Term
| What are the 4 functions of money? |
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Definition
1. Medium of exchange
2. Unit of exchange
3. Store of value
4. Standard of deferred payment |
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Term
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Definition
| The narrowest definition of the money supply: The sum of currency in circulation, checking account deposits in banks, and holdings of traveler’s checks. |
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Term
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Definition
1. Currency, which is all the paper money and coins that are in circulation, where “in circulation” means not held by banks or the government.
2. The value of all checking account deposits at banks.
3. The value of traveler’s checks. |
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Term
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Definition
| A broader definition of the money supply: It includes M1 plus savings account balances, small-denomination time deposits, balances in money market deposit accounts in banks, and noninstitutional money market fund shares. |
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Term
| What are two key points to keep in mind about the money supply? |
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Definition
1. The money supply consists of both currency and checking account deposits.
2. Banks play an important role in the way the money supply increases and decreases. |
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Term
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Definition
Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve.
Reserves are not loaned out or invested.
Vault cash is physically kept within the bank. |
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Term
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Definition
| Reserves that a bank is legally required to hold, based on its checking account deposits. |
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Term
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Definition
| The minimum fraction of deposits banks are required by law to keep as reserves. |
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Term
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Definition
| Reserves that banks hold over and above the legal requirement. |
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Term
| Simple deposit multiplier |
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Definition
| The ratio of the amount of deposits created by banks to the amount of new reserves. |
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Term
| Equation for simple deposit multiplier |
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Definition
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Term
| Change in checking account deposits= ? |
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Definition
| Change in bank reserves x (1/RR) |
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Term
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Definition
| The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives. |
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Term
| To manage the money supply, the Fed uses three monetary policy tools: |
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Definition
1. Open market operations
2. Discount policy
3. Reserve requirements |
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Term
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Definition
| The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply. |
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Term
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Definition
By lowering the discount rate, the Fed can encourage banks to take more loans and thereby increase their reserves, giving them a stronger incentive to make more loans to households and firms, which will increase checking account deposits and the money supply.
Raising the discount rate will have the reverse effect. |
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Term
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Definition
When the Fed reduces the required reserve ratio,
it converts required reserves into excess reserves.
If the Fed raises the required reserve ratio, it will have the reverse effect. |
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Term
| What is the quantity equation? |
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Definition
The quantity equation states that the money supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by real output (Y).
M x V = P x Y |
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Term
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Definition
The average number of times each dollar in the money supply is used to purchase goods and services included in GDP.
V= (PxY)/M |
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Term
| The Quantity Theory of Money |
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Definition
| A theory about the connection between money and prices that assumes that the velocity of money is constant. |
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Term
| If velocity is constant, then what is the inflation rate? |
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Definition
| Inflation rate = Growth rate of money supply-Growth rate of real output |
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Term
| The inflation rate equation leads to the following three predictions: |
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Definition
1. If the money supply grows at a faster rate than real GDP, there will be inflation.
2. If the money supply grows at a slower rate than real GDP, there will be deflation. (Recall that deflation is a decline in the price level.)
3. If the money supply grows at the same rate as real GDP, the price level will be stable, and there will be neither inflation nor deflation. |
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