ECONOMICS 0281

MONEY AND BANKING VOCABULARY-PART 3

64. RESERVES: Deposits held at the Fed plus vault cash.

65. REQUIRED RESERVES: Reserves that are held to meet the Fed’s requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves. (Fraction of checkable deposits held in reserve as specified by law.)

66. EXCESS RESERVES: Reserves in excess of required reserves.

67. MONETARY BASE/HIGH-POWERED MONEY (MB): The sum of the Fed’s monetary liabilities (currency in circulation and reserves) and U.S. Treasury liabilities (primarily coins).

68. DISCOUNT LOANS (FDL): A bank’s borrowing from the FRS.

69. OPEN MARKET OPERATIONS: The Fed’s buying or selling of Treasury bonds in the open market.

70. THE SIMPLE MONEY MULTIPLIER: The multiple increase in deposits generated from an increase in the banking system’s reserves in a simple model in which the behavior of depositors and banks play no role. (In other words, there is no leakage into currency or excess reserves).

71. THE COMPLEX MONEY MULTIPLIER: A ratio that relates changes in the money supply to changes in the monetary base.

72. POLITICAL BUSINESS CYCLE: A business cycle which occurs when the political authorities persuade the Fed to conduct an expansionary monetary policy before an election in order to lower interest rates and unemployment. The long-term effects of these expansionary policies produce inflation, a result occurring after the election.

73. DYNAMIC OPEN MARKET OPERATION: Those open market operations that are intended to change the level of reserves and the monetary base.

74. DEFENSIVE OPEN MARKET OPERATION: Those open market operations that are intended to offset other factors that affect reserves and the monetary base (such as changes in Treasury deposits with the Fed or float).

75. REPURCHASE AGREEMENT (REPO): An arrangement whereby the Fed purchases government securities and the seller agrees to repurchase them from the Fed in the near future.

76. MATCHED SALE-PURCHASE TRANSACTION (REVERSE REPO): An arrangement whereby the Fed sells government securities and the buyer agrees to sell them back to the Fed in the near future.

77. LENDER OF LAST RESORT: The central bank should provide reserves to solvent banks when no other bank would in order to avoid bank failures which create a banking panic.

78. PROCYCLICAL MONETARY POLICY: A monetary policy which produces a positive association between the money supply and the business cycle.

79. COUNTERCYCLICAL MONETARY POLICY: A monetary policy which produces a negative association between the money supply and the business cycle.

80. FREE BANKING SYSTEM: A banking system which is characterized by the lack of a central bank and the ability of each bank to print its own currency.

81. ADVERSE CLEARINGS: The process by which bank notes are returned to the bank of issue by those who have accepted the notes in payment but who prefer to use the currency of their own bank. (The issuing bank will lose reserves through this process whenever it over-issues its notes.)

NOTE: For example, Bank A’s notes will be exchanged for Bank B’s notes by those who bank at Bank B. Bank B will then return Bank A’s notes to Bank A in return for an equivalent value of Bank A’s reserves. Bank A will lose reserves whenever it over-issues notes because the excess notes will not stay in circulation but will be returned to Bank A either directly or indirectly through other banks.

82. SECONDARY NOTE MARKET: This market arises when a bank’s notes circulate beyond the local area where its reputation for safety is not well known. In this case, other banks will accept a given bank’s notes at face value only when it is deemed to be quite safe. If a given bank is in some danger of becoming insolvent, its notes will trade at a discount.

NOTE: The secondary note market can be used to distinguish safe from unsafe banks by indicating whether a particular bank’s notes are accepted at face value or not.

83. CLEARINGHOUSES: These institutions lower the costs of returning notes to issuing banks by acting as an intermediary between accepting bank and issuing bank.

84. OPTION CLAUSES: Contractual clauses which are attached to a bank’s notes stating the conditions under which a bank will not redeem their notes. Typically, banks in this situation offer to pay the note holders interest as a penalty for not redeeming their notes on demand.

NOTE: Such clauses help banks which are under pressure from note holders for redemption to reduce the need for liquidating relatively illiquid assets and thereby decrease the risk of insolvency.