ECON1102 Study Guide - Final Guide: Monetary Policy, Commercial Bank, Monetary Base

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The Financial Sector and Monetary Policy

Money and the Macroeconomy

• In the long-run money is neutral and simply exists to facilitate exchange in the real economy.

• In the short-run, money can interact with the real economy to have real - but temporary - effects.

What is money and why do we need it?

• Money is much broader than currency and refers to anything that has the following functions:

1. Medium of exchange - allows us to conduct transactions more efficiently than bartering, i.e. direct

exchanging of goods and services for other goods and services.

2. Unit of account - means that clear and easy-to-use benchmark is provided against which to measure

all prices and transactions against.

3. Store of value - money can "hold" the value of resources reliably across time. Many commodities are

perishable and some become obsolescent and thus cannot hold value consistently. Money, does not

have this problem, which allows value to be stored, saved and retrieved as desired.

4. Standard of deferred payment - the function of facilitating economic transactions across time, i.e.

borrowing and lending.

Measuring Money by Degrees of Liquidity

• Money is liquid, i.e. can be immediately tendered and received for transactions between buyers and

sellers of real goods and services.

• The most liquid part of a nation's money supply is the monetary base which includes currency in

circulation and accounts, called reserves, which private banks hold with the economy's central bank,

which pay no interest.

• Reserves ensure that banks have sufficient cash on hand in case there is a run on the bank asking for

currency withdrawals.

• In AUS, the RBA measures: currency; the broader monetary base as defined above; then has a broader

measure, M1, that adds current deposits of the private non-bank sector; and the M3 which adds all

other bank deposits of the private non-bank sector, and "Broad money" which adds other borrowings.

• Slide 15 detailed description

Credit vs. Money

• Credit includes loans, advances and bills provided to the private non-bank sector (individuals and firms)

by all financial intermediaries.

• Credit is not a direct form of money, but is now used by the RBA as a main measure of monetary

movements in AUS.

• Financial intermediation - process in which financial institutions specialise in brokering and enabling

money market transactions.

• Credit is a product of such a process and is often more important than money itself. Credit creation is

largely driven through and by the banking sector.

Commercial Banking

• Commercial banking is a business where an entity (the commercial bank) first accept money from

savers, primarily in the form of interest-bearing deposits.

SPREAD - the commercial banking business model

• You borrow money at one price and then lend that same money out again at another, higher price.

• The price of money is called the interest rate.

• SPREAD - the difference between the interest rate that the intermediary is paying to get (i.e. borrow) its

money and the interest rate that it charges others to whom it lends the borrowed money.

• Example slide 20, 21

Money Creation

• Commercial banks thus have two basic dimensions.

1. They operate as private businesses to connect savers and borrowers and earn profit in the

form of spread.

2. Second, they have systemic functions: (1) to provide for an efficient allocation of funds

across present and future; (2) leveraging existing 'official' money into a larger money supply

or money creation.

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Document Summary

In the long-run money is neutral and simply exists to facilitate exchange in the real economy. In the short-run, money can interact with the real economy to have real - but temporary - effects. Many commodities are perishable and some become obsolescent and thus cannot hold value consistently. Money, does not have this problem, which allows value to be stored, saved and retrieved as desired: standard of deferred payment - the function of facilitating economic transactions across time, i. e. borrowing and lending. Credit includes loans, advances and bills provided to the private non-bank sector (individuals and firms) by all financial intermediaries. Credit is not a direct form of money, but is now used by the rba as a main measure of monetary movements in aus. Financial intermediation - process in which financial institutions specialise in brokering and enabling money market transactions. Credit is a product of such a process and is often more important than money itself.

Related Questions

QUESTION 46

When the Fed buys a U.S. bond in the open market

		its action has no effect on the total reserves or the money supply because the check it writes increases reserves at one bank but they fall at another.
		its action expands total reserves and the money supply.
		its action contracts total reserves and the money supply.
		total reserves increase by the amount of the purchase but the money supply stays the same.

1.11 points

QUESTION 47

When the Fed sells government securities,

		reserves increase, leading to a decrease in the money supply by an amount more than the sale of the government securities.
		reserves decrease, leading to a decrease in the money supply by an amount more than the sale of the government securities.
		reserves increase, leading to a increase in the money supply by an amount more than the sale of the government securities.
		reserves decrease, leading to a increase in the money supply by an amount more than the sale of the government securities.

1.11 points

QUESTION 48

The maximum potential money multiplier is equal to

		the reserve ratio.
		one minus the reserve ratio
		the inverse of the required reserve ratio.
		the number of dollars on reserve.

1.11 points

QUESTION 49

The potential money multiplier gives us

		the growth in the money supply when income increases.
		the growth in real national income when the money supply increases.
		the maximum potential change in the money supply due to a change in income.
		the maximum potential change in the money supply due to a change in reserves.

1.11 points

QUESTION 50

An increase in the reserve ratio

		increases the money multiplier.
		will cause banks to make more loans.
		has an expansionary effect on the money supply.
		has a contractionary effect on the money supply.

