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91

Medium of exchange

An item that buyers give to sellers when they want to purchase goods and services. Money is the most liquid asset available

92

Unit of account

The yardstick people use to post prices and record debts.

93

Store of value

An item that people can use to transfer purchasing power from the present to the future.

Money is not the best store of value (shares, bonds, real estate...). Value of money deteriorates when there are inflationary expectations.

94

Liquidity

The ease with which an asset can be converted into the economy's medium of exchange.

95

Kinds of money

When money takes the form of a commodity with intrinsic value, it is called commodity money (e.g. gold.)

Flat money: Money without intrinsic value that is used as money because of government decree.

96

Monetary policy in Australia today

The RBA uses the cash rate to influence the level of economic activity rather than attempting to control the money supply. The RBA uses open-market operations to guarantee that its target rate is the equilibrium interest rate in the short-term money.

97

Cash rate

The interest that financial institutions can earn on overnight loans of their currency or reserves.

98

Open-market operations

The purchase and sale of Australian government securities by the RBA

99

Problems in controlling the money supply

Can not control the amount that bankers chose to lend.

Trade-off between inflation and unemployment in short-run

Bank runs

Can not control the amount of money that households choose to hold as deposits in banks.

100

Bank runs

Large numbers of depositors all try to withdraw their deposits at the same time

101

Banks and the money supply

100 per cent reserve banking

Fractional-reserve banking

102

100 per cent reserve banking

Reserves: Deposits that banks have received but have not lent out

In banks hold all deposits in reserve, banks don't influence the supply of money.

Photo in favourites 11/9/18

103

Fractional-reserve banking

A banking system in which banks hold only a fraction of deposits as reserves. Lend out a majority of their deposits thereby creating money.

Reserve ratio

Money multiplier

104

Reserve ratio

The fraction of deposits that banks hold as reserves.

105

The money multiplier

The amount of money the banking system generates with each dollar of reserves.

106

Fractional reserve ratio example

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When banks hold only a fraction of deposits in reserve, banks create money. While new money has been created so has debt. There is no new wealth created by the process. The process of money creation does not continue forever. It stops when the actual reserve-deposit ratio is equal to the desired reserve-deposit ratio.

107

Money in the Australian economy

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108

Money supply

The quantity of money available in the economy.

Currency

Current deposits

109

Currency

The plastic notes and metal coins in the hands of the public.

110

Current deposits

Balances in bank accounts that depositors can access on demand by using a debit card or writing a cheque.

111

Central Bank (or The Reserve Bank of Australia)

An institution designed to oversee the banking system and regulate the quantity of money in the economy.

112

Roles of the RBA

Monitor individual banks and ensure their stability

Act as a lender of last resort

Determine monetary policy

113

Monetary policy

The management by the central bank of liquidity conditions in the economy. Liquidity conditions refers to the price and availability of funding for the economy's expenditure.

114

There is a _____:
a.short-run trade-off between prices and interest rates

b.long-run trade-off between inflation and unemployment

c.short-run trade-off between inflation and unemployment

d.short-run trade-off between inflation and the money supply

ANS: C The Reserve Bank of Australia (RBA) can choose to pursue the goal of “inflationary pressures” via the use of raised interest rates in order to reduce Aggregate Expenditures (AE) in the economy or it may choose to pursue the goal of “unemployment” by reducing interest rates in order to stimulate/ increase aggregate expenditures.Because the goal of inflation implies the use of high interest rates whilst the goal of unemployment implies the use of low interest rates, both goals cannot be successfully pursued by the RBA simultaneously. Further, the pursuit of one goal moves the economy further away from the attainment of the other goal. Therefore, there is a trade of between inflation and unemployment as the pursuit of one objective leads to worsening problems with the other objective.

115

If the public switches from doing most of its shopping with currency to using cheques instead, and the Reserve Bank takes no action, the money supply will:

Increase

Cheques are a method of deferred payment where the exact amount is transferred out of the cheque

116

If a bank uses $80 of reserves to make a new loan when the reserve ratio is 25 per cent, then:

The level of wealth in the economy will not have changed

New loans lead to an expansion of the money supply. Changes in true wealth however are linked to changes in GDP per capita. That is, the level of goods and services that each average person is endowed with. Increases in the money supply alone, that is not accompanied by increases in GDP per capita do not represent a true change in the wealth of a nation.

117

A decrease in reserve requirements will likely result in banks:

A decrease in reserve requirements means that banks are now required to hold a smaller portion of deposits as required reserves. This means banks have more money available for creating loans. As banks create a larger number of loans, the money supply increases.

118

If you withdraw $100 from your bank, then:

the reserves of your bank will initially fall by $100

119

If banks choose to hold more excess reserves, then:

By holding more reserves, banks are implicitly making fewer loans so the money supply decreases.

120

Store of value deteriorates when

There are inflationary expectations.

Money in currency form loses value when there is inflation because stored money is a fixed amount of money that does not increase in line with inflation. Specifically, when the prices of goods and services increase, stored money is worth less because it now exchanges for (buys) a smaller quantity of goods and services.