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Questions and Answers
What is the main shortcoming of the barter system?
What is the main shortcoming of the barter system?
The double coincidence of wants.
What are the key roles of money?
What are the key roles of money?
Fiat money has intrinsic value.
Fiat money has intrinsic value.
False
Which of the following is NOT a component of M2?
Which of the following is NOT a component of M2?
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What is the primary tool used by the Federal Reserve to control the money supply?
What is the primary tool used by the Federal Reserve to control the money supply?
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The Federal Reserve's dual mandate is to achieve full employment and price stability.
The Federal Reserve's dual mandate is to achieve full employment and price stability.
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What is the target inflation rate for the Federal Reserve?
What is the target inflation rate for the Federal Reserve?
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The Fed Open Market Committee (FOMC) consists of 7 members and 5 bank presidents.
The Fed Open Market Committee (FOMC) consists of 7 members and 5 bank presidents.
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What is the role of the New York Federal Reserve President?
What is the role of the New York Federal Reserve President?
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What is the reserve requirement?
What is the reserve requirement?
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The excess reserve is the amount of deposits that banks hold above the legal minimum.
The excess reserve is the amount of deposits that banks hold above the legal minimum.
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What is the difference between bank assets and liabilities?
What is the difference between bank assets and liabilities?
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Banks create money by lending out excess reserves.
Banks create money by lending out excess reserves.
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What is the money multiplier?
What is the money multiplier?
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A smaller reserve ratio results in a higher money multiplier.
A smaller reserve ratio results in a higher money multiplier.
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Bank capital is the amount of resources put into a financial institution.
Bank capital is the amount of resources put into a financial institution.
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What is leverage?
What is leverage?
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A higher leverage ratio signifies a greater proportion of borrowed funds to bank capital.
A higher leverage ratio signifies a greater proportion of borrowed funds to bank capital.
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The bank run phenomenon occurs when depositors fear the bank's inability to meet their withdrawal requests.
The bank run phenomenon occurs when depositors fear the bank's inability to meet their withdrawal requests.
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What was the key event that prompted the establishment of the Federal Reserve in 1913?
What was the key event that prompted the establishment of the Federal Reserve in 1913?
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What is the purpose of deposit insurance?
What is the purpose of deposit insurance?
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Hyperinflation is characterized by inflation that exceeds 50% per month.
Hyperinflation is characterized by inflation that exceeds 50% per month.
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What does classical theory suggest about the long-run determinants of the price level?
What does classical theory suggest about the long-run determinants of the price level?
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As the value of money increases, the demand for money decreases.
As the value of money increases, the demand for money decreases.
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The quantity theory of money primarily focuses on the effects of the money supply on the price level.
The quantity theory of money primarily focuses on the effects of the money supply on the price level.
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In the short run, the monetary neutrality theory argues that monetary policy can directly influence the real economy.
In the short run, the monetary neutrality theory argues that monetary policy can directly influence the real economy.
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What is the equation for the velocity of money?
What is the equation for the velocity of money?
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According to the quantity theory of money, changes in the money supply significantly affect the real GDP.
According to the quantity theory of money, changes in the money supply significantly affect the real GDP.
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Hyperinflation can lead to an increase in unemployment and a decrease in economic activity.
Hyperinflation can lead to an increase in unemployment and a decrease in economic activity.
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What is the Federal Funds Rate?
What is the Federal Funds Rate?
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The Federal Reserve can influence the Federal Funds Rate through open market operations.
The Federal Reserve can influence the Federal Funds Rate through open market operations.
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The discount rate is the interest rate the Federal Reserve charges banks for loans.
The discount rate is the interest rate the Federal Reserve charges banks for loans.
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The Federal Reserve implements monetary policy to control the money supply and influence interest rates.
The Federal Reserve implements monetary policy to control the money supply and influence interest rates.
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The Federal Reserve’s primary goal is to maintain stable prices.
The Federal Reserve’s primary goal is to maintain stable prices.
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Study Notes
Barter and Money
- Barter exchanges are impossible due to the "double coincidence of wants"
- Money is an asset that quickly converts into anything else
- Liquidity is important; some assets are less liquid (e.g., house) than others (e.g., dollar).
- Money loses value during inflation. Money acts as a medium of exchange and a store of value.
- Commodity money is an object with intrinsic worth (e.g., gold, cigarettes).
- Digital currencies like Bitcoin aren't intrinsically valuable but validate transactions and secure the network.
- Fiat money has no intrinsic value (e.g., USD).
The Federal Reserve (Fed)
- The Fed is the central bank of the US, established in 1913 to prevent banking crises.
- The Fed's seven governors serve 14-year terms; the current chairman is Jerome Powell.
- The Fed's dual mandate is full employment and stable prices (inflation target rate of 2%).
- The Fed's actions are predictable, to regulate the money supply. This is done through the FOMC (Federal Open Market Committee)
- FOMC is composed of seven Governors and five presidents.
- The primary tool for managing the money supply is open market operations (buying/selling government bonds).
- Purchases increase the money supply; sales decrease the money supply.
Fractional-Reserve Banking
- Banks influence the demand deposit amount and the amount of money they have to lend
- Banks hold reserves and loan out the excess deposits
- Fractional reserve banking is when banks hold a fraction of deposits in reserve.
- The reserve requirement is a minimum percentage of deposits that banks must hold in reserve.
- Excess reserves are those above the legal minimum.
- Banks create money by making loans
- Money multiplier is the ratio of money a banking system creates to reserves. A lower ratio equates to a larger multiplier.
- Reserve requirements were significantly lowered during the pandemic to stimulate the economy.
- Bank capital are the resources in an institution, while leverage is borrowing money to supplement existing funds, magnifying gains and losses.
Leverage, Bank Capital, and Bank Runs
- Leverage ratio is the total assets of a bank over its capital.
- A low ratio (more equity than assets) makes a bank more resilient.
- Bank failures can occur if banks lose assets or owners' equity decreases.
- Bank runs occur when depositors fear a bank won't be able to give back their money and withdraw their money. This forces the bank to close its doors.
- Deposit insurance programs mitigate bank runs.
Federal Funds Rate
- The Federal funds rate is the interest rate banks charge each other for overnight loans.
- The Fed influences this rate using open market operations (buying/selling government bonds).
- Buying bonds lowers the rate and increases the money supply.
- Selling bonds raises the rate and decreases the money supply.
Money Supply and Demand
- Money supply and price levels are inversely related.
- Economic equilibrium occurs when supply equals demand.
- Inflation is the rate at which prices increase.
- Increase in money supply leads to increased price level and a reduced value of money.
- Quantity theory of money focuses on the relationship between money supply, price levels, and output.
- Classical theory states that changes in money supply only affect nominal variables (prices).
Classical Equation and Velocity of Money
- The classical equation of exchange, MV = PQ, illustrates the relationship between money supply (M), money velocity (V), price level (P), and output (Q).
- Velocity represents how quickly money changes hands in the economy.
- Velocity is stable over time.
- Changes in money supply primarily affect the price level.
- Hyperinflation occurs when the money supply grows much faster than the overall economy, causing prices to rise rapidly.
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Description
This quiz explores the concepts of barter and money, highlighting the limitations of barter systems and the significance of liquidity, inflation, and different forms of money such as fiat and commodity money. Additionally, it delves into the role of the Federal Reserve in the US economy and its functions in regulating the money supply.
