Term
| What constitutes the official money supply in the US? |
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Definition
| M1 and M2. M1 is the elements that can be used as a medium of exchange (coins, currency, checkable deposits and traveler's checks). M2 is everything in M1 plus time deposits (savings accounts, certificates of deposit) |
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Term
| Why are credit card charges not considered part of the money supply? |
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Definition
| Because they are short-term loans from financial services institutions. They have to be paid off with money from M1 or M2 |
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Term
| What are the basic differences among the M1 and M2 definitions of the money supply? |
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Definition
| The difference is the degree of liquidity. M1 is 100% because it is already M1. M2 has to be converted into M1 before it can be used, so they have less liquidity |
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Term
| What backs or gives value to the money supply today? How is this different from previous periods in American history? |
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Definition
| The money today has no precious metal backing. Earlier, currency and checking accounts were convertible into gold because Us and others operated under an international gold standard. |
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Term
| Describe the structure of the Fed. Explain how this structure is designed to ensure independence of Fed from political process. |
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Definition
| Fed has a Board of Governors comprised of 7 people nominated by the president and senate. Each serves a single term of 14 years. There are 12 Fed District Banks, presidents make up Federal Advisory Council that advises Board of Governors. |
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Term
| List and explain the 5 functions of the Fed |
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Definition
| (1) to clear and collect checks (2) to supervise member banks (3) to act as a fiscal agent for the US government (4) to supply the economy with paper money (5) to control the money supply |
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Term
| Why do banks and other financial institutions accept deposits? |
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Definition
| Banks would never accept deposits unless they were allowed to make loans with some part of the funds that are deposited with them. Banks are for-profit institutions, and they would never accept deposits if they were not allowed to make loans. |
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Term
| What is the legal reserve requirement and how is its value determined? |
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Definition
| the legal reserve requirment is the percentage of deposits that banks cannot loan out, but rather must be held in the form of required reserves. If deposits are $100 and the legal reserve requirement is 25%, then $25 of the $100 is required reserves and cant be loaned out. The remaining $75 can be used for loans |
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Term
| What is mean by the money multiplier? What determines its value? |
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Definition
| It is the ratio of the change in the money supply that the banking system can create to the original amount of excess reserves available. The value is determined as the recipricol of the legal reserve requirement. |
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Term
| Explain the difference between legally required and excess reserves? |
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Definition
| legally required reserves cannot be loaned by banks. Excessive reserves are those reserves above and beyond amounts that are legally required, and that is why they are called excess reserves. Only excess can be used to make new loans. |
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Term
| What is the discount rate? How does the Fed use it to change the money supply? |
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Definition
| Commercial banks and other deposit holding institutions may borrow excess reserves from their Fed District Bank. In order to do so, they must agree to pay interest on the excess reserves that they borrow. The interest rate charged by the Fed on such loans is called discount rate. |
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Term
| Explain how changes in the legal reserve requirement cause the money supply to change. |
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Definition
| when required reserves decline the excess reserves will rise. A reduction in legal reserve requirement not only increases the amount of excess reserves, but also increases the maximum value of the money multiplier |
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Term
| What are open market operations and how do they impact the size of the money supply and rates of interest in the economy? |
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Definition
| Open market operations involve the purchase or sale of government bonds by the Fed. If the money supply increases, government bonds will be purchased from commercial banks. When these banks sell their bonds to the Fed, they are paid by the Fed with funds that are excess reserves. When new excess reserves become available, the commercial banking system is able to expand the money supply by some multiple of the intitial rise in the excess reserves. |
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Term
| What monetary policy tools are available to the Fed to increase or decrease the money supply? |
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Definition
| If Fed wants to increase they: (1) lower the legal reserve requirement (2) purchase government bonds (3) reduce the discount rate. If Fed wants to decrease: (1) increase the legal reserve requirement (2) sell government bonds (3) raise the discount rate. |
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Term
| Describe the chain of causation associated with Keynesian monetary policy |
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Definition
| If the fed wants to use monetary policy to shift the aggregate demand schedule to the right, it will undertake actions to increase the money supply. As money supply rises, interest rate falls, then investment expenditures rise, then the AD schedule shifts right. |
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Term
| Explain the transactions, precautionary and speculative demands for money. What are the principle determinants of each component of the total demand for money? |
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Definition
| reasons why households and businesses are willing to hold a portion of their wealth in the form of money: (1) the transactions demand for money (2)the precautionary demand for money and (3)the speculative demand for money. |
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Term
| What factors determine the extent to which the maximum value of the money multiplier is achieved |
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Definition
