MACROECONOMICS: BANKING TEST EXAM QUESTIONS AND ANSWERS EXPLAINED

MACROECONOMICS: BANKING TEST EXAM QUESTIONS AND ANSWERS EXPLAINED Money - answersAny asset that can easily be used to purchase goods and services Medium of exchange - traded for goods, not consumption Store of value - holds power over time Unit of account - can be a measure of the value of other goods Types of Money - answersCommodity Money Commodity Backed Money Fiat Money COMMODITY MONEY - answersA good that had value in other uses Ex. If the material used to make a quarter costs the amount that a quarter costs COMMODITY BACKED MONEY (In the textbook) - answersAn asset that takes the place of a commodity What's not money - answersAny asset included in stocks, bonds etc. Credit cards Why is too much money in circulation a bad thing - answersThe value of the dollar is worth less, creating inflation Why is too little money in circulation a bad thing - answersThe value of the dollar is worth more, creating deflation What would happen if inflation was negative - answersIt would cause a deflationary spiral, deflation or 0% would cause people not to buy things, creating a deflationary spiral Is zero percent inflation bad - answersIt is not ideal because an economy would be getting close to deflation What types of assets do banks use - answersBanks use liquid assets to let people buy illiquid things (harder to sell things) What are liquid assets - answersMoney that can easily be converted to cash when needed Ex. Cash, stocks and bonds Goods that are hard to sell, such as houses or cars, are not liquid because the money is not easily convertible to cash What are bank reserves - answersBanks required to hold on to certain amount in currency or a Federal Reserve account ASSETS - answersEconomic resources (things of value) owned by a firm Money and other valuables belonging to an individual or business LOANS OWED AND RESERVES What the bank owns that has a value What are the three assets that a bank holds onto - answersLoans Reserve requirement Bonds Liabilities - answersDeposits made by customers This is a liability because a customer can ask for their money at any point Reserve Ratio - answersPercent of deposits held as reserves Minimum percentage set by the Federal Reserve Banks must have the required reserves at the end of each day Federal Funds Market - answersIf banks are short of reserve requirements, they can borrow from other banks Usually one day loans, at the "federal funds rate" Banks can also get loans from Federal Reserve at the "discount rate (THE RATE IS SUPPOSED TO BE HIGHER - CURRENTLY 5.5% WHICH IS A SIGNIFICANT PENALTY) What type of rates does the Federal Reserve control - answersThe Federal Funds Rate and Discount Rate The banks raise their interest rates according to the federal funds rate/discount rate What type of policy is it when the Federal Reserve raises their interest rate - answersContractionary Monetary Policy Causes banks to raise interest rates Government Bonds - answersGovernment receives money in return for promises to pay more at interest in the future (Bond = Promise) The money the government receives helps "balance" the budget/pay for services Bonds can then be traded between other groups and with Federal Reserves Treasury Bills/T-Bills - answersAnother term for Bonds THE FEDERAL RESERVE - answersThe central banking system of the United States Members are not voted on, yet funded by the federal government Technically a type of government TWELVE BANKS SERVING DIFFERENT REGIONS WITH WASHINGTON BANK AT THE HEAD - EACH BANK HAS A CHAIR WHICH MAKES UP PART OF THE FED What three tools does the Federal Reserve use to influence the economy - answersReserve Requirement Discount Rate Open-Market Operations Reserve Requirement - answersThe percentage of deposits that banking institutions must hold in reserve per day Currently at 10% Unchanged since 1992 U.S. Central Bank - answersOversees banking and monetary base What is the monetary base - answersThe sum of currency in circulation and bank reserves Discount Rate - answersFed rate on loans to banks OPEN-MARKET OPERATIONS - answersBuying/selling government DEBT/bond by the Fed to change the money supply The Fed makes these transactions with banks The Fed never buys/sells from government Expansionary Monetary Policy - answersResponds to a recessionary gap in AD/SRAS Will increase money supply to shift AD right Lowers reserve requirement Lowers the Fed Funds and discount rate Buy bonds from banks Contractionary Monetary Policy - answersResponds to an inflationary gap in AD/SRAS Decreases money supply to shift AD left How does the Federal Reserve protect against bank runs - answersDeposit insurance Reserve requirements Discount window Bank Runs - answersWhen people rush to get deposits out Deposit insurance - answersBanks pay into system that insures deposits up to an amount In the U.S., the FDIC (Federal Deposit Insurance Corporation) does this up to $250,000 How to banks generate money - answersBy loaning customer deposits while maintaining the proper reserve requirements So if Mr. Healy deposits $500 at his bank which has a reserve requirement of 10%, how much should money supply increase? - answers What is the primary purpose of checking accounts - answersChecking accounts are used to hold money for temporary periods of time Easy to put money in and take money out of checking accounts Checking accounts do not generally offer interest What types of places can people put their money to receive interest - answersUS Treasuries CDs - Certificate of Deposit Savings accounts (more in the past than now) CDs - Certificate of Deposit - answersA savings certificate with a fixed maturity date There are minimum investment requirements set by the issuing institution Restricts access to the funds until the maturity date of the investment Money Demand / Supply Curve - answersRelationship between interest rates and quantity of money (all interest rates are included) Demand is downward sloping What is the relationship between interest rates and demand on Money Demand / Supply Curves - answersLow interest rates = High demand High interest rates = people get rid of money to get interest Why do high interest rates lower the demand for money - answersWhen interest rates are high, the opportunity cost of holding money becomes more significant because individuals and businesses could earn more interest by investing or saving their money in interest-bearing assets (ex. Bonds or savings accounts) High-interest rates increase the cost of borrowing money, causing individuals and businesses to become less inclined to borrow money for loans Who fixes the supply of money - answersThe Central Bank (Federal Reserve) What causes demand shifts - answersChange in aggregate prices (Prices up = Demand shifts right) Changes in Real GDP (GDP up = shift right) Technology Regulations What effect has technology had on the demand for money within the past thirty years - answersLess actual money is demanded due to online payment forms (less cash) WHY IS MONEY SUPPLY A VERTICAL LINE - answersMoney supply is controlled by the Fed The Fed will rarely ever alter money supply due to changes in the interest rate or national income during the short term How does the Fed shift money supply - answersOpen Market Operations Discount Rate Reserve Requiremnts Forward Guidance Financial Crisis of 2008 - answersWith interest rates very low, lots of people got loans Major banks began significantly lowering the requirements for people to take out loans (ex. N.I.N.A. Loans - No Asset No Income Loans) Loans were bundled into mortgage-backed securities Rating agencies used loan defaulting data that included years pre-dating people taking N.I.N.A. loans, etc (causing loan default percentages to appear much lower than they actually were - causing rating agencies to rate these CDO's as Triple A investments) When loans collapsed, over-leveraged banks collapsed Many banks either collapsed or were bailed out by government Left a devastating impact on the global economy (Poverty increased drastically) What type of money do you want when a country is unstable - answersCommodity money Very rare Federal Funds Rate - answersThe interest rate that banks charge each other Interest Rates - answersGeneral rates that people are charged