36.  MONEY: That part of a person’s wealth that serves as a medium of exchange, unit of account, and a store of value.


37.  MEDIUM OF EXCHANGE: Anything that is used to pay for goods and services.


38.  STORE OF VALUE: A repository of purchasing power over time.


39.  UNIT OF ACCOUNT: Anything used to measure value in an economy.


40.  FIAT MONEY: Paper currency decreed by a government as legal tender but not convertible into precious metal.


41.  LIQUIDITY: The relative ease and speed with which an asset can be converted into a medium of exchange.


42.  FINANCIAL INTERMEDIARY: A firm that channels funds from savers to investors by accepting deposits from savers and making loans to investors. Such indirect finance lowers the transactions costs of investing in an impersonal market because the firm can specialize in discovering the creditworthiness of borrowers.


43.  FRACTIONAL RESERVE SYSTEM: A system in which banks hold reserves that are less than the amount of total deposits.


44.  REQUIRED RESERVES: Minimum reserve holdings legally mandated by the Federal Reserve.


45.  LEGAL RESERVES: An asset requirement mandated by the central bank. Only cash held by depository institutions in their vaults or deposits held at the regional Federal Reserve Bank qualify as legal reserves.


46.  EXCESS RESERVES: Reserves held over and above required reserves.


47.  REQUIRED RESERVE RATIO: The ratio of required reserves to total deposits mandated by the Federal Reserve. Banks may keep a higher proportion of their assets as reserves so the ratio specified by the Fed is a minimum.


48.  NET WORTH: The excess of assets over liabilities, or equity capital.


49.  THE SIMPLE MONEY MULTIPLIER: Relates changes in reserves in the banking system to changes in the money supply when there are no conversions of reserves into currency or excess reserves in the various rounds of the multiplier process.


50.  THE COMPLEX MULTIPLIER: Relates changes in the monetary base to changes in the money supply when reserves can be converted into currency in the various rounds of the multiplier process.


51.  MONETARY BASE: The sum of the reserves in the banking system plus the amount of circulating currency.



*52. BANK RUN: A situation where deposit holders of a bank which has pursued unwise investments will rush to their bank and convert their deposits into currency to avoid losing their deposits when the bank fails. The fact that bank customers can withdraw their funds when doubts about the safety and soundness of the bank arise causes banks to avoid unwise investments whenever possible. (NOTE: Bank runs are a form of market discipline which minimizes the propensity for risk-taking on the part of bank managers and contributes to the safety and soundness of a banking system.)


*53. BANKING PANIC: A run on all banks in the banking system regardless of whether they are nearly insolvent or highly solvent. Holders of deposits in banks will hurry to convert those deposits to currency thereby forcing even solvent banks to sell off significant portions of their interest earning assets, some of which are highly illiquid. As a result, many banks will not be able to meet their customers’ demands for currency and will become insolvent.


54.  FEDERAL RESERVE SYSTEM: The central bank in the United States which is responsible for managing the money supply. The system is divided into 12 regional banks which are responsible for carrying out the monetary policies set by the Board of Governors in Washington, D.C.


55.  FEDERAL OPEN MARKET COMMITTEE (FOMC): The committee which executes open market operations as part of the Board of Governors’ monetary policy.


56.  OPEN MARKET OPERATIONS: The buying and selling of government securities by the FOMC in order to change the level of reserves in the banking system.


57.  COUNTERCYCLICAL MONETARY POLICY: A monetary policy which is designed to stabilize the fluctuations in GDP by (a) increasing the money supply (an expansionary monetary policy) when a recession occurs in order to stimulate private expenditures or (b) decreasing the money supply (a contractionary monetary policy) in the expansion phase of the business cycle in order to reduce private expenditures and inflation.


58.  RECOGNITION LAG: A time period which begins with the emergence of a problem and ends when policymakers recognize it as a problem.


59.  ACTION (IMPLEMENTATION) LAG: A time period which begins with the recognition of a problem and ends when policymakers have implemented a policy designed to counter the problem.


60.  RESPONSE LAG: A time period which begins with the implementation of a policy designed to counter a problem and ends when that policy has its desired impact on the economy.


61.  PROCYCLICAL MONETARY POLICY: A monetary policy which unintentionally destabilizes the economy by following an expansionary monetary policy in the expansion phase of the business cycle and a contractionary monetary policy in the recession phase of the business cycle.





62.  MONETARISM: The view that changes in the supply of money are the primary cause of fluctuation in real GDP in the short-run and the ultimate cause of inflation in the long-run.


63.  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.


64.  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 overissues 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 overissues notes because the excess notes will not stay in circulation but will be returned to Bank A either directly or indirectly through other banks.


*65. 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 which can easily develop knowledge about the safety of Bank A will accept its notes at face value only when Bank A is quite safe. If Bank A is in some danger of becoming insolvent, its notes will trade at a discount. Thus 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.


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








*67. 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. 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.

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