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115 Cards in this Set
- Front
- Back
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Asset management
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How a bank handles its loans and other assts.
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Bank
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A financial institution whose primary function is accepting deposits for, and lending money to, individuals and firms.
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Excess reserves
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reserves help by the banks in excess of what banks are required to hold.
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Federal Reserves bank (the fed)
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The U.S. central bank whose liabilities (Federal Reserve Notes) serve as cash in the United States.
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Financial assets
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Assets such as stocks or bonds, whose benefit to the owner depends on the isser of the asset meeting certain obligations.
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Interest rate
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The price paid for use of a financial asset.
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Liability management
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How a bank attracts deposits and what it pays for them.
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M1
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Currency in the hands of the public, checking account balances, and travelers checks.
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M2
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M1 plus savings deposits, small denomination time deposits, and money market mutual funs shares, aling with some esoteric financial instruments.
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Money
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A highly liquid financial asset that’s generally accepted in exchange for other goods, is used as a reference in valuing other goods, and can be stored as wealth.
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Money multiplier
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(1+c)/(r+c), where r is the percentage of deposits bank hold in reserve and c is the ratio of money people hold in currency to the money they hold as deposits.
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Precautionary motive
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holding money for unexpected expenses and impulse buying.
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Reserve Ratio
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the ratio od reserves to total deposits.
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Reserves
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Currency and deposits a bank keeps on hand or at the Fed or central bank, enough to manage the normal cash inflows and outflows.
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Simple Money Multiplier
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The measure of the amount of money ultimately created per dollar deposited in the banking system, when people hold no currency.
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Transactions motive
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Holding cash to avoid halding financial assets whose prices are falling.
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Speculative motive
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The need to hold money for spending.
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If financial institutions don't produce any tangible real assets, why are they considered a vital part of the U.S. economy?
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The financial sector tranfers savings into investment and makes the real economy more efficient.
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2. What are loanable funds?
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Loanable funds are financial assets that are available for lending and borrowing.
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3. In what market are long-term interest rates determined?
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Loanable funds market
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1. In what market are short-term interest rates determined?
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Money market
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2. Will there be too much or too little investment in the economy if the interest rate is higher than the rate that would equilibrate the supply and demand for loanable funds?
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Too little
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3. What are the three functions of money?
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A store of wealth, unit of account, and a medium of exchange.
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4. If dollar bills (Federal Reserve notes) are backed by nothing but promises and are in real terms worthless, why do people accept them?
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Social convention: everyone believes that other people will accept it in exchange for goods.
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1. For each of the following, state whether it is considered money in the United States. Explain why or why not.
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a. A check you write against deposits you have at Bank USA.
Money b. Brazilian reals. Not money c. The available credit you have on your MasterCard. Not money d. Reserves held by banks at the Federal Reserve Bank. Not money e. Federal Reserve notes in your wallet. Money f. Gold bullion. Not money |
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1. What function is money serving when people compare the price of chicken to the price of beef?
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Unit of account.
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2. How does inflation affect money's function as a store of wealth?
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Inflation reduces how much can be produced with a given amount of money. (lowers the value of money)
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3. State whether the following is an example of the transactions, precautionary, or speculative motive for holding money:
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a. I like to have the flexibility of buying a few things for myself, such as a latte or a snack, every day, so I generally carry $10 in my pocket.
Transactions b. You never know when your car will break down, so I always keep $50 in my pocket. p. 331 Precautionary c. When the stock market is falling, money managers generally hold more in cash than when the stock market is rising. Speculative d. Any household has bills that are due every month. Transactions. |
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4. What are two components of M2 that are not components of M1?
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savings deposits, small denomination time deposits, and money market mutual funs shares.
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1. Categorize the following as components of M1, M2, both, or neither.
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a. State and local government bonds.
Neither b. Checking accounts. Both c. Money market mutual funds. M2 d. Currency. Both e. Stocks. Neither f. Corporate bonds. Neither g. Traveler's checks. Both |
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1. State the immediate effect of each of the following actions on M1 and M2:
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a. Barry writes his plumber a check for $200. The plumber takes the check to the bank, keeps $50 in cash, and deposits the remainder in his savings account.
M1 would go up by $50 and the M2 (savings) would go up by $200. b. Maureen deposits the $1,000 from her CD in a money market mutual fund. Nothing changes, it goes from M2 to M2. c. Sylvia withdraws $50 in cash from her savings account. M1 goes up by $50 d. Paulo cashes a $100 traveler's check that was issued in his Ohio bank at a New York bank. Nothing changes. |
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2. Why was character George Bailey in the film It's a Wonderful Life right when he stated on the day of a bank run that depositors could not withdraw all their money from the bank?
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A bank only holds a fraction of deposits on hand. It lends the remainder.
