Important Definitions Related to Monetary Policy

IMPORTANT DEFINITIONS RELATED TO MONETARY POLICY


· Monetary policy is the management of the nation’s money supply, interest rates, and banking system to promote economic growth, low unemployment, and low inflation.

· Fiscal policy is taxing and spending by the government.

A central bank is an institution that oversees the banking system and regulates the quantity of money in an economy.

The Federal Reserve System (the Fed) is the U.S. central bank, which oversees the banking system and regulates the quantity of money in an economy.

Expansionary monetary policy occurs when the Federal Reserve System induces commercial banks to increase the amount of money they create through loans and thus increases the money supply.

Contractionary monetary policy occurs when the Federal Reserve System induces commercial banks to decrease the amount of money they create through loans and thus decreases the money supply.

Money is anything that is generally accepted to serve as a medium of exchange, store of value, and unit of account.

· A medium of exchange is something, such as money, that facilitates trade.

· Barter is the exchange of a good or service for another good or service.

· A double coincidence of wants is the need for a trader to find a partner who has a product he wants and who wants what he is offering to trade.

· A store of value is something, such as money, that is used to hold purchasing power for use at a later time.

· A unit of account is something, such as money, that is commonly used to measure the prices of things.

· Currency is paper bills and coins.

· Paper bills are paper or cloth notes with markings that indicate their monetary denominations.

· Coins are hard materials, typically metals, with markings that indicate their monetary denominations.

· Fiat money is money that does not have intrinsic value.

· Fiat lux is the motto of Jacksonville University. It is Latin for “let there be light” or “let the light shine.”

· Commodity money is money that has intrinsic value.

· M1 is the narrowest definition of the U.S. money supply. It includes currency, travelers’ checks, demand deposits and other checkable deposits.

· A traveler’s check is a draft, available in various denominations, that must be signed at the time of purchase and which can be redeemed only when countersigned with a matching signature at the time of redemption.

· A demand deposit is the balance in a checking account at a commercial bank.

· M2 is a definition of the U.S. money supply that includes currency, travelers’ checks, demand deposits and other checkable deposits, savings accounts, money market accounts, money market mutual funds, and small denomination certificates of deposit

· M3 is a definition of the U.S. money supply that includes currency, travelers’ checks, demand deposits and other checkable deposits, savings accounts, money market accounts, money market mutual funds, small denomination certificates of deposit, and large denomination certificates of deposit

· Commercial banks are financial institutions, chartered by the federal or state government, that generate income primarily by accepting deposits from the general public and using these funds to create loans.

· Credit unions are not-for-profit organizations that provide banking services to members.

· Open market operations are the purchases and sales of government securities by the Federal Reserve System’s Federal Open Market Committee (FOMC) to or from the general public.

· Open market purchases are the purchases of government securities by the Federal Reserve System’s Federal Open Market Committee (FOMC) from the general public.


· Open market sales are the sales of government securities by the Federal Reserve System’s Federal Open Market Committee (FOMC) to the general public.

· The discount rate is the interest rate charged on loans from the regional Federal Reserve Banks to commercial banks.

· Discount loans are loans from regional Federal Reserve Banks to commercial banks

· The federal funds rate is the interest rate charged on loans from commercial banks to other commercial banks. It is one half of a percentage point less than the discount rate.

· Federal funds are reserves that are loaned overnight from a commercial bank with excess reserves to a commercial bank with a shortage of reserves.

· The Board of Governors is the seven-member committee that sets policy for the Federal Reserve System.

· The Federal Open Market Committee (FOMC) is the twelve-member Federal Reserve System committee that conducts open market operations to alter the money supply and influence the economy.

· Regional Federal Reserve Banks are the Federal Reserve System institutions that oversee the health of the U.S. banking system. The 12 regional Federal Reserve banks also clear checks, issue new currency, withdraw damaged currency from circulation, evaluate some merger applications, administer and make discount loans to banks in their districts, act as liaisons between the business community and the Federal Reserve System, examine state member banks, collect data on local business conditions, and research topics related to the conduct of monetary policy.

· Fractional-reserve banking is a banking system in which banks hold only a fraction of deposits as reserves.

· Reserves are the cash in the vault of a commercial bank plus its deposits in accounts at a Federal Reserve Bank.

· Vault cash is the currency held in a commercial bank’s vault.

· An asset is a financial claim or piece of property that is a store of value.

· Liabilities are debts.

· Net worth is the difference between a firm’s assets and its liabilities.

· Reserves are a commercial bank’s deposits in accounts at the Fed plus currency that is held in the bank’s vault.

· Required reserves are the vault cash and deposits at the Fed that commercial banks hold to meet the Fed’s requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves.

· Excess reserves are the vault cash and deposits at the Fed that commercial banks hold is addition to those held to meet the Fed’s requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves.

· U.S. government securities are long-term debt instruments (such as bonds) issued by the U.S. Treasury to finance the budget deficits of the federal government.

· Liquidity is the relative ease and speed with which an asset can be converted into cash. Loans are assets for banks

· The required reserve ratio (rr) is the fraction or percentage of deposits that commercial banks are required to hold in the form of reserves.

· The monetary base is the amount of currency in circulation or held as reserves.

· The reserve ratio (R) is the fraction of deposits that banks hold as reserves.

· The money multiplier is the amount of money the banking system generates with each dollar of reserves. It is the reciprocal of the reserve ratio.

· A T-account is a simplified balance sheet with lines in the form of a T that lists only the changes that occur in the balance sheet items from some initial balance sheet position.