Banking and Expansion of Money Supply - AP Macroeconomics

Explain an expansionary monetary policy.

Policy aimed at increasing the money supply to stimulate the economy. Lower rates and more money supply boost economic growth.
Which tool can the central bank use to combat inflation?

Raising the reserve requirement or interest rates. Both tools reduce money supply to control price increases.
What is a 'checkable deposit'?

Deposits in bank accounts from which money can be withdrawn via checks. Also called demand deposits, immediately accessible for transactions.
What effect does a lower discount rate have on the economy?

It encourages borrowing and increases the money supply. Cheaper borrowing costs stimulate lending and economic activity.
Define 'money supply'.

The total amount of monetary assets available in an economy. Includes all forms of money circulating in the economy.
Define 'fractional reserve banking'.

Banks hold a fraction of deposits as reserves and loan out the rest. Allows banks to create money through lending excess reserves.
How does increasing the federal funds rate affect the money supply?

It decreases the money supply. Higher rates discourage borrowing and reduce lending.
Identify the role of the Federal Reserve.

To control the money supply and maintain financial stability. The U.S. central bank implements monetary policy.
How does an open market operation affect the money supply?

Buying securities increases, selling decreases the money supply. Fed purchases inject money; sales remove money from circulation.
What is 'seigniorage'?

The profit made by the government by issuing currency. Revenue from creating money at low cost but high face value.
Identify the effect of an increase in the money multiplier.

The money supply increases. Higher multipliers create more money from each deposit.
Explain the 'lender of last resort' function.

The central bank provides funds to banks during financial distress. Emergency lending prevents banking system collapse.
What happens to the money supply if the central bank buys bonds?

The money supply increases. Bond purchases inject cash into the banking system.
What is a contractionary monetary policy?

Policy aimed at decreasing the money supply to control inflation. Reduces money supply to prevent excessive inflation.
What is the primary goal of monetary policy?

To achieve and maintain price stability and full employment. Balancing employment and inflation through monetary tools.
What is the effect of a central bank decreasing the reserve ratio?

Increases the money supply. Lower ratios allow banks to lend more freely.
What is the discount rate?

The interest rate the Federal Reserve charges on loans to banks. Lower rates encourage borrowing and increase money supply.
What does 'M1' consist of?

Currency, demand deposits, and other liquid assets. The most liquid measure of money supply.
What is a 'certificate of deposit' (CD)?

A savings certificate with a fixed maturity date and interest rate. A time deposit with penalty for early withdrawal.
Which of the following is not part of the money supply: bonds, currency, deposits?

Bonds. Bonds are investments, not immediate spending power.
Define 'bank run'.

A scenario where many depositors withdraw their money simultaneously. Mass withdrawals can cause bank failures and financial panic.
What is the primary function of a central bank?

To manage a nation's monetary policy and regulate banks. Central banks oversee monetary policy and supervise commercial banks.
What is the impact of raising the reserve requirement?

It decreases the money supply. Higher requirements reduce bank lending capacity.
What happens if the reserve ratio increases?

The money supply decreases. Higher ratios require more reserves, reducing lending capacity.
Define 'monetary base'.

Currency in circulation plus reserves held by banks. The foundation for all money creation in the economy.
Define 'liquidity'.

The ease with which an asset can be converted into cash. How quickly assets can become spendable cash.
What is the federal funds rate?

The interest rate at which banks lend reserves to each other overnight. The target rate for interbank lending affects all interest rates.
What is 'M2' in the context of money supply?

M1 plus savings deposits, small time deposits, and money market funds. A broader money supply measure including less liquid assets.
What is the primary goal of open market operations?

To control the money supply and interest rates. Fed's main tool for implementing monetary policy decisions.
What is the impact of selling government securities?

Decreases the money supply. Sales remove money from banks, reducing lending capacity.
State the formula for the money multiplier.

$\frac{1}{\text{Reserve Ratio}}$ . One divided by the reserve ratio determines money creation potential.
How does the central bank influence the money supply through reserve requirements?

By increasing or decreasing the reserve ratio. Higher ratios reduce lending; lower ratios increase it.
What is quantitative easing?

The purchase of long-term securities to increase the money supply. Unconventional policy when standard tools reach their limits.
How does a reduction in the discount rate affect banks?

Encourages banks to borrow more and lend more, increasing money supply. Cheaper Fed lending promotes bank lending to customers.
What is the relationship between the money supply and interest rates?

An inverse relationship; as one increases, the other typically decreases. More money typically leads to lower interest rates.
What is the role of the reserve requirement in banking?

To ensure banks have sufficient reserves to meet withdrawal demands. Prevents bank failures by maintaining adequate cash reserves.
Define 'fiat money'.

Currency that has value because of government decree, not intrinsic value. Value comes from government backing, not gold or silver.
What is the reserve requirement?

The percentage of deposits banks must hold in reserve. Set by the central bank to ensure bank liquidity.

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