| three conditions must hold: (1) there must be no leakages into cash at each round of re-lending and re-depositing in the money supply expansion process. (2) banks must be willing to loan out all of their excess reserves. (3) banks must be able to find willing borrowers for their excess reserves. |
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Term
| Provide examples of different tools of monetary policy working in the same direction. |
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Definition
| to increase money supply, the Fed could lower the legal reserve requirement, lower the discount rate, or buy government bonds. To reduce money supply, Fed could raise legal reserve requirement, raise discount rate, or sell government bonds. |
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Term
| What is the quantity theory of money? |
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Definition
| The equation of exchange is MV=PQ where M is money supply, V is velocity of money, P is the average price level and Q is real GDP |
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Term
| How did the Classical economists use the quantity theory of money? |
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Definition
| as a theory of long-run movements of the price level. They assumed that Q was fixed at full employment and that V was fixed or changed very slowly over time |
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Term
| How do modern “Monetarists’ use the quantity theory of money? |
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Definition
| as a theory of the demand for holding money balances. Money is held only for the purpose of buying goods and services |
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Term
| What is meant by the velocity of the money supply? |
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Definition
| the average number of times each dollar is spent to purchase a part of the economy's GDP in a given year |
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Term
| Why does monetarism depend importantly on the stability, or at least the predictability, of the velocity of money? |
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Definition
| they believe that future values of GDP can be predicted if the money supply and velocity can be known/predicted |
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Term
| According to Monetarists, how could the modern quantity theory of money be used in the short-run and in the long-run? |
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Definition
| long-run: increases in aggregate demand caused by either monetary or fiscal policy will only cause inflation. Short-term: increases in the money supply will shift the AD schedule to the right and cause equilibrium GDP to rise. |
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Term
| Describe chain of causation upon which the modern version of the quantity theory of money is based |
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Definition
| Both the transactions and precautionary demands for money depend on the level of GDP, then there is only one level of nominal GDP at which the quantity of money would be equal to the quantity of money supplied by the Fed. |
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Term
| What are the principle policies advocated by Monetarists today, and how do they differ from those of the Keynesian economists? |
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Definition
| Monetarists believe that the Fed should not engage in in constantly monitoring and changing the money supply but should estimate the growth rate of real GDP and then increase the money supply by the same percentage |
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Term
| What is the Phillips curve? What did the philips curve look like in the 60's? |
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Definition
| it shows the combinations of inflation rates and unemployment rates actually observed in an economy over a period of time. In the 60's it showed a very stable and negative relationship between inflation rates and unemployment rates. |
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Term
| How can the AD-AS theory be used to explain the stability and shape of the Philips curve in the US during that decade? |
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Definition
| If the short-run aggregate supply schedule is upward sloping and stable, then rightward and leftward shifts of the AD schedule would trace out a negatively sloped Philips curve |
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Term
| How does the shape of the long-run Philips curve differ from the shape of the short-run Philips curve? |
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Definition
| the short-run is negatively sloped while the long-run is vertical |
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Term
| What is meant by the natural rate of unemployment |
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Definition
| the unemployment rate towards which the economy will tend in the long-run |
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Term
| Define the concept of adaptive expectations |
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Definition
| based on the idea that workers form their expectations about future inflation rates on the basis of inflation rates in the recent past |
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Term
| Define the concept of rational expectations |
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Definition
| workers use all available information to set their wage demands for the coming year. they dont just extrapolate past inflation trends |
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Term
| What events or policies would shift the short-run philips curve downward and to the left, or upward and to the right? |
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Definition
| the short run philips curve should be shifted upward and right due to increased energy costs, increased government regulations or an increase in wage rates not caused by increases in worker productivity. To shift down and left are the same that shift it down and right such as a reduction in structural unemployment, increased education and training of the labor force, technological change or a reduction in income tax rates |
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Term
| What policies would shift the long-run curve to the right? |
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Definition
| government programs designed to reduce structural or frictional unemployment |
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Term
| Explain how changes in the money supply cause the rate of interest to change in Keynesian monetary theory |
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Definition
| an increase in the money supply will cause a reduction in the rate of interest |
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Term
| Explain why Monetarists argue that the Fed should increase the money supply at the same rate as the growth rate of real GDP |
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Definition
| a stable price level can be achieved by the increasing of the money supply at an equal rate as the rate of real GDP |
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