[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. In the long run, the full-employment model implies that
money is neutral. Changes in the quantity of money affect
the price level and the level of nominal wages but leave
real output, real wages, and employment unaffected.
2. Money is anything that is generally accepted in a given
society as a unit of account, a medium of exchange, and a
store of value.
3. The Federal Reserve is the central bank of the United
States. Its policy actions affect the level of reserves and
the money supply.
4. There are many ways of measuring the money supply.
The most common measures in the United States are
M1, M2, and M3. All include currency and demand
deposits (checking accounts); M2 and M3 also include
assets that are close substitutes for currency and
checking accounts.
5. Financial intermediaries, which include banks, savings
and loan institutions, mutual funds, insurance companies,
and others, all form the link between savers who
have extra funds and borrowers who desire extra funds.
6. Government is involved with the banking industry for
two reasons. First, by regulating the activities banks
can undertake and by providing deposit insurance,
government tries to protect depositors and ensure the
stability of the financial system. Second, by influencing
the willingness of banks to make loans, government
attempts to influence the level of investment and overall
economic activity.
7. By making loans, banks can create an increase in the
supply of money that is a multiple of any initial increase
in the bank’s deposits. If every bank lends all the money
it can and every dollar lent is spent to buy goods purchased
from other firms that deposit the checks in
their accounts, the money multiplier is 1 divided by the
reserve requirement imposed by the Fed. In practice,
the multiplier is considerably smaller.
8. The Federal Reserve can affect the level of reserves by
changing the reserve requirement, by changing the discount
rate, or by conducting open market operations.
9. The chief tool of the Fed is open market operations,
which affect the supply of reserves.
10. The reserve requirement, capital requirements, the
Fed’s status as lender of last resort, and deposit
insurance have made bank runs rare.
KEY TERMS
quantity equation of exchange
velocity
neutrality of money
unit of account
medium of exchange
store of value
money
demand deposits
M1
M2
M3
fractional reserve system
money multiplier
central bank
Federal Open Market Committee (FOMC)
open market operations
Open Market Desk
discount rate
REVIEW QUESTIONS
1. What is meant by “the neutrality of money”?
2. What is the name of the committee that sets monetary
policy for the United States? Who are the members of
this committee?
3. What are the three characteristics that define “money”?
4. What are the differences between M1, M2, and M3?
5. What are the three instruments of the Federal Reserve?
6. Why do reserves fall if the Fed engages in an open
market sale? Why do they rise if the Fed engages in an
open market purchase?
7. Why do borrowed reserves fall if the Fed raises the
discount rate?
REVIEW AND PRACTICE ∂ 633