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What is liquidity?
How easily an asset can be converted into cash.
What is the nominal interest rate?
The interest rate before accounting for inflation.
What is the real interest rate?
The interest rate adjusted for inflation.
Define M1.
The most liquid forms of money (cash, checking accounts).
Define M2.
M1 + savings accounts, money market accounts, etc.
What is a fractional banking system?
A system where banks keep a fraction of deposits as reserves and loan out the rest.
What are required reserves?
The percentage of deposits banks must keep in reserve.
What is the money multiplier?
The amount of money the banking system can create from an initial deposit.
Define the discount rate.
The interest rate at which commercial banks can borrow money directly from the Fed.
What are open market operations?
The buying and selling of government bonds by the Federal Reserve.
What is the Loanable Funds Market?
The market where savers (suppliers of funds) and borrowers (demanders of funds) meet.
How does inflation affect the store of value function of money?
Inflation erodes the purchasing power of money, reducing its effectiveness as a store of value.
If the nominal interest rate is 5% and expected inflation is 2%, what is the real interest rate?
3% (Real Interest Rate = Nominal Interest Rate - Expected Inflation Rate)
How does an increase in the price level affect the demand for money?
It increases the demand for money because people need more money to conduct transactions.
How does the FED use open market operations to combat inflation?
The FED sells government bonds, decreasing the money supply and increasing interest rates, which cools down the economy.
How does an increase in real GDP affect the demand for money?
It increases the demand for money because there are more transactions occurring in the economy.
How does a decrease in the reserve requirement affect the money supply?
It increases the money supply because banks can lend out a larger portion of their deposits.
How does an increase in the discount rate affect borrowing?
It discourages borrowing by banks, leading to a contraction in the money supply.
How would the purchase of bonds by the FED affect the money supply?
The money supply would increase.
How does increased investor confidence affect the loanable funds market?
It increases the demand for loanable funds as businesses seek to expand, potentially raising real interest rates.
How does increased government borrowing affect the loanable funds market?
It increases the demand for loanable funds, potentially raising real interest rates and crowding out private investment.
How do transaction costs affect the demand for money?
Lower transaction costs decrease the demand for money.
What is the impact of lowering the discount rate on the money supply?
Increases the money supply.
What is the impact of increasing the reserve requirement on the money supply?
Decreases the money supply.
What is the impact of the FED buying bonds on aggregate demand?
Increases aggregate demand.
What is the impact of contractionary monetary policy on inflation?
Decreases inflation.
What is the impact of expansionary monetary policy on unemployment?
Decreases unemployment.
How does the FED use monetary policy to stimulate the economy during a recession?
By lowering interest rates and increasing the money supply.
What is the effect of the FED raising the federal funds rate?
It decreases the money supply and increases interest rates.
What is the impact of increased government borrowing on private investment?
It can decrease private investment (crowding out).
What is the impact of a decrease in the discount rate on investment?
It tends to increase investment.
What is the impact of the FED selling bonds on the nominal interest rate?
It increases the nominal interest rate.
What is the impact of a lower reserve requirement on the amount of loans banks can make?
Increases the amount of loans banks can make.