

Front 1

What is money?

Back 1

A means of payment, a store of value, and a unit of account.

Front 2

Barter

Back 2

The direct exchange of goods and services for other goods and services. The alternative to a monetary economy.

Front 3

Medium of exchange, or Means of Payment

Back 3

What sellers generally accept and buyers generally use to pay for goods and services. It eliminates the double coincidence of wants problem.

Ex: Monetary system

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Store of Value

Back 4

An asset that can be used to transport purchasing power from one time period to another. Surplus earnings.

Front 5

Liquidity Property of Money

Back 5

The property of money that makes it a good medium of exchange as well as a store of value: It is portable and readily accepted and thus easily exchanged for goods.

Money is easily spent, flowing out of you hands like liquid.

Front 6

Disadvantage of Money as a Store of Value

Back 6

Value of money falls when the prices of goods and services rises.

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A Unit of Account

Back 7

A standard unit that provides a consistent way of quoting prices. All prices are quoted in monetary units.

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Commodity Monies

Back 8

Items used as money that also have intrinsic value in some other use.

Ex: Cigarettes served as money for prisoners of war but could also be smoked.

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Fiat Money, or Token Money

Back 9

Items designated as money that are intrinsically worthless.

Ex: US currency, paper with green ink is worthless and has no other uses.

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Legal Tender

Back 10

Money that a government has required to be accepted in settlement of debts.

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Currency Debasement

Back 11

The decrease in the value of the money that occurs when its supply is increased rapidly.

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M1: Transaction Money

Back 12

Money that can be directly used for transactions.

1. Money in circulation

2. Demand Deposits

3. Traveler's Checks

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M2: Broad Money

Back 13

M1 plus...

1. Savings Accounts

2.Money Market Accounts

3. Other Near Monies

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Near Monies

Back 14

Close substitutes for transactions money, such as savings accounts and money market accounts.

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Financial intermediaries

Back 15

Banks and other institutions that act as a link between those who have money to lend and those who want to borrow money.

Mediate

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Run on a Bank

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Occurs when many of those people who have claims on a bank (deposits) present them at the same time.

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Assets

Back 17

Things a firm owns that are worth something.

Bank Assets...

1. Loans

2. Vault Cash

3. Deposits with the US Central Bank

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Federal Reserve Bank (the Fed)

Back 18

The central bank of the United States.

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Liabilities

Back 19

It's debts - what it owes.

Bank liabilities:

Deposits

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Basic Rule of Accounting

Back 20

Assets - Liabilities = Net Worth

Front 21

Reserves

Back 21

The deposits that a bank has at the Federal Reserve bank plus its cash on hand.

Basically... Vault cash + Acct with FRB

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Required Reserve Ratio

Back 22

The percentage of its total deposits that a bank must keep as reserves at the Federal Reserve

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Excess Reserves

Back 23

The difference between a banks actual reserves and its required reserves.

Front 24

Money Multiplier

Back 24

The multiple by which deposits can increase for every dollar increase in reserves; equal to 1 divided by the required divided by the required reserve ratio.

1

Money Multiplier = --------------------------------

required reserve ratio

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Federal Open Market Committee (FOMC)

Back 25

A group composed of the seven members of the Fed's Board of Governors, the president of the NY Federal Reserve Bank, and four of the other 11 district bank presidents on rotating basis; it set goals concerning the money supply and the interest rates and directs the operation of the Open Market Desk in NY.

Sets the US monetary policy.

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Open Market Desk

Back 26

The office in the NY Federal Reserve Bank from which government securities are bought and sold by the Fed.

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Lender of Last Resort

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One of the functions of the Fed: It provides funds to troubled banks that cannot find any other sources of funds.

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Functions of the Federal Reserve Bank

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1. Clearing interbank payments

2. Regulating the banking system

3. Assisting banks in difficult financial positions

4. Managing exchange rates

5. intercountry negotiations on international economic issues

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How can the Fed Control Money Supply?

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1. Changing the required reserve ratio.

2. Changing the discount rate.

3. Engaging in open market operations.

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How does changing the reserve rate affect the money supply?

Back 30

When the reserve rate is lowered it increases the excess reserve since less money is required for the required reserve. An increase in excess reserve allows for more loans to be giving which increase money supply.

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Discount Rate

Back 31

The interest rate that banks pay to the Fed to borrow from it.

Front 32

How does the discount rate effect the money supply?

Back 32

The Fed can influence bank borrowing, and thus the money supply, through the discount rate. The higher the cost of borrowing the less borrowing banks will do. If the Fed wants to curtail the growth of the money supply it will raise the discount rate and discourage banks from borrowing restricting the growth of reserves.

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Moral Suasion

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The pressure that in the past the Fed exerted on member banks to discourage them from borrowing heavily from the Fed.

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Open Market Operations

Back 34

The purchase and sale by the Fed of government securities in the open market; a tool used to expand or contract the amount of reserves in the system and thus the money supply.

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How does engaging in open market operations effect the money supply?

Back 35

When the Fed purchases a security, it pay for it by writing a check that, when cleared expands the quantity of reserves in the system, increasing the money supply. When the Fed sells a bond, private citizens or institution pay for it with their bank deposits, which reduces the quantity of reserves in the system.

It changes by the:

Money Multiplier x the change in reserves

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Money Supply Curve

Back 36

It is assumed to be vertical because it is assumed that the Fed can achieve any particular value of the money supply through one of its 3 tools.