Lecture 9: Money & Banking
55 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to Lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the primary purpose of holding money in cash or checking accounts for transactions?

  • To minimize transaction costs
  • To earn interest
  • To invest in assets
  • To have income available for spending (correct)

Holding money in cash accounts allows individuals to earn interest.

False (B)

What are precautionary reasons for holding money?

Unplanned spending and unexpected expenses.

The cost incurred to convert cash back to spendable money is known as a __________.

<p>transaction cost</p> Signup and view all the answers

Which scenario best illustrates the need for precautionary money demand?

<p>Saving cash for emergencies (D)</p> Signup and view all the answers

Match the parts of money demand with their explanations:

<p>Transactions = Money held for regular spending Precaution = Money saved for unexpected events Speculation = Money held for potential investment opportunities</p> Signup and view all the answers

If a bond costs $5 to cash and returns $2 in interest over a week, a person would likely keep their $100 in __________ instead of cashing the bond.

<p>cash</p> Signup and view all the answers

Interest earned on bonds can outweigh the cost of cashing them in for spending.

<p>False (B)</p> Signup and view all the answers

What is the total amount held in cash and bonds at the interest rate of 2%?

<p>$300 in cash and $100 in bonds (D)</p> Signup and view all the answers

As the interest rate increases, the demand for money for precautionary motives generally increases.

<p>False (B)</p> Signup and view all the answers

What is the opportunity cost of holding cash when investing in bonds?

<p>$5</p> Signup and view all the answers

If the interest rate increases to 3%, the amount held in cash will be _____.

<p>$200</p> Signup and view all the answers

What yields 3·$3 = $9 in bonds during the 4th week's investment decision?

<p>3 (D)</p> Signup and view all the answers

Speculation primarily involves holding assets for long-term security.

<p>False (B)</p> Signup and view all the answers

What is considered speculative behavior in finance?

<p>Flipping various financial assets</p> Signup and view all the answers

Match the following terms with their definitions:

<p>Bonds = Financial instruments with fixed interest payments Precautionary motive = Holding cash for unexpected needs Speculation = Investing for short-term profits Interest rate = The cost of borrowing money</p> Signup and view all the answers

What is a defining characteristic of fiat money?

<p>It is used as legal tender by government decree. (D)</p> Signup and view all the answers

The money supply refers specifically to cash that is held outside of banks only.

<p>False (B)</p> Signup and view all the answers

What does M1 specifically include in the money supply?

<p>Cash held outside banks and checkable accounts.</p> Signup and view all the answers

Fiat money is valuable primarily because it is accepted as __________.

<p>money</p> Signup and view all the answers

Match the following definitions or terms with their corresponding descriptions:

<p>M1 = Money acceptable for most transactions M2 = Includes less liquid assets than M1 Central Bank = Government institution for monetary authority Transactions money = Cash and checkable accounts</p> Signup and view all the answers

Which of the following statements is true about the central bank?

<p>It operates autonomously from the rest of the government. (A)</p> Signup and view all the answers

Paper money was first invented in Europe around the year 1000 AD.

<p>False (B)</p> Signup and view all the answers

Explain why fiat money does not have intrinsic value.

<p>Because its value comes from people's agreement to accept it as money, not from any physical commodity.</p> Signup and view all the answers

What does a high discount rate incentivize banks to do?

<p>Hold reserves above the required reserve ratio (C)</p> Signup and view all the answers

The __________ is responsible for overseeing the monetary system in a country.

<p>Central Bank</p> Signup and view all the answers

Open Market Operations (OMOs) are less predictable by the market than other methods of controlling money supply.

<p>False (B)</p> Signup and view all the answers

What aspect of money supply includes relatively less liquid assets than M1?

<p>Broad money (M2) (A)</p> Signup and view all the answers

What is the primary purpose of Open Market Operations?

<p>To control the money supply.</p> Signup and view all the answers

The quantity of money that firms and households want to hold is known as _____ .

<p>money demand</p> Signup and view all the answers

Match the monetary components with their descriptions:

<p>Discount Rate = Interest rate banks pay to borrow from the central bank OMOs = Tool used by the central bank to control money supply Money Supply = Total amount of money available in the economy Money Demand = The quantity of money firms and households desire to hold</p> Signup and view all the answers

Which of the following is NOT a reason for money demand?

<p>To avoid inflation (C)</p> Signup and view all the answers

Money inflows and outflows for firms and households are always synchronized.

<p>False (B)</p> Signup and view all the answers

What can the central bank set the money supply to through Open Market Operations?

