AP Macro Unit 4 - Financial Sector

• Money earned from working

• Value of accumulated assets

• Something you own that has value that can be converted into cash (liquified)

• Examples: cars, homes

• A financial obligation that has to be paid back

• Examples: loans

• Government spends more money in one year than it receives in tax revenue

• Government receives more money in one year in tax revenue than its spends

• Sum of all the budget deficits and budget surpluses added together

• The ease with which an asset can be accessed and converted into cash

• Cash is the most liquid asset

• Net gain or loss of an investment over a specific time period

• Chance that an outcome or an investment’s actual gains differ from the expected outcome

• An interest-bearing asset often issued by businesses or the government

• Also referred to as “securities”

• Sold by a firm with the expectation to be paid back with interest

• Occurs when a company raises money by selling debt instruments to investors

• Opposite of Equity Financing

• The BORROWING of money to fund the company

• A security that gives you ownership in a company

• Sold on the Stock Market

  • Prices are determined by company growth expectations

• Process of raising capital through the sell of shares

• Done to avoid debt

• Gives external control over management and profits of the firm

• Opposite of Debt Financing

• The SELLING of equity in the company

• The process of borrowing money and repaying it back with interest

• Agreement between a borrower and lender

• Can be an asset or a liability

• Types of loans:

  • Credit cards

• The money in your bank account

• AKA Demand Deposits

• Debit card

• Inverse

• Why?

  • Most bonds pay a fixed rate of interest so as interest rates fall in the economy, the bonds are more desirable and their prices rise

  • Consumers are less interested in fixed-rate interest rates with a bond when interest rates in the economy are increasing, because they’ll get less in return than they can right now, so they demand less and the prices decrease

• IOUs issued by the government, or firms, with a fixed repayment date

  • On that day, you get your money back plus the fixed interest rate agreed upon before hand

• Used to control the money supply

  • Increase - buy bonds back from banks, giving money

  • Decrease - sell bonds to banks, taking money

• Reward for saving money (deposit)

• Price for borrowing money (loan)

• Interest rates that are not adjusted for the impact of inflation

• What is advertised by banks, investments, and debt issuers as the interest rate

• Always higher than real interest rates because it doesn’t take into account the continual loss of value in money

• Real Interest Rate + Expected Inflation Rate

• Interest rates that have been adjusted for the impact of inflation

• Investors can use this to estimate actual returns later on for when the value of money has changed

• Nominal Interest Rate - Inflation

• The interest rate at which the Federal Reserve lends money to banks

• The interest rate banks are charged to borrow money from the FED

• If it increases, lending becomes more expensive and the money supply decreases

• If it decreases, lending becomes less expensive and the money supply increases

• Something that serves as money or currency and has no other uses

• Examples:

  • Paper money

  • Coins

• Something that performs the function of money and has alternative, non-monetary use

• Examples:

  • Gold

  • Silver

  • Other precious metals

  • Oil

  • Tobacco

• Medium of Exchange

  • Used to buy goods and services without complications of bartering

• Unit of Account

  • Used to measure the value of goods and services

• Store of Value

  • Used to preserve or save purchasing power for future consumption

• Constant - vertical supply curve

• M1 + M2

• Coins, paper currency, and checkable deposits, including checking accounts and debit accounts

• High liquidity

• Acts as a Medium of Exchange

cash + coins + checking deposits + traveller’s checks

• Measure of the money supply that includes all elements of M1 as well as “near money” (savings deposits, money market securities, mutual funds, and other time deposits)

• Medium liquidity

• Acts as a Store of Value

M1 + savings deposits + small time deposits + money market deposits + money market mutual funds

• Refers to the money in circulation or in bank reserves

• The physical paper and coin currency used in the economy and bank deposits

• NOT included in the money supply

Currency in circulation + Bank reserves

• Practice by which a bank accepts deposits and is required to hold only a fraction of its deposits in cash reserves

• Set by the Federal Reserve

• Amount (in percentage) of demand deposits the bank has to hold in reserve

• If it decreases, there is more money available to loan out, and the money supply increases

• If it increases, there is less money available to loan out, and the money supply decreases

• A deposit of money left in a bank that can be withdrawn without prior notice by the account holder

• The remainder of every demand deposit after required reserves are held

• Turned into new loans - what is multiplied through the economy to “make new money”

• Amount of money banks generate with each dollar of excess reserves

• Take the new loans and multiply that amount by this number to find the amount of money generated by banks

• 1 / (reserve ratio)

• Visual records of fractional reserve banking within a bank

• Shows the assets and liabilities of a bank

  • Assets and liabilities must equal each other

• Financial obligations a bank must pay to a customer, and must be repaid when requested

• Examples:

  • Demand Deposits

  • Account investments

  • Equity

• Possessions that are owned or credited to a bank that can be collected or liquified into cash

• Examples:

  • Required reserves

  • Excess reserves

  • Outstanding loans

  • Securities

• Inverse

• Why?

