Glossary
Assets
Anything of value owned by an individual or firm, which can be converted into cash.
Example:
A company's assets include its factories, equipment, and the cash it holds in its bank accounts.
Bank Balance Sheets (T-Accounts)
Accounting statements that show a bank's assets (what it owns) on one side and its liabilities (what it owes) and owner's equity on the other.
Example:
Using Bank Balance Sheets (T-Accounts), we can see how a new loan increases both a bank's assets (the loan itself) and its liabilities (the new deposit created).
Discount Rate
The interest rate at which commercial banks can borrow money directly from the Federal Reserve.
Example:
If the FED wants to increase the money supply, it might lower the Discount Rate to encourage banks to borrow more and lend out more.
Expected Inflation Rate
The rate at which consumers and businesses anticipate the general price level to rise in the future.
Example:
If people believe the Expected Inflation Rate will be high next year, they might demand higher nominal wages today.
Federal Reserve Bank (FED)
The central bank of the United States, responsible for conducting monetary policy and supervising the banking system.
Example:
The Federal Reserve Bank decided to raise interest rates to cool down an overheating economy and curb inflation.
Fractional Banking System
A banking system in which banks hold only a fraction of deposits as reserves and lend out the remainder, thereby creating money.
Example:
Because of the Fractional Banking System, when you deposit $100, the bank only keeps a portion and loans out the rest, expanding the money supply.
Liquidity
The ease with which an asset can be converted into cash without a significant loss in value.
Example:
Cash is the most liquid asset, while real estate is generally considered less liquid because it takes time to sell.
Loanable Funds Market
A market where savers supply funds and borrowers demand funds, determining the real interest rate.
Example:
An increase in government borrowing can increase the demand for funds in the Loanable Funds Market, potentially raising the real interest rate.
M1
The narrowest measure of the money supply, including the most liquid forms of money such as currency in circulation and checking account deposits.
Example:
The cash in your wallet and the balance in your checking account are part of M1.
M2
A broader measure of the money supply that includes M1 plus less liquid assets like savings account deposits, money market deposit accounts, and small-denomination time deposits.
Example:
Your savings account balance, in addition to your checking account, contributes to the M2 money supply.
M3
The broadest measure of the money supply, including M2 plus large time deposits, institutional money market funds, and other less liquid assets.
Example:
Large institutional investments in money market funds are typically included in the M3 measure of the money supply.
Medium of Exchange
One of the three functions of money, meaning it is widely accepted as payment for goods and services.
Example:
When you buy a coffee with a $5 bill, that bill is serving as a Medium of Exchange.
Monetary Policy
Actions undertaken by a central bank, like the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.
Example:
To combat a recession, the FED might use expansionary Monetary Policy by lowering interest rates to encourage borrowing and spending.
Money Market
A market where the demand for and supply of money determine the nominal interest rate.
Example:
When the Federal Reserve increases the money supply, it shifts the supply curve in the Money Market to the right, lowering the nominal interest rate.
Money Market Equilibrium
The point in the money market where the quantity of money demanded equals the quantity of money supplied, determining the nominal interest rate.
Example:
When the nominal interest rate adjusts to a level where people are willing to hold exactly the amount of money supplied by the FED, the Money Market Equilibrium is achieved.
Money Multiplier
The ratio of the change in the money supply to the initial change in bank reserves, indicating how much the money supply can expand from an initial deposit.
Example:
With a 20% reserve requirement, the Money Multiplier is 5, meaning an initial 500 increase in the money supply.
Nominal Interest Rate
The stated interest rate on a loan or investment, not adjusted for inflation.
Example:
If your bank account offers a 5% annual interest rate, that is the Nominal Interest Rate.
Open-Market Operations
The buying and selling of government bonds by the Federal Reserve to influence the money supply.
Example:
When the FED buys government bonds through Open-Market Operations, it injects money into the banking system, increasing the money supply.
Rate of Return
The percentage gain or loss on an investment over a period of time.
Example:
If you invest 110 in a year, your Rate of Return is 10%.
Real Interest Rate
The nominal interest rate adjusted for inflation, reflecting the true purchasing power of the interest earned.
Example:
If the nominal interest rate is 5% and inflation is 3%, the Real Interest Rate is 2%, meaning your purchasing power only increased by 2%.
Required Reserves
The minimum fraction of deposits that banks are legally required to hold in reserve and not lend out.
Example:
If the reserve requirement is 10%, a bank receiving a 100 as Required Reserves.
Reserve Ratio/Requirement
The percentage of deposits that banks are legally required to hold in reserve and not lend out.
Example:
A decrease in the Reserve Ratio/Requirement allows banks to lend out a larger portion of their deposits, increasing the money supply.
Risk
The potential for financial loss or gain on an investment.
Example:
Investing in a volatile stock market carries a higher risk compared to putting money in a savings account.
Store of Value
One of the three functions of money, meaning it can be held and exchanged for goods and services later without significant loss of value.
Example:
Saving money in a bank account allows you to use it to buy something in the future, demonstrating its function as a Store of Value.
Unit of Account
One of the three functions of money, meaning it provides a common measure of value for goods and services.
Example:
Knowing that a car costs 30,000 down payment on a house, as money serves as a Unit of Account.