<p>Whatever value it wants.</p> Signup and view all the answers

High discount rates decrease the _____ rate.

<p>money multiplier</p> Signup and view all the answers

A creditor benefits from inflation because they receive repayments at a higher value than the original loan amount.

<p>False (B)</p> Signup and view all the answers

How does inflation impact individuals on fixed incomes?

<p>They cannot re-negotiate their income after inflation occurs. (B)</p> Signup and view all the answers

In monetary policy, what does 'r' represent when plotting money supply?

<p>Real interest rate (D)</p> Signup and view all the answers

What are 'menu costs' associated with inflation?

<p>Administrative costs incurred by firms due to constantly changing prices.</p> Signup and view all the answers

Individuals who can adjust their incomes during inflation include __________, contractors, and entrepreneurs.

<p>freelancers</p> Signup and view all the answers

Match the following inflation scenarios with their outcomes:

<p>No inflation = Creditor receives full value plus premium Unanticipated inflation of 10% = Creditor receives less value than expected Fixed income individuals = Cannot adjust income Inflation creates inefficiencies = Increased administrative costs for firms</p> Signup and view all the answers

What happens to a bond's price when interest rates rise?

<p>The price decreases (B)</p> Signup and view all the answers

A bond contains fixed interest payments known as coupons.

<p>True (A)</p> Signup and view all the answers

What is the face value of a bond?

<p>$100</p> Signup and view all the answers

A bond is a _______ for the payment of a debt.

<p>promissory note</p> Signup and view all the answers

If a bond with a $10 coupon is sold for $125, what is its interest rate?

<p>8% (B)</p> Signup and view all the answers

When the price of bonds decreases, speculators want to buy bonds.

<p>True (A)</p> Signup and view all the answers

What happens after the expiration of a bond?

<p>The debtor pays back the initial capital to the creditor.</p> Signup and view all the answers

The demand for money is negatively related to the _______.

<p>interest rate</p> Signup and view all the answers

Which of the following factors can shift money demand?

<p>Increase in real GDP (D)</p> Signup and view all the answers

Match the types of money demand with their descriptions:

<p>Transactions = Money needed for daily purchases Speculation = Money held for investment opportunities Precautionary = Money held for unexpected expenses</p> Signup and view all the answers

Speculators prefer to hold more bonds when bond prices are high.

<p>False (B)</p> Signup and view all the answers

What is the relationship between bond prices and interest rates?

<p>Inversely related</p> Signup and view all the answers

When public safety is at risk, money demand tends to _______.

<p>rise</p> Signup and view all the answers

What does an increase in prices do to money demand?

<p>It increases money demand (C)</p> Signup and view all the answers

Flashcards

Unit of Account

A standard measure for expressing value, price, or cost.

Fiat Money

Money that has value because a government says it does; not backed by a physical commodity.

Money Supply (M1)

The most liquid form of money, including cash and checkable accounts.

Money Supply (M2)

A broader measure of money supply, including less liquid assets than M1.

Signup and view all the flashcards

Central Bank

The government institution that controls a country's monetary system.

Signup and view all the flashcards

Objective Value Carrier

Means having a value that can be measured and agreed upon by all.

Signup and view all the flashcards

Easily Denominated

Value that can be expressed clearly, in commonly understood units.

Signup and view all the flashcards

Difficult to Counterfeit

Hard to copy or fake, making it reliable.

Signup and view all the flashcards

Transactions Money

The most liquid form of money, suitable for everyday transactions.

Signup and view all the flashcards

Legal Tender

Currency that a government requires be accepted as payment.

Signup and view all the flashcards

Discount Rate

The interest rate banks pay to borrow from the central bank (CB).

Signup and view all the flashcards

Reserve Requirement (RR)

The minimum amount of reserves a bank must hold.

Signup and view all the flashcards

Open Market Operations (OMO)

Methods used by a central bank to control the money supply.

Signup and view all the flashcards

Real Interest Rate (r)

The interest rate adjusted for inflation.

Signup and view all the flashcards

Money Demand (MD)

The total amount of money firms and households want to hold.

Signup and view all the flashcards

Money Demand for Transactions

The need for money held for spending.

Signup and view all the flashcards

OMO's control of money supply

Central banking activity to fine-tune money supply.

Signup and view all the flashcards

Money inflows and outflows

Flows of money into and out of firms and households.

Signup and view all the flashcards

Optimal Cash Holdings

The amount of cash held to minimize the costs of interest forgone and transaction costs of converting assets to cash.

Signup and view all the flashcards

Money Demand (Transactions)

Money needed for everyday transactions and spending.