  • The opportunity cost to hold wealth in the form of money instead of the form of other assets is nominal interest rate

  • When interest rates are low, the opportunity cost is lower, so people opt to hold wealth in money because they will have more chance to gain more in other investments than depositing their money in banks

• People demand money in transaction demand (to buy stuff) and asset demand (liquid asset vs non-liquid asset)

• Price Level

• Real GDP

• Transaction costs

increases

• Vertical line on the Demand for Money graph

• Unrelated to the interest rate - set by the FED

• Reserve Requirement

• Discount Rate

• Open Market Operations

• Quantity of money demanded is equal to quantity of money supplied

• The FED buys or sells bonds

• When the FED buys bonds, money is injected into the economy and the money supply increases

• When the FED sells bonds, money is taken out of the economy and the money supply decreases

• PL (Inflation)

  • Inflation increases, demand for money increases

• Income

  • Income increases, demand for money increases

• Technology

  • Products like ApplePay and GooglePay have decreased demand for money

• The FED pays interest on reserves, encouraging banks to keep more deposits in reserve and loan less out

• Decreasing will increase the money supply

• Increasing will decrease the money supply

• The desired quantity of investment spending by firms across the economy on physical capital and other resources for the purpose of future productivity/profitability

• Inverse

  • When interest rates fall, investment increases

  • When interest rates rise, investment decreases

• AKA Easy Monetary Policy

• Increase money supply

• Increase RGDP output

• AKA Tight Monetary Policy

• Decrease money supply

• Decrease RGDP output

• Discount Rate

• Reserve Ratio

• Open-Market Operations

• Federal Funds Rate

• The interest rate the Federal Reserve charges commercial banks to borrow money directly from the Treasury

… banks to borrow more because it’s cheaper, increasing the money supply

… banks borrow less because it’s more expensive, decreasing the money supply

• AKA Reserve Requirement

• Portion or percentage of all new demand deposits that banks must hold in reserve and cannot lend

… less money to be leant out, decreasing the money supply

… more money to be leant out, increasing the money supply

• Most popular tool used by the Federal Reserve

• Involves the buying and selling of treasury bonds

… it gives money to banks, increasing the money supply

… it takes money from the banks, decreasing the money supply

• The interest rate that commercial banks and depository institutions borrow money directly from each other

… borrowing money to be more expensive, so banks borrow less and decrease the money supply

… borrowing money to be less expensive, so banks borrow more and increase the money supply

… an increase in Quantity of Investment Demanded, which will increase Aggregate Demand

… a decrease in Quantity of Investment Demanded, which will decrease Aggregate Demand

• The interaction of borrowers and savers in the economy

  • Borrowers demand loanable funds

  • Savers supply loanable funds

• Real Interest Rate is adjusted so that the amount of borrowing is equal to the amount of saving

• The quantity of credit wanted and needed at every real interest rate by borrowers in an economy

When interest rates rise, the demand for loanable funds decrease

• FADE

• Foreign Demand for Domestic Currency

• All Borrowing, Lending, and Credit

• Deficit Spending

• Expectations for the Future

• Foreign investors want more of a country’s money to make purchases of that country’s goods and services, so the demand for the country’s currency increases

• When the demand for a country’s currency increases, the demand for loanable funds decreases

• Increase in loans, credit, and borrowing by consumers and firms leads to an increase in demand for loanable funds

• When the government spends more money than is being brought in with tax revenue

• If the government spends more, there is an increase in demand for loanable funds to cover costs not covered by tax revenue

• Government borrowing drives up the interest rate on loanable funds and decreases private investment

  • The amount of private investing decreases because less people want to take out loans with an increased interest rate, but the overall quantity of loanable funds increases because of government borrowing

• If there are predictions for future growth, there will be an increase in demand for loanable funds

  • Businesses are willing to take out loans to improve and invest in their business

  • Consumers are confident in the economy and feel comfortable taking out loans

• Concerns about the economy will lead to a decrease in demand for loanable funds

• The quantity of credit provided at every real interest rates by banks and other lenders in an economy

When interest rates rise, the supply of loanable funds increase

• SELF

• Savings Rate

• Expectations for the Future

• Lending at the Discount Window

• Foreign Purchases of Domestic Assets

• When consumers put more money into savings, demand deposits increase, increasing the reserves banks can loan out, increasing the supply of loanable funds

• When the economy contracts, consumers will put more money into banks, giving banks more reserves to loan out, increasing the supply of loanable funds

• When the discount rate is lowered by the Fed, banks are more willing to borrow funds, increasing the supply of loanable funds

• A foreign investor decides to buy domestic assets, such as bonds, and puts more money in the banking system and increases the supply of loanable funds