Term
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Definition
o Money is the most important driver in an economy.
o Too much money in circulation is bad/Shortage of money in circulation is bad.
• Too much causes inflation that is a national problem because it raises out cost of living an hence it reduces our standard of living. |
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Term
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Definition
o The Central Bank (The Fed):
• Creates money supply
• In charge of the monetary policy with autonomy.
o Commercial Banks:
• Traditionally mobilize savings/deposits.
• Make various types of loans:
• Loan is the lifeblood of business activities.
o Plays intermediary roles between savers and investors |
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Term
| o The Central Bank (The Fed): |
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Definition
• Creates money supply
• In charge of the monetary policy with autonomy. |
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Term
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Definition
• Traditionally mobilize savings/deposits.
• Make various types of loans:
• Loan is the lifeblood of business activities.
o Plays intermediary roles between savers and investors. |
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Term
| • Importance of Financial Markets in US Economy: |
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Definition
o Money Market (short-term):
o Capital Market (long-term):
• Stock and bond market are major example.
• Gov. (fed, state, local) issue bonds to raise capital for financing new projects and other expenses.
• Investments lead to higher economic growth and employment.
o Money, banking, and financial markets are highly integrated and intensely interactive. |
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Term
| • Usefulness of the course: |
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Definition
o Role of money in an economy.
o Role of banking system.
o Role of financial markets. |
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Term
| • Overview of the Course: |
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Definition
o Money bears a close link to the real economy by influencing national output, employment, investment, interest rate, inflation, exchange rate, trade flows, etc. The role is profound with global implications.
o The central bank (The Fed) conducts and formulates monetary policy to promote non-inflationary growth with orderly exchange rate.
o The depository financial institutions contribute to money supply process. They mobilize surplus (house) units to deficient units (business firms).
o Financial markets channel resources toward productive business/economic activities and these markets continue to change rapidly sometimes throwing participants into unchartered territory. |
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Term
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Definition
• Dominance of agricultural sector (1930-60)
• Largest employees of labor.
• Small manufacturing sector
• Tiny services sector
• Less open to the rest of the world (closed economy)
• No digitization |
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Term
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Definition
• Shrinkage in agriculture (employs only 2% workforce)
• Expansion in manufacturing sector
• Rise of services sector
• Increasing openness to the rest of the world
• Digitization of business and economic activities.
o Transformed into a “click” economy due to revolution progress in information technology. |
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Term
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Definition
| o An aggregation of major economic activities by different economic participants during a given period. |
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Term
| • Major Economic Activities: |
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Definition
• Private Consumption (c)
• Private Investment (I)
• Government Exp (g)
• Exports (x)
• Imports (m) |
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Term
| • Major Economic Participants: |
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Definition
• 1) Consumers:
o Supply labor
o Earn labor
o Buy goods/ services
o Save/Invest
o Pay Taxes
• Business Firms:
o Hire workers
o Acquire capital
o Invest
o Produce goods
o Export
o Import
o Earn Profit
• Government:
o Collect Taxes
o Sped Tax Dollars on economic and social progress. |
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Term
| o US Economy is the largest in the world: |
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Definition
| • US annual GDP at 16.5 trillion, represents 27% of the world GDP. |
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Term
| o USA has the largest market in the world: |
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Definition
| • 310 million people consume 20% of global-industrial products. |
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Term
| o Per-capita annual median income in the USA is $43,000 |
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Definition
| • Highest buying power in the world. |
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Term
| Other factors that contribute to the U.S economy |
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Definition
o USA is still the technological leader in the world with near-monopoly in defense technologies and civilian aircrafts.
o The US physical infrastructure (roads, highways, airports, and seaports) is the best in the world.
o US Labor Productivity (output per work hours) is one of the highest in the world due to access to modern technologies and capital.
o The USA has the most developed banking sector with global connectivity.
o The USA has the most developed capital markets (stock and bond markets) in the world.
o The US Fed is the leader of all major central banks in the world.
o The US economy is globally interdependent |
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Term
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Definition
| o Has no clear definition that is accepted, but merely anything that a society accepts as a means of transactions is money. |
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Term
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Definition
commodity money
fiat money
electronic money |
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Term
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Definition
• Consists of coins of precious metals like gold and silver.
• Face value equals intrinsic value (cost of producing N contents). |
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Term
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Definition
• Consists of coins of cheap metals and paper note (modern money)
• Face value is much higher than intrinsic value.