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3. U.S. paper currency is made with several features that are difficult to counterfeit including a security thread, color-shifting ink, microprinting, a portrait, a watermark, and a fine-line printing pattern. As duplication technology, however, continually improves and more and more counterfeits are circulated, what will happen to the following?
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a. The value of money circulated.- It will decrease
b. The volume of cashless transactions.- They would decrease because more cash would be being used. |
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4. Write the equations for the simple money multiplier and the money multiplier. Which multiplier is most likely to be larger?
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Money multiplier is (1+c)/(r+c), Simple money multiplier 1/r. The simple money multiplier would be larger.
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5. True or false? Policy makers in practice use the money multiplier to determine the amount of reserves needed to achieve the desired money supply. Explain
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False- The cash to deposit rate fluctuates to much, making the multiplier change.
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1. If the U.S. government were to raise the reserve requirement to 100 percent, what would likely happen to the interest rate banks pay on deposits? Why?
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The interest rate that the banks would pay on a deposit would go down, because they have to keep all the deposit in reserves which is not allowing them to loan out the money, which is where the bank earns their money.
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While Jon is walking to school one morning, a helicopter flying overhead drops a $100 bill. Not knowing how to return it, Jon keeps the money and deposits it in his bank. (No one in this economy holds currency.) If the bank keeps 5 percent of its money in reserves:
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a. How much money can the bank initially lend out? $95
b. After this initial transaction, by how much is the money in the economy changed? $95 c. What's the money multiplier? (1+c)/(r+c) (1+0)/(.05+0)= 20 d. How much money will eventually be created by the banking system from Jon's $100? $100 x 20= $2,000 |
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2. Calculate the money multipliers below:
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a. Assuming individuals hold no currency, calculate the simple money multiplier for each of the following: 5%, 10%, 20%, 25%, 50%, 75%, 100%.
a.) 20 b.) 10 c.) 5 d.) 4 e.) 2 f.) 1.333 b. Assuming the currency to deposit ratio is 20 percent, recalculate the money multipliers in a. a.) 4.8 b.) 4 c.) 3 d.) 2.67 e.) 1.71 f.) 1.26 |
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3. If people expect interest rates to rise in the future, how will they change the quantity of money they demand? Explain your answer.
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If people expect interest rates to rise they will demand more right now before there is a spike in interest rates.
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4. Do interest rates and prices of bonds vary inversely or directly with one another? Explain your answer.
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Inversley because when a bond matures the holder is paid the face value.
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1. Why is the demand for money downward-sloping?
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The demand for money is downward sloping because the interest rate reflects the opportunity costs of holding money. The higher the interest rate the higher opportunity costs of holding money. So people hold less of it when the cost rises.
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2. Money is to the economy as oil is to an engine. Explain.
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If the economy doesn’t have money then there is nothing to keep the economy going. Just like oil is not an engine, its fuel.
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3. About 30 U.S. localities circulate their own currency with names like “Ithaca Hours” and “Dillo Hours.” Doing so is perfectly legal (although by law they are subject to a 10 percent federal tax, which currently the government is not collecting). These currencies are used as payment for rent, wages, goods, and so on. Are these currencies money? Explain.
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Yes because it gives value to an item and it can be exchanged for goods.
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1. Economist Michael Bryan reports that on the island of Palau, the Yapese used stone disks as their currency. The number of stones in front of a person's house denoted how rich he or she was.
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a. Would you expect these stones to be used for small transactions?
No they probably have stones inside of there home that they use for transactions. b. An Irish-American trader, David O'Keefe, was shipwrecked on the island, and thereafter returned to the island with a boatload of stones. If they were identical to the existing stones, what would that do to the value of the stones? It would decrease them because there would now be many more in circulation. c. If O'Keefe's stones could be distinguished from the existing stones, how would that change your answer to b? It wouldn’t change the value of the existing stones because O’keefe’s stones would be worthless. |
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An anthropologist described the stones as “a memory of contributions”—the more stones a person has, the more that person has contributed to the community. Could the same description be used to describe our money?
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Yes because when we work we are contributing to the community.
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• Annuity rule-
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The present value of any annuity is the annual uncome it yiels divided by the interest rate.
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• Bond-
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A promise to pay a certain amount of money plus interest in the future.
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• Financial liabilities-
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Liabilities incurred by the issuer of a financial asset to stand behind the issued asset.
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• Present value-
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A methos of translating a flow of future income or savings into its current worth
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• Rule of 72-
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- The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest.
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• Stock-
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A financial asset that conveys ownership rights in a corporation. Also, certificates of ownership in a company.
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• Central bank
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A type of bankers’ bank whose financial obligations underlie an economy’s money supply.
