Exam_3_Review - Chapter 13 Money, Banks, and the Federal...

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1 Chapter 13 – Money, Banks, and the Federal Reserve System What Is Money and Why Do We Need It? -Money – assets that people are generally willing to accept in exchange for goods and services or for payment of debts -Commodity money – a good used as money that also has value independent of its use as money -Why do we need money? -What are the four functions of money? 1. Medium of exchange 2. Unit of account 3. Store of value -What affects the store of value and how? Why do people still hold money? 4. Standard of deferred payment -What are examples of each of these? -What is the difference between commodity and fiat money? -What are the criteria an asset must meet to serve as a medium of exchange? -Why is confidence in fiat money important? -Households and firms have confidence that if they accept paper dollars in exchange for goods and services, the dollars will not lose much value during the time they hold them. Without this confidence, fiat money cannot serve as a medium of exchange How Is Money Measured Today? -What is included in the definitions of M1 and M2? -How do changes in certain components affect both measures? How Do Banks Create Money? -Reserves – deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve 1. Required - reserves that a bank is legally required to hold, based on its checking account deposits -Determined by the required reserve ratio (RR). How? 2. Excess – reserves that banks hold over and above the legal requirement -T-Accounts -Basically banks create money by holding a fraction of new deposits and lending the rest out which creates new checkable deposits and increases the money supple
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2 -Simple deposit multiplier – ratio of the amount of deposits created by banks to the amount of new reserves Simple deposit multiplier = 1 °° Change in checking account deposits = Change in bank reserves * 1 °° -So how does much do checkable deposits change when you deposit currency into your account? Withdraw currency? -How much does the money supply change? (Remember with Federal Reserve actions you do not have to take into account any change in currency in circulation.) -What is the difference between the simple deposit multiplier and the real-world deposit multiplier? -The simple deposit multiplier assumes people do not hold currency and banks do not hold excess reserves. In the real-world, this is not true. If people choose to hold currency and/or banks choose to hold excess reserves, the change in deposits will not be as large. -But the basic idea is the same 1. Whenever banks gain reserves, they make new loans, and the money supply expands. 2. Whenever banks lose reserves, they reduce their loans, and the money supply contracts. The Federal Reserve System
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This note was uploaded on 04/27/2010 for the course ECON 2010 taught by Professor Roussel during the Spring '08 term at LSU.

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Exam_3_Review - Chapter 13 Money, Banks, and the Federal...

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