1 chapter 5 money and the federal reserve these slides supplement the textbook, but should not...
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1
Chapter 5Money and the Federal Reserve
These slides supplement the textbook, but should not replace reading the textbook
2
What is barter?The practice of trading one good or service for another
3
What is a double coincidence of wants?
A situation in which two traders are willing to exchange their products directly
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What is currency?Anything that can be used to signify someone’s credit and someone’s debit in a financial transaction
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What are the 4 basic functions of money?
Medium of exchangeUnit of accountStore of valueStandard deferred payment
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What is amedium of exchange?
Money is accepted in exchange for a good or service
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What aunit of account?
Money is used to compare the relative value of different goods and services
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What is astore of value?
Money is used as a means of saving
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What is astandard of
deferred payment?Money is used to keep track of the method and the amount of money is to be paid back in the future
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What are the properties of money?
ScarcityPortabilityDivisibility
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What is commodity money?
Anything that serves both as money and as a commodity
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What is token money?
Money that exceeds the value from which it was made, for example, quarters
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What are examples of money?
Federal Reserve NotesCoinsChecksTravelers checks
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What does the term liquidity mean?
The easier something is to spend the more liquid it is, the more difficult it is to spend the less liquid it is
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Which form of money is most liquid?
It all depends on the circumstances
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What is fiat money?Money not redeemable for any commodity; its status as money is conferred by the government
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What is legal tender?Currency that constitutes a valid and legal offer of payment for debts
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Does gold or silver back up our money?No, our money is not backed up by anything
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What happenedin 1968?
U.S and a number of European nations stopped selling gold on the London market, allowing the market to freely determine the price of gold
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What happenedin 1971?
From 1968 to 1971, only central banks could trade with the U.S. at $35/oz. Finally, in 1971, even this bit of gold convertibility died
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Why does money have value?
It is useful and relatively scarce
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What determines the value of money?
The general price level
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Why are banks called depository institutions?
Because they accept deposits from the public
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What arecommercial banks?
Depository institutions that make loans to the public
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What aredemand deposits?
Accounts at financial institutions that pay no interest and on which depositors can write checks to obtain their deposits
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How do banks make profit?
After interest paid or services rendered minus costs equals bank’s profit
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Who were the first bankers?
Goldsmiths in the middle ages
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What is the Federal Reserve System?
The central bank and monetary authority of the United States; known as “the Fed”
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What is the function of the Fed?
To ensure the availability of enough money and credit in the banking system to support a growing economy
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When was the federal reserve
system established? The Federal Reserve Act of 1913
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Does the Fed loan money to private
companies? No, they only do business with financial institutions
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Why would the Fed want to decrease the
money supply?To lower inflation
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Why would the Fed want to increase the
money supply?To stimulate employment
34
How many Federal Reserve banks are there?
The U. S. is divided into 12 Federal Reserve districts, each district has a Federal Reserve Bank
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Who makes the decisions for the
Federal Reserve? The Board of Governors and the Open Market Committee
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How long do most board members serve?
14 years, after which they cannot serve again
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How long does the chairman of
the board serve? The Chairman serves 4 years, but can serve again
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What is the Federal Open Market Committee?
Made up of the 7 board members and 5 presidents of Federal Reserve Banks
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What is the role of the Federal Open
Market Committee? The FOMC makes decisions as to the buying and selling of government securities
40
Member Banks
owns stock in Federal Reserve
only national banks are required to be members
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What do the letters FDIC stand for?
The Federal Deposit Insurance Corporation
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When was the FDIC established?
1933
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What is the function of the FDIC?
To ensure deposits in any banking institution that purchases FDIC insurance
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How much are deposits insured for?
Each account in a bank is insured up to $250,000 per depositor per bank
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What is the name of the market where money is
bought and sold?The loanable funds market
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Why would the Fed want to expand the
money supply?If we have unemployment the Fed wants to increase the money supply to stimulate employment
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Why would the Fed want to contract the
money supply?If we have inflation the Fed wants to decrease the money supply to bring down prices
48
What does the term liquidity mean?