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• Contractionary monetary policy-
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Monetary policy that decreases the money supply and increases interest rates
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• Discount rate
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The rate of interest the Fed charges for loans it makes to banks.
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• Expansionary monetary policy
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Monetary policy that increases the money supply and decreases the interest rate.
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• Fed funds-
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Loans of excess reserves banks make to one another.
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• Federal funds market
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The market in which banks lend and borrow reserves.
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• Federal funds rate-
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The interest rate banks charge one another for Fed funds.
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• Federal open market committee (FOMC)-
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The Fed’s chief body that decides monetary policy.
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• Inverted yield curve-
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A yield curve in which the short-term rate is higher than the long-term rate.
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• Monetary base-
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Vault cash, deposits at the Fed, plus currenct in circulation.
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• Monetary policy-
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A policy of influencing the economy through changes in the banking system’s reserves that influence the money supply and credit availability in the economy.
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• Monetary regime-
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A predetermined statement of the policy that will be followed in carious situations.
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• Nominal interest rate-
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The interest rate you actually see and pay when borrowing, or receive when lending.
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• Open market operations
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The Fed’s buying and selling government securities.
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• Quantitative easing tools
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Tools that increase the money supply but that do nt affect the Fed funds rate.
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• Real interest rate
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Nominal interest rate adjusted for expected inflation.
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• Reserve requirement-
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The percentage the Federal Reserve Bank sets ad the minimum amount of reserves a bank must have.
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• Taylor rule-
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The rule is: Set the Fed funds rate at 2 percent plus current inflation if the economy is at desired output and desired inflation. If the inflation rate is higher than desired, increase the Fed fund rate by .5 imes the difference between desired and actual inflation. Similarly, if output is higher than desired, increase the Fed funds rate by .5 times the percentage deviation.
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• Yield curve
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A curve that shows the relationship between interest rates and bonds’ time to maturity.
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1. Demonstrate the effect of contractionary monetary policy in the AS/AD model.
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Ad shifts left
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2. Demonstrate the effect of expansionary monetary policy in the money and loanable funds markets.
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S shifts right
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1. Is the Fed a private or a public agency?
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Neither completely public nor private
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2. Why are there few regional Fed banks in the western part of the United States?
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When the fed was established there were few banks in the west.
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3. What are the six explicit functions of the Fed?
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Conduct monetary policy
Supervise financial institutions Serving as a lender of last resort Providing banking services to the US government Issuing coin and currency Provide financial serves to commercial banks |
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4. How does the Fed use open market operations to increase the money supply?
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The fed buys bonds to INCREASE the amont of reserves banks have on hand. When the Fed buys bonds banks have more reserves and then are able to lend more. As they lend more, the money supply increases, therefore increasing the money supply.
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5. Write the formula for the money multiplier. If the Fed eliminated the reserve requirement, what would happen to the money multiplier and the supply of money?
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(1+c)/(r+c)
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1. If a bank is unable to borrow reserves from the Fed funds market to meet its reserve requirement, where else might it borrow reserves? What is the name of the rate it pays to borrow these reserves?
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Banks can also boorow reserves from the fed at the sicount window at the discount rate.
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2. What happens to interest rates and the price of bonds when the Fed buys bonds?
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When the fed buys bonds the price of bonds rises and the interest rate falls.
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3. If the Federal Reserve announces a change in the direction of monetary policy, is it describing an offensive or defensive action? Explain your answers?
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Offensive action because it desires to affect the direction of the economy.
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4. Why would a bank hold Treasury bills as secondary reserves when it could simply hold primary reserves—cash?
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Treasury bills pay interest, cash does not.
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5. The Fed wants to increase the money supply (which is currently 4,000) by 200. The money multiplier is 3 and people hold no cash. For each 1 percentage point the discount rate falls, banks borrow an additional 20. Explain how the Fed can achieve its goals using the following tools:
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a. Change the reserve requirement.- lower
b. Change the discount rate- it would lower the rate allowing banks to borrow more c. Use open market operations- buy securities |
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6. Suppose the Fed decides it needs to pursue an expansionary policy. Assume people hold no cash, the reserve requirement is 20 percent, and there are no excess reserves. Show how the Fed would increase the money supply by $2 million through open market operations.
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The Fed would buy securities back from the people, putting that money back in the money supply (circulation).
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7. Suppose the Fed decides that it needs to pursue a contractionary policy. It wants to decrease the money supply by $2 million. Assume people hold 20 percent of their money in the form of cash balances, the reserve requirement is 20 percent, and there are no excess reserves. Show how the Fed would decrease the money supply by $2 million through open market operations.
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They would sell securities, which brings money in.
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8. Some individuals have suggested raising the required reserve ratio for banks to 100 percent.
