Money & Monetary Policy

Contractionary monetary policy decreases the money supply to raise interest rates and reduce inflation.

The interest rate the Federal Reserve charges commercial banks for short-term loans.

Excess reserves are the funds a bank holds above its required reserves, which are available to lend out.

Expansionary monetary policy increases the money supply to lower interest rates and stimulate aggregate demand.

The interest rate at which banks lend their excess reserves to other banks overnight.

Fractional reserve banking is a system in which banks hold only a fraction of deposits as reserves and lend out the rest.

Money serves three functions: a medium of exchange, a unit of account, and a store of value.

M1 and M2 are measures of the money supply; M1 is the most liquid money and M2 includes M1 plus less-liquid near-money.

Monetary policy is the central bank's use of the money supply and interest rates to influence the economy.

Money demand is the amount of wealth people choose to hold as money rather than in interest-bearing assets.

The money market is the model in which the supply of and demand for money determine the nominal interest rate.

The money multiplier is the maximum amount the money supply can increase for each dollar of new bank reserves.

The money supply is the total amount of money circulating in an economy, including cash and checkable deposits.

Open market operations are the central bank's buying and selling of government bonds to change the money supply.

A theory stating that the general price level of goods and services is directly proportional to the amount of money in circulation.

The required reserve ratio is the fraction of deposits that banks must hold in reserve rather than lend out.

The percentage of deposits that banks are legally required to hold as reserves rather than lend out.

The average frequency with which a unit of money is spent in a given period.

The net export effect is the channel by which monetary policy changes interest rates, which move the exchange rate and net exports, amplifying the policy's impact on AD.

The transmission mechanism is the chain by which a central bank's interest-rate change passes through to investment, consumption, exchange rates, and ultimately AD and inflation.

Money neutrality is the idea that changes in the money supply affect only nominal variables (prices, wages) in the long run, leaving real GDP and employment unchanged.

Vault cash is the physical currency a bank keeps on its premises; it counts toward the bank's reserves alongside its deposits at the Fed.

The monetary base, or high-powered money, is currency in circulation plus bank reserves — the money the central bank directly controls.

Interest on reserve balances (IORB) is the rate the Fed pays banks on reserves held at the Fed; it is now the Fed's main tool for steering the federal funds rate.

Real money balances (M/P) are the money supply adjusted for the price level — the purchasing power of money rather than its dollar amount.

The Taylor rule is a formula prescribing how a central bank should set the policy interest rate based on inflation gaps and the output gap.

A lender of last resort is a central bank that supplies emergency liquidity to solvent banks during a panic to stop bank runs from spreading.

Currency in circulation is the physical cash held by the public outside banks; it counts in M1, while cash sitting in bank vaults does not.