Macro Unit 4 Key
Unit 4: Money, Monetary Policy, and
accomplish its functions, money should have certain characteristics which
uniformity, acceptability, durability, divisibility,
and stability in value.
history, there have been four basic types of money: commodity money,
representative money, fiat money, and checkbook money.
has three main functions- as a medium of exchange, a standard of value,
and a store of value.
often disagree about what money is. M1 is the narrowest definition and
of checkable deposits, traveler’s checks, and currency. Checkable deposits are called demand
and account for about 75% of M1.
M3 are broader definitions of money and include savings accounts and other
MV=PQ is the equation of exchange;
money times velocity equals price times quantity of goods.
PQ is the nominal GDP.
is the number of times per year the money supply is used to make payments
final goods and services: V=GDP/M
is created when banks make loans.
One bank’s loan becomes another bank’s demand deposit.
Demand deposits are money. When a loan is repaid, money is
are required to keep a percentage of their deposits are reserves. Reserves can be currency
in the bank
vault or deposits at the Federal Reserve Banks. This reserve requirement limits the
amount of money banks
money multiplier is equal to one divided by the reserve requirement.
higher the reserve requirement, the less money can be created; the lower
the reserve requirement,
the more money can be created.
Federal Reserve, or “Fed,” regulates financial institutions and controls
the nation’s money supply.
three main tools that it uses to control the money supply are: changing
the discount create, changing
the reserve requirement, and buying and selling
Economics bonds on the open market (open market operations).
Fed wants to encourage bank lending and increase the money supply, it will
decrease the discount rate,
decrease the reserve requirement, and buy
bonds on the open market.
expands the money supply to
fight unemployment. This is called an expansionary monetary policy or an “easy
Fed wants to hold down or decrease the money supply, it will discourage
bank lending by increasing
the discount rate, increasing the reserve
requirements, and selling bonds on the open market. The Fed
discourages bank lending during
This is called a
contractionary monetary policy or a “tight money” policy.
reserve requirement is the most powerful tool of monetary policy; it is
rarely used because of its power.
Open market operations are the most frequently used tool because
they permit the Fed to make
small changes in the money supply.
believe that money directly affects the economy through the equation of
Monetarists believe the
money supply should be increases at the rate of three to five percent a
exactly the same amount as the increases in real GDP.
believe that money affects interest rates and that interest rates, in
turn, affect investment and GDP.
Tight money increases interest rates, which decrease aggregate
demand, which helps fight inflation.
Easy money decreases interest rates and increases GDP during
Fed cannot target both the money supply and interest rates simultaneously
so it must choose which goal to attempt to achieve.