• Seignorage = Face Value – Intrinsic Value > 0
• Ex) $100, seignorage = $100 - $0.04 (print cost) = $99.96
• Single most source of all power of the government |
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Term
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Definition
• Smart Card (like phone card)
• Bit Coin (money simulated by super computers) |
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Term
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Definition
o Money is a legal tender.
o Most liquid asset.
o Supply is either in excess or in shortage in any economy.
• Right amount is unknown in an economy |
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Term
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Definition
o Medium of Exchange:
o Unit of Account:
o Store of Value: |
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Term
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Definition
• Currency is instantly accepted by all within country as a mean of transactions.
• Most important function of money, without other two functions do not exist. |
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Term
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Definition
| • A national currency is used for accounting purposes. Items are quoted in terms of units of the national currency. |
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Term
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Definition
• Preservation of the buying power of money.
• Value fluctuates due to changes in inflation.
• Fed’s number one mandate (given by congress) is to maintain price stability over time. |
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Term
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Definition
Uses of Barter:
• Exchange one good for another.
• Inefficient because it is time consuming. There would need to be more than one transaction to meet needs so a search/information cost with regard to who have which good and need for another good. |
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Term
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Definition
• More than one transaction to satisfy needs of individuals involved.
• Information/Search costs
• Transportation cost
• Time-consuming
• Inefficient |
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Term
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Definition
Common Good:
• Some society’s introduced a common good for exchange (sheep).
• This reduced information with regard to who has which good.
• Inefficient because transportation costs, feeding cost, maintenance cost, and loss due to disease. |
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Term
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Definition
Stone Exchange:
• A particular type of stone would be used as a medium of exchange.
• Size determined value.
• Inefficient because of transportation costs, shortage of supply of particular stone, and fear of theft. |
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Term
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Definition
Coins of Gold and Silver:
• Inefficient because of shortage in supply of gold/silver, erosion in the value of coins, because of wearing and emptying overtime. |
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Term
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Definition
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Term
| problems with stage 5- modern money evolved |
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Definition
• Inflation due to excess money.
• Ups and downs in real GDP growth due to excess and shortage of money. |
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Term
| advantages of stage 5- modern money evolved |
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Definition
• Single transaction satisfies needs.
• No search/information costs
• No transportation costs
• Flexibility and speed added to economy
• Efficiency |
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Term
| evolution of modern money |
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Definition
o Stage 1 – Uses of Barter:
o Stage 2 – Common Good:
o Stage 3 – Stone Exchange:
o Stage 4 – Coins of Gold and Silver:
o Stage 5 – Modern Money Evolved: |
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Term
| • Roles of the Fed and commercial banks in money creation: |
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Definition
o Central Bank (The Fed):
• Creator of money supply in charge of the US monetary policy, independently.
• Sets very short-term interest rate that influences other types of interest rates.
o Commercial Bank:
• Attract deposits and make various types of loans to promote economic growth and employment.
• Follow the policy of the Fed.
• Fed requires every commercial bank to keep 10% of demand deposts (CU=DD). |
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Term
| • Federal Open Market Committee (FOMC): |
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Definition
o Most powerful org. of the Fed
o Headed by the president of the NY Fed, not by the chair of the Federal Reserve in DC.
o Fed in DC is the monetary policy formation body.
o NY Fed is the Central Bank of the USA in functional sense.
o Sets the overnight intra-bank short-term rates and directly influences the Bnb through open market operations. |
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Term
| • Open Market Operations: |
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Definition
• Non-borrowed monetary base (Bnb) is directly influenced by the Fed through open market operations.
• When the Fed buys Treasury Securities, issued by the Federal Government (Bnb increases)
• When the Fed sells Treasury Securities issued by the Federal Government (Bnb decreases) |
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Term
| • Multiple Deposit Expansion: |
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Definition
o Assumption is no leakages of money out of deposits.
o Commercial banks also contribute to money supply through deposit expansion.
o DT=1/r x Do
• Dt = cumulative total deposit
• 1/r = deposit multiplier
• D0 = initial deposit with bank A (original bank) |
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Term
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Definition
o M1 Cu + DD
o M2 = M1 +DD
o M2 = M1 + M2 (much larger than M1)
o B= CU + TR –OR- B=Bnb +DL
• Bnb (open market operations)
• When Fed buys and sells T-securities |
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Term
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Definition
o B(Monetary Base)
o TR (Total Reserve)
o ER (excess reserve is used for solvency)
• Bnb = non-borrowed monetary base
• DL = discount loan |
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Term
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Definition
given to member commercial banks at a discount by the Fed as the last resort.
o The borrowing member commercial bank has to convince the Fed that it has run out of all other options to borrow to meet liquidity need. If convinced, the Fed will make DL.
o The Fed discourages member commercial banks from asking for DL frequently. |
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Term
| • Fed’s Measures of Money Supply: |
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Definition
o M1 = narrow money
o M2 = broad money |
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Term
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Definition
• M1 + small denomination time deposits + savings deposit and retail money market accounts + money market mutual fund shares.