1.11 points

QUESTION 51

The Federal Deposit Insurance Corporation insures

		banks against lawsuits.
		the deposits held in member banks.
		the deposits held in the Fed.
		the federal funds market.

1.11 points

QUESTION 52

Bank runs are a possibility because

		in difficult times people want currency instead of demand deposits.
		the FDIC is inefficient.
		banks do not keep enough reserves to cover all their depository liabilities.
		bankers are often poor businesspeople.

1.11 points

QUESTION 53

The manner in which FDIC deposit insurance is set up in the United States encourages banks to

		make riskier loans than they otherwise would.
		reject some loans that probably would be profitable.
		maintain excess reserves that are too great.
		be too conservative in their lending practices.

1.11 points

QUESTION 54

The Federal Deposit Insurance Corporation

		discourages banks from engaging in excessive risk taking.
		was established after the Panic of 1907.
		only insures deposits in money-center banks.
		increases the stability of the banking system by reducing the likelihood of bank runs.

1.11 points

QUESTION 55

What are the two features of money that distinguish it from all other goods in the economy?

		Money is government issued and it is redeemable for gold or silver.
		Money is part of every barter transaction and it is divisible.
		Money is accepted as a medium of exchange and it is the common unit of account used to express prices.
		Money is a common unit of account and it is also can be traded for other currencies at a guaranteed exchange rate.

1.11 points

QUESTION 56

Holding money to meet unplanned expenditures and emergencies is known as

		asset demand.
		precautionary demand.
		aggregate demand.
		transactions demand.

1.11 points

QUESTION 57

When people want to hold money to make regular planned expenditures, this is

		the transaction demand for money.
		the spending demand for money.
		the asset demand for money.
		the precautionary demand for money.

1.11 points

QUESTION 58

When interest rates rise, the transactions demand for money usually

		decreases.
		increases.
		decreases initially and then increases to the original position.
		does not change.

1.11 points

QUESTION 59

As nominal Gross Domestic Product (GDP) rises, the transactions demand for money

		increases, and the money demand curve shifts to the right.
		remains constant, and the money demand curve remains the same.
		decreases, and the money demand curve shifts to the left.
		increases, and the money demand curve shifts to the left.

1.11 points

QUESTION 60

One of the economic costs of holding currency is that

		it fulfills no precautionary role.
		it fulfills no transactions role.
		it earns no interest income.
		its real value always increases.

blacktrout920

1. Fiscal policy attempts to affect the level of overall spendingin the economy by changes in:
A) the interest rate.
B) the money supply.
C) banking regulations.
D) taxes and spending.

2. Economists have identified several consecutive months of fallingemployment and forecasts for the next few months are for more ofthe same. At what point in the business cycle is the economyapparently located?
A) recession
B) expansion
C) business cycle peak
D) business cycle trough

3. The onset of the Great Depression:
A) was not a shock to anyone since most economists predicted theâroaring 20sâ were bound to end in disaster.
B) created a disagreement between the Hoover administration andconventional economists because Hoover wanted the government tointervene much more quickly than most others.
C) came as a considerable shock to the conventional wisdom ofeconomics at that time and opened the door for critiques ofmainstream thought by economists like JM Keynes.
D) was in 1918 at the end of World War I.

4. When economists measure economic growth, they often use:
A) the inflation rate.
B) the unemployment rate.
C) nominal GDP.
D) real GDP.

5. In a typical business cycle, the business cycle peak isimmediately followed by the:
A) recession.
B) business cycle trough.
C) expansion.
D) depression.

6. Suppose an economy experiences rising total output accompaniedby increasing employment, this is generally known as:
A) stagflation.
B) recession.
C) inflation.
D) expansion.

7. Controlling interest rates is an example of:
A) fiscal policy.
B) tax policy.
C) monetary policy.
D) exchange rate policy.

8. The alternation between recessions and expansions is known asthe:
A) unemployment rate.
B) long-run economic growth.
C) business cycle.
D) macroeconomy.

9. A recession in America is typically associated with:
A) a falling unemployment rate.
B) a decrease in the number of people living in poverty.
C) a decrease in the percentage of Americans with healthinsurance.
D) an increase in corporate profits.

10. The purpose of macroeconomic policy is to:
A) bring unemployment closer to the natural rate.
B) reduce the severity of recessions.
C) rein in excessively strong expansions.
D) bring unemployment closer to the natural rate and to reduce theseverity of recessions.

11. The trade balance is the difference between the value ofthe:
A) trade deficit and the budget deficit.
B) goods and services that one country sells to other countries andthe value of the goods and services it buys in return.
C) exchange rates of two countries that are engaged ininternational trade.
D) national debt and the foreign debt.

12. Increasing the total amount of available productive resourcesis the focus of __________.
A) macroeconomics
B) fiscal policy
C) monetary policy
D) microeconomics

13. The point on a business cycle when real GDP stops rising andbegins falling is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.

14. During a recession, one will often observe:
A) aggregate output rising.
B) unemployment rates will be increasing while aggregate output isfalling.
C) employment rates will be rising.
D) zero unemployment rates.

15. Monetary policy involves:
A) changes in government spending.
B) changes in government tax receipts.
C) changes in the quantity of money.
D) changes in tax rates.