A measure of the ease with which an asset can be converted into money without significant loss in its value
49
What does liquidity have to do with the
money supply?With inflation the Fed wants banks to be less liquid
With unemployment the Fed wants banks to be more liquid
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What makes a bank more or less liquid?A lot of cash in excess reserves - very liquid
Little cash in excess reserves - less liquid
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What is arequired reserve ratio?
The ratio of reserves to deposits that banks are required to hold
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What arerequired reserves?
The dollar amount of reserves a bank is legally required to hold
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Where are bank’s reserves held?
Deposits with the Fed and cash in the bank’s vault
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What are excess reserves?
Bank reserves in excess of required reserves
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What money do banks lend out?Excess reserves
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If a bank has $6,000 in checkable deposits with a
reserve ratio of .2 how much can the bank lend?
No more than $4,800
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How does the Fed influence the money
supply?Change reserve requirements
Change discount rateChange federal funds rateBuy/sell govt. securities
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What arereserve requirements?The percentage of a bank’s assets that must be kept in cash and therefore cannot be lent out
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Who setsreserve requirements?Reserves are determined by the Fed for all financial institutions
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If we have inflation what will the Fed do to reserve requirements?
Raise reserve requirements thereby decreasing bank’s excess reserves
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If we have unemployment what will the Fed do to reserve requirements?
Lower reserve requirements thereby increasing bank’s excess reserves
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What is thediscount rate?
The interest that banks pay when they borrow money from the Fed
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What will the Fed do to the discount rate during periods
of inflation?The Fed will raise the discount rate to discourage borrowing and thus spending
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What will the Fed do to the discount rate during periods of unemployment?
The Fed will lower the discount rate to encourage borrowing and thus spending
65
What is thefederal funds rate?
The interest rate that banks pay to borrow excess reserves from another bank
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What will the Fed do to the federal funds rate
during periods of inflation?
The Fed will raise the federal funds rate to discourage borrowing and thus spending
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What will the Fed do to the federal funds rate
during periods of unemployment?
The Fed will lower the federal funds rate to encourage borrowing and thus spending
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What is theprime interest rate?The interest rate that big banks charge their best and most credit worthy customers
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What is a government security?A short term bond that the federal government sells
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What is the open market?
A place where bonds are bought and sold
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What areopen market operations?
The act of the Fed buying or selling government securities at the open market
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Why does the government sell
securities?This is its way of borrowing money
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What will the Fed do if we have unemployment?
The Fed will buy government securities making banks more liquid so they can lend out more money
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What will the Fed do if we have inflation?
The Fed will sell securities making banks less liquid so they will have less money to lend
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Which monetary tool is most often used?Open-market operations
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What is moral suasion?
A host of different measures that the Fed uses to influence the activities of banks in one way or another
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What is the largest component of
assets of the Fed?U.S. government securities
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What is the largest component of the Fed’s liabilities?
Federal Reserve notes
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Why is the Fed so profitable?
Because it pays no interest on its liabilities but earns interest on its assets
80
If the Fed wants to increase the money
supply by $1,000 million, what should it do?
With a reserve requirement of 10% it should increase the money supply by $100 million
81
What is the money multiplier with a
reserve requirement of 1/10?
10
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What is the Money Multiplier formula?
1/Required reserve ratio
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If the required reserve ratio is 1/10 and all banks are exactly
meeting their reserve requirement - how do
we calculate the money multiplier?
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One divided by one tenth equals 10
11..10
=
1 X10
1=
Multiplier
10
85
$100$90$81$74$63...
$1,000
original deposit
total money
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If the Fed wants to decrease the money
supply by $1,000 million, what should it do?
With a reserve requirement of 10% it should decrease the money supply by $100 million
87
Why is the Fed better at fighting inflation
than unemployment?The Fed can’t force people to borrow more money
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What things will cause interest rates to rise?
Demand for money increasesThe Fed raises the Discount
or Federal Funds RateThe Fed sells government
securities
89
What things will cause interest rates to fall?
Demand for money decreasesThe Fed lowers the Discount
or Federal Funds RateThe Fed buys government
securities
90
What is Quantitative Easing?
A politically polite term for monetizing the debt, the Fed creates money to buy bonds
91
END
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