Signup and view all the flashcards

Money Demand (Precaution)

Money held to cover unexpected expenses or future needs.

Signup and view all the flashcards

Interest-Bearing Assets

Financial assets that earn interest, like bonds or savings accounts.

Signup and view all the flashcards

Transaction Cost

The cost of converting assets into cash.

Signup and view all the flashcards

Interest Forgone Cost

The potential interest income lost by holding cash instead of interest-bearing assets.

Signup and view all the flashcards

Money Demand Components

Money demand is comprised of transaction demand and precautionary demand.

Signup and view all the flashcards

Real Interest Rate

Interest rate adjusted for inflation.

Signup and view all the flashcards

Precautionary Money Demand

Holding cash for unexpected expenses or opportunities.

Signup and view all the flashcards

Opportunity Cost of Holding Cash

The potential return you lose by keeping money in cash instead of investing it.

Signup and view all the flashcards

Money Demand and Interest Rate

Higher interest rates decrease money demand for precautionary motives.

Signup and view all the flashcards

Transaction Money Demand

Money needed to pay for everyday expenses.

Signup and view all the flashcards

Interest Rate (Bonds)

The rate of return on a bond investment.

Signup and view all the flashcards

Speculation (Finance)

Holding assets with the goal of making short-term profits by buying and selling.

Signup and view all the flashcards

Bond's Face Value

The amount a bond is worth at maturity.

Signup and view all the flashcards

Bond's Coupon Payment

Fixed interest payments made on a bond.

Signup and view all the flashcards

Inflation's Impact on Income

Inflation redistributes income, favoring those who can adjust their earnings (like freelancers) over those with fixed incomes (like pensioners).

Signup and view all the flashcards

Inflation and Creditors

Unanticipated inflation hurts creditors because they receive back less in real value when repaying loans.

Signup and view all the flashcards

Inflation and Menu Costs

Firms face costs associated with constantly adjusting their prices due to inflation, known as 'menu costs.'

Signup and view all the flashcards

Who Benefits from Inflation?

Those with flexible incomes, able to adjust their earnings with inflation, benefit from rising prices, while those with fixed incomes suffer.

Signup and view all the flashcards

Inflation's Impact on Purchasing Power

Inflation erodes the purchasing power of money, meaning you can buy fewer goods and services with the same amount of money.

Signup and view all the flashcards

Bond

A debt security that represents a loan made by an investor to a borrower (typically a government or corporation).

Signup and view all the flashcards

Coupon

A fixed interest payment made to the bondholder at regular intervals, usually semiannually, until the bond matures.

Signup and view all the flashcards

Face Value

The original principal amount borrowed by the issuer of the bond, which is repaid to the bondholder at maturity.

Signup and view all the flashcards

Maturity Date

The date when the principal amount of a bond is repaid to the bondholder, marking the end of the bond's life.

Signup and view all the flashcards

Secondary Market

A market where previously issued bonds are traded among investors, after their initial issuance.

Signup and view all the flashcards

Bond Price and Interest Rate Relationship

The price of a bond is inversely related to interest rates. When interest rates rise, the price of existing bonds falls, and vice versa.

Signup and view all the flashcards

Money Demand for Speculation

The portion of money demand driven by investors who hold money to take advantage of future changes in interest rates and bond prices.

Signup and view all the flashcards

How Money Demand Affects Interest Rates

Increased money demand in the market for loanable funds pushes interest rates up, while decreased money demand pushes interest rates down.

Signup and view all the flashcards

Shifters of Money Demand

Factors that cause the overall money demand curve to shift, leading to changes in interest rates at every level of money supply.

Signup and view all the flashcards

Real GDP and Money Demand

An increase in real GDP leads to an increase in money demand as individuals and businesses need more money for transactions.

Signup and view all the flashcards

Price Level and Money Demand

A rise in the general price level (inflation) increases money demand as individuals need more money to purchase the same amount of goods and services.

Signup and view all the flashcards

Public Safety and Money Demand

If individuals feel a threat to their safety, they might want to hold more cash for security purposes, increasing money demand.

Signup and view all the flashcards

Relationship Between Money Demand and Interest Rate

The overall money demand curve is negatively sloped, indicating an inverse relationship between money demand and the interest rate.

Signup and view all the flashcards

Bonds and Interest Rates

The interest rate on a bond is determined by dividing the coupon payment by the bond's price, revealing the effective return on the investment.

Signup and view all the flashcards

Bond Liquidity

The ease with which a bond can be bought or sold in the secondary market, impacting its price and overall attractiveness to investors.