• Much larger than M1 |
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Term
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Definition
• The numerical coefficient by which narrow money supply multiplies due to a given increase in the monetary base (B).
• Currency in circulation + traveler’s checks + demand deposit checking deposit + other checked deposits. |
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Term
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Definition
o Cu/DD > 0 (always positive)
o Cu = c x DD (cross multiplication)
o M1 = CU + DD
• =c x DD + DD
• =DD (c +1)
• =DD (1+c) |
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Term
| • Reciprocal Reserve Ratio (r): |
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Definition
o RR/DD
o RR= r x DD
o r is set by the Fed. Has been at 10% of DD since 1989
o usually does not change, during a recession the fed might reduce it but changes are not very effective. |
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Term
| • Excess Reserve Ratio (e): |
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Definition
o ER/DD greater than or equal to zero
o ER = e x DD
o B= CU + TR
• = CU + RR + TR
• = c x DD + r x DD + e x DD
• = DD (c + r + e) |
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Term
| • Determinants of Currency Ratio (c): |
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Definition
o Recession (Real GDP decrease) and unemployment rate increases. (C increases for safety)
• Okuns Law
• Cash is the King
o Economic Prosperity (Real GDP increases, unemployment decreases) (C decreases due to job security)
o Economic Uncertainty increases = C increase
o Size of underground Economy (officially unrecorded transactions), C increases, about 30% of US economy.
o Subject to frequent changes
o Determined by public |
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Term
| • Determinants of Excess Reserve Ratio (e): |
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Definition
o Demand for loan when loan demand increases
• Demand increases during economic prosperity and decreases during recession
o Management Philosophy of Banks:
• Aggressive banks e decreases for profit
o Subject to frequent changes
o Determined by banks |
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Term
| • Feds control over US money supply: |
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Definition
o No, the fed does not have control over US money supply alone.
o m1 = (1+c/c+r+e) x (Bnb + DL)
o The fed has more direct control over B than M1
o The Fed can influence Bnb through open market operations and DL since it has to be the last resort banks request money.
o $1 bills and $2 bills and coins are supplied by the US Dept. of Treasury |
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Term
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Definition
o Exogenous (Ms):
o Endogenous (Ms): |
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Term
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Definition
| • Commercial banks objective is to maximize total interest income by making more short-term loans (for less than one year). |
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Term
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Definition
• Money supplied by the Fed
• Has no relationship with short-term investment rate (is)
• The Feds objective is not to maximize interest income by raising Ms. |
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Term
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Definition
o Unemployment rate reached around 10%, very high
• Money supply almost tripled to $3 trillion
• Interest rate plunged from 6.5% to 0%
o Slow recovery, actions of the fed took unusually long 4 years to produce desired outcome.
o Inflation rate still below 2%
o In light of the low unemployment rate still, there is an expectation of a rise in the unemployment rate.
• Fed is poised to reduce money supply and to raise interest rate.
• Timing is uncertain due to slow down of China’s economy, Eurozone and other counties. |
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Term
| o To reduce inflation rate |
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Definition
| the Fed will reduce money supply and raise interest rate, in return is higher unemployment |
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Term
| o To reduce unemployment rate |
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Definition
| the Fed will supply excess money and lower interest rate. This leads to higher inflation in the future. |
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Term
| • Current State of US Economy Vs. Rest of the World: |
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Definition
o USA:
• Slow economic recovery
• Declining unemployment rate from 10% in 2009 to 4.9%
• Declining budget deficit due to ongoing recovery
• Inflation rate is below 2% annual target
• Strong dollar
• Good shape
o Rest of the World:
• Unemployment rate increasing
• Slowdown in economic growth
• Budget deficit increase
• Inflation rate decrease
• Weak currencies against US dollar
• Depreciation of their currencies against $ on average is above 20% |
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