Econ 101 Financial Markets & IS-LM Model

Financial Market Concepts

• Saving is the portion of after-tax income not allocated to consumption.
• Money is a liquid asset utilized for transactions.

Types of Money

• Coins: Serve as a medium of exchange for goods and services.
• Checkable Deposits: Demand deposit accounts permit checks or drafts.
• Money Market Funds: Investment funds focused on short-term, high-quality financial assets.

Investment Categories

• Investment: Refers to purchasing new capital goods, such as machinery and buildings.
• Financial Investment: Involves acquiring financial assets, like stocks or bonds.

Demand for Money

• Represents the total amount individuals and firms want to hold for transactions.
• The demand for money decreases as interest rates rise.

Key Financial Measures

• Nominal Income: Total income measured in current dollars, excluding inflation adjustments.
• Real Income: Income adjusted for inflation, reflecting true purchasing power.
• Interest Rate: The percentage paid on bonds, essential for determining investment returns.

Financial Market Equilibrium

• Achieved when the supply of money matches the demand for money.

Important Market Operations

• Expansionary Open Market Operation: Central bank buys bonds, increasing money supply, elevating bond prices, and lowering interest rates.
• Contractionary Open Market Operation: Central bank sells bonds, reducing money supply, lowering bond prices, and raising interest rates.

Miscellaneous Concepts

• Transaction Costs: Costs incurred when buying or selling bonds, including broker fees.
• Transaction Level: Total volume of economic transactions, proportional to nominal income.
• Daily Cash Flow Management: Refers to overseeing the inflows and outflows of cash.
• Interbank Transactions: Settlements between banks involving asset transfers.
• Regulatory Requirements: Compliance with central bank-mandated reserve ratios.

Central Bank Functions

• Central Bank Balance Sheet: Captures the bank's assets (like bonds) and liabilities (money supply).
• Zero Lower Bound: Occurs when interest rates near zero, limiting monetary policy effectiveness.