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a. What would the money multiplier be if this change were made?
It would stay at 1 b. What effect would such a change have on the money supply? It would decrease the money supplu c. How could that effect be offset? Expansionary monetary policy. |
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9. What is meant by the Federal funds rate?
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The interest rate that the banks charge one another for fed funds or reserves.
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1. Why is the Fed funds rate the interest rate that the Fed most directly controls?
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The fed most directly affects the bank reserves and the fed funds rate is the rate that the banks charge one another for over night reserves.
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2. What is the relationship between tools, operating targets, intermediate targets, and ultimate targets?
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The tools of monetary policy are those things over which the fed has direct control such as open market operations. These tools have a direct affect on operating targets such as the, fed fund rate. These operating targets in turn will affect intermediate targets such as consumer confidence. It is these intermediate targets that then impact affect the feds ultimate targets- prices growth and employment. Because the fed cannot directly control its ultimate argets the fed must rely on adjusting its tools to try to achieve its ultimate targets.
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3. What are examples of tools, operating targets, and ultimate targets?
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Tools
Open market operations Discount rate Reserve requirments Operating target Fed funds rate Ultimate target Stable prices Sustainable growth Acceptable employment. |
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4. The “Check 21” Act, which allows banks to transfer check images instead of paper checks, speeds up check processing. What is the likely effect on:
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a. Float (duplicate money because a check has been deposited but not yet deducted from the payer's account). Decrease
b. Variability of float. Decrease c. Defensive Fed actions. Decrease |
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5. Target inflation is 2 percent; actual inflation is 3 percent. Output equals potential output. What does the Taylor rule predict will be the Fed funds rate?
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(2% + current inflation) =5%
+/- .5(current inflation – desired inflation)= 5%+ .5(3-2)= 5% + .5%= 5.5% |
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6. State the Taylor rule. What does the rule predict will happen to the Fed funds rate in each of the following situations?
a. Inflation is 2 percent, the inflation target |
a. Inflation is 2 percent, the inflation target is 3 percent, and output is 2 percent below potential.
(2% + 2%)= 4% +/- .5(2-3)=-.5= 3.5% + .5(2%)= 1% = 4.5% b. Inflation is 4 percent, the inflation target is 2 percent, and output is 3 percent above potential. (2%+4%)= 6% +/- .5(2)=1%=7% +.5 (3%) = 1.5% = 8.5% |
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1. What is the shape of the effective supply curve for money?
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Horizontal
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2. Why does the effective supply curve for money have the shape it does?
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Because the fed adjusts the money supply to changes in the demand for money to target a specific interest rate.
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3. If the nominal interest rate is 6 percent and inflation is 5 percent, what's the real interest rate?
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a. R= (n-i)= 1%
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4. Are you more likely to see an inverted yield curve when the Fed is implementing contractionary or expansionary monetary policy?
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Contractionary
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5. Why would policy makers pay attention to the shape of the yield curve?
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It will tell policy makers whether there policies are likey to be effective.
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6. Does it matter to policy makers how people form expectations?
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Yes, expectations generally effect the impact of policy
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7. How does a policy regime differ from a policy?
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A policy regime is a predetermined statement about what policies will be followed in various situations. It ties the hands of policy makers. A policy is a one time action that does not imply the course of future actions.
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8. How might an inflation target policy impair the ability of the Fed?
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An inflation target policy might make the fed pursue a contractionary monetary policy when only temporary factors raise inflation and it might have been better to wait until the temporary factors disappear instead of slowing the economy.
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9. How are transparency and credibility related?
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By telling people what the fed is doing, transparency enhances the credibility of the fed because the people see that in fact, the fed does what it says it will do.
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What are two quantitative easing tools?
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For the fed to buy bonds when the federal funds rate is zero
For the fed to buy financial assets such as mortgage-backed securities rather than bonds. |
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yield curve
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yield to maturity compared to maturity date.
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Inverted yield curve
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Short term yield (i) is higher than long term
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Monetary policy
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predetermined, builds responsible expectations
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leverage
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borrow to invest in an asset
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government debt
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how much they owe. Total deficit over time
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Money multiplier
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1+c/r+c
c=cash/deposits |
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Demand for money- why downward sloping
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people want to hold less if the interest rate is higher because they will gain more opportunity cost
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How does fed use open market operations to increease money supply?
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By buying bonds
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Duties of federal reserve bank
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Issue coin and currency
lender of last resort issue monetary policy supervise and reg. financial instituations bank for government provide banking for the commercial bank |
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systemic
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affects everyone- canot be diversified
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nonsystemic
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only affects certian industries. risk-variability of what we expect isn't always negative
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inflation
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erodes the value of the debt asset
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2 ways to finance debt
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raise taxes and sell bonds.
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