Signup and view all the flashcards

Study Notes

Lecture 9: Money & Banking

  • Global GDP is approximately 80trillionannually,whilethetotalglobalmoneysupplyisaround80 trillion annually, while the total global money supply is around 80trillionannually,whilethetotalglobalmoneysupplyisaround6 trillion.
  • Money isn't a good or service, and its face value isn't included in GDP.
  • Money facilitates transactions, acting as an intermediary in the market system.
  • Money is the common denominator in economic activity, converting all transactions into a monetary value.

Money

  • The amount of circulating money is changing over time, not holding the same value for decades.
  • Money is not always globally interchangeable (e.g., US currency won't work everywhere).
  • Some assets are more useful in specific situations (e.g., gold in a desert, versus cash at a store).
  • Money is now increasingly used in digital forms and less frequently in physical form.

Functions of Money

  • Money is not income or wealth.
  • A barter system requires a double coincidence of goods, quantities, and timing.
  • Money's three primary roles are:
    • Medium of exchange.
    • Store of value.
    • Unit of account.

Properties of Money

  • Money is generally accepted as a medium of exchange.
  • Various forms of money have existed throughout history (e.g., silver, gold, goats).
  • Desired properties of money include general acceptance, portability, durability, controllable quantity, objective value, easy denomination, and difficulty to counterfeit.

Fiat Money

  • Fiat money is legal tender by government decree, not backed by physical commodities.
  • Its value is derived from the agreement to accept it as money.

Money Supply

  • Money supply definitions vary based on asset liquidity.
    • M1 (transactions money): cash and checkable accounts.
    • M2 (broad money): M1 + fixed-term accounts + semi-liquid financial assets.
    • M2 is generally more stable than M1.
  • The central bank (CB) is the main operator for the monetary system.

Central Bank Functions

  • The CB acts as a coordinator/regulator for banking systems.
  • It assists banks in financial difficulty.
  • It manages exchange rates and foreign exchange reserves.
  • It clears inter-bank payments.
  • It sets reserve requirements for financial institutions.

How Banks Create Money

  • Banks keep a portion of deposits as reserves (required reserve ratio or RR).
  • The rest is loaned out, creating new money.
  • This process creates a multiple of the initial deposit, (1/RR)x Initial Deposit.
  • This "money multiplier" (MM) amplifies the money supply.

How CB Controls the Money Supply

  • There are four ways the CB controls the money supply:
    1. Printing/Withdrawing money.
    2. Changing the RR.
    3. Adjusting the discount rate.
    4. Open Market Operations (OMO).
  • OMOs are considered the CB's primary tool for controlling the money supply—it's precise, flexible, and predictable.

Money Demand

  • Money demand is the desired quantity of money held by individuals and firms.
    • Transactions motive: holding money for everyday purchases.
    • Precautionary motive: holding money for unexpected expenses.
    • Speculative motive: holding money for profit opportunities related to financial assets (e.g., bonds).
  • Money demand is inversely related to the interest rate.

Equilibrium Interest Rate

  • The CB can set a desired interest rate by adjusting the money supply.
  • A change in money demand (due to unexpected inflation) can shift the interest rate to a new point, requiring CB adjustments.

Monetary Policy and Money Supply/GDP

  • Monetary policy is controlled by the Central Bank.
  • Changes in money supply are correlated with changes in GDP and inflation.

Inflation

  • Inflation occurs when money supply rises faster than real output.
  • The difference between money supply growth and real GDP growth dictates the inflation rate.
  • Unanticipated inflation creates uncertainty, distorts credit relations, and has social costs.
  • Inflation is inversely related to unemployment.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Quiz Team

Related Documents

Lecture 9 Money & Banking PDF

Description

Explore the key concepts related to money and banking in this quiz based on Lecture 9. Understand the functions of money, its role in the economy, and the dynamics of the global money supply. Test your knowledge on how money facilitates transactions and its various forms in today's market.

More Like This

Money and Banking Functions Quiz
4 questions

Money and Banking Functions Quiz

StimulativeOxygen avatar
StimulativeOxygen
Money and Banking
40 questions

Money and Banking

ExquisiteMiracle9241 avatar
ExquisiteMiracle9241
Banc Central Europeu i els Diner
45 questions

Banc Central Europeu i els Diner

IlluminatingErbium avatar
IlluminatingErbium
Money and Banking Overview
42 questions

Money and Banking Overview

ConciseEucalyptus2407 avatar
ConciseEucalyptus2407
Use Quizgecko on...
Browser
Open
Browser
Browser