16. The trough of the business cycle:
A) comes right after the expansion phase.
B) comes before the recession phase.
C) is a temporary maximum level of real GDP.
D) is a temporary minimum level of real GDP.

17. Which one of the following statements about the U.S. economy isnot accurate?
A) Since the Second World War, aggregate output grew at a ratelower than the average annual growth rate of population.
B) Since the Second World War, aggregate output grew at a ratehigher than the average annual growth rate of population.
C) Since the Second World War, macroeconomic policy has helped makethe economy more stable.
D) Long-run growth per capita is the key to higher wages and arising standard of living.

18. An economic recovery is all of the following except:
A) economic growth of a sustained nature.
B) a short-run increase in aggregate production in aneconomy.
C) a time of increasing employment.
D) the end of the business cycle.

19. Which of the following would NOT be classified as amacroeconomic question?
A) How many people are employed in the economy as a whole?
B) What determines the overall level of prices in the economy as awhole?
C) What determines the overall trade in goods, services, andfinancial assets between the United States and the rest of theworld?
D) What determines the cost to a university or college of offeringa new course?

20. Which of the following statements regarding price level orinflation is correct?
A) Supply and demand can not explain why a particular good orservice becomes more expensive relative to other goods andservices.
B) Inflation affects only the more advanced countries whereas lessadvanced countries face deflation.
C) Prices of most goods and services remained stable during thegreat depression.
D) In general, when the economy is in recession and jobs are hardto find, inflation tends to fall.

21. If wages grew at a 5% rate last year and average prices grew ata 3% rate, then the average worker is:
A) better off.
B) worse off.
C) no better or worse off.
D) unaffected.

22. In an open economy:
A) the exchange rate is determined by the government.
B) specialization in activities with a comparative advantage is notpossible.
C) trade is only beneficial to the relatively larger economy.
D) there is trade in goods, services, or assets with othercountries.

23. Changes in government spending and taxes in an effort to changeoverall spending in an economy is:
A) fiscal policy.
B) monetary policy.
C) investment.
D) the stock market.

24. If an economy is open, this means that:
A) anyone can immigrate to the country.
B) trading with other countries makes up a portion of itseconomy.
C) it does not trade with other countries.
D) it will experience a drop in its real GDP.

25. Inflation is a situation where:
A) the average price level falls.
B) the average price level increases.
C) the average price level becomes negative.
D) the real price level falls.

26. The topics studied in macroeconomics include:
A) the price of a motorcycle.
B) the wages of engineers.
C) the average price level in the economy.
D) how much ice cream consumers buy.

27. A period of rising real GDP is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.

28. The modern tools of macroeconomic policy are:
A) tax policy and antitrust policy.
B) fiscal policy and monetary policy.
C) monetary policy and exchange rate policy.
D) capital policy and labor policy.

29. A ârubber neckingâ traffic jam is an example of:
A) microeconomics in action.
B) individual behavior that has a large aggregate impact.
C) the paradox of thrift.
D) an outcome smaller than the sum of its parts.

30. The most painful consequence of a recession is:
A) rising unemployment.
B) increasing inflation.
C) increasing aggregate output.
D) higher interest rates.

31. Per capita economic growth is:
A) economic growth per unit of capital.
B) economic growth per person.
C) economic expansion over the business cycle.
D) sustained increase in aggregate output.

32. Keynesian economics stressed:
A) total spending.
B) the self-regulating power of free markets.
C) the long run.
D) that the Depression should run its course to bring down the highcost of living.

33. When an economy's overall production grows faster than itspopulation, this is referred to as:
A) long-run growth per capita.
B) an increase in nominal GDP.
C) deflation.
D) the paradox of thrift.

34. Fiscal policy attempts to affect the overall level of spendingin the economy through:
A) changes in the inflation rate.
B) changes in the quantity of money or the interest rate.
C) changes in tax policy or government spending.
D) discretionary regulation of profits and wages.

35. With regard to the aggregate price level, economists generallybelieve:
A) price stability is a desirable goal.
B) inflation is worse than deflation.
C) deflation is worse than inflation.
D) inflation actually benefits most retired people.

36. Recessions are periods when:
A) output rises.
B) the aggregate price level rises.
C) the unemployment rate is falling.
D) output and employment are falling.

37. Monetary policy attempts to affect the overall level ofspending in the economy by changes in:
A) taxes.
B) taxes and spending.
C) taxes and interest rates.
D) interest rates and the quantity of money.

38. The basic difference between an economic recession and economicdepression is that:
A) the latter is a shorter economic downturn than the former.
B) during recessions output falls faster than duringdepressions.
C) during depressions employment falls faster than duringrecessions.
D) the former is a longer economic downturn than the latter.

39. The central mission of modern macroeconomics is to prevent_____ from happening again.
A) recessions
B) inflation
C) deflation
D) anything like the Great Depression

40. Fiscal policy refers to:
A) the control of interest rates.
B) the control of government spending and taxations.
C) the control of the quantity of money.
D) the control of interest rates and of government spending.

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ECON1102 Study Guide - Final Guide: Monetary Policy, Commercial Bank, Monetary Base

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