Chapter 16 example #46356

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

1. Medium of exchange - item buyers give to sellers when they want to purchase goods and services 2. Unit of account - yardstick people use to post prices and record debts 3. Store value - an item people can use to transfer purchasing power from the present to the future

Ease with which an asset can be converted into the economy's medium of exchange

1. Commodity money - item would have value even if it were not used as money (gold coins) 2. Fiat money - money without intrinsic value, used as money because of government decree (US dollar)

Quantity of money available in the economy

1. Currency 2. Demand deposits

The paper bills and coins in the hands of the (non-bank) public

Balances in bank accounts that depositors can access on demand by writing a check

currency, demand deposits, traveler's check, and other checkable deposits

M1 + saving deposits, small time deposits, money market mutual funds, and a few minor categories

An institution that oversees the banking system and regulates the money supply

The setting of the money supply by policymakers in the central bank

The central bank of the US

1. board of governors - 7 members 2. 12 regional Fed banks 3. Federal Open Market Committee (FOMC) - decides monetary policy

Banks keep a fraction of deposits as reserves and use the rest to make loans

Established by Fed - sets minimum amount of reserves that banks must hold against deposits

reserve ratio - fraction of deposits that banks hold as reserves

Simplified accounting statement that show's a banks assets and liabilities

Reserves and loans

Deposits

Amount of money the banking system generates with each dollar of reserve

1/R

1. Open-Market Operations 2. Reserve Requirements 3. The Discount Rate

Buying and selling of US government bonds by the Fed

Fed buys government bonds, new dollars deposited in banks, reserves increase, banks use reserves to make more loans, money supply expands

Fed sells government bonds, taking dollars out of circulation, less reserves available for banks to loan out, money supply decreases

Affect how much money banks can create by making loans

Reduce RR, banks make more loans from each dollar of reserves, money multiplier increases, money supply increases

Raise RR, banks decrease amount of loans they make, money multiplier decreases, money supply decreases

When banks are running low on reserves, they may borrow reserves from the Fed. The discount rate refers to the interest rate on loans the Fed makes to banks.

Lower discount rate, encourages banks to borrow more reserves, banks make more loans, money supply increases

Raise discount rate, discourage banks from borrowing reserves, banks make less loans, money supply decreases

Interest rate on loans between banks - when one borrows reserves from the other

-Fed sells government bonds (OMO) -Removes reserves from banking system -Reduces supply of federal funds -Federal funds rate raises

1. Households hold more of their currency 2. Banks hold more reserves than required (both reduce money supply)

When people suspect bank is in trouble, they may run to the bank to withdraw their funds, holding more currency and less deposits (banks don't have enough reserves to pay off ALL depositors)