Financial Market

• what is the financial system?

  the group of institutions in the economy that help to match one person's saving with another person's investment
• What is the bank lending rate?

  average interest rate charged by banks on loans to firms and households
• what is the money market rate?

  the interest rate at which banks borrow/lend liquidity
• what is the policy interest rate

  The interest rate on base money set by the central bank
• What is base money?

  held by households, firms, and banks, and the balances held by commercial banks in their accounts at the central bank, known as reserves. base money is liability of the central bank
• what is bank money?

  Money in the form of bank deposits created by commercial banks when they extend credit to firms and households. Liability of commercial banks
• what is broad money/ money supply?

  the amount of broad money in econ is measured by stock of money in circulation. defines as sum of bank money that is in hands of the non-bank public. Cash + deposits.
• what are banks ?

  firms (financial intermediaries) that make profits by lending and borrowing (taking deposits)
• what do banks provide?

  - provide the economy with the service of maturity transformation

  - the service of risk transformation
• How do banks make a profit?

  they charge interest rates larger than the one paid on deposits.
• what is maturity transformation?

  where deposits can be withdrawn anytime but loans only need to be repaid after a specified time
• what is liquidity transformation?

  deposits are liquid and loans to borrowers are frozen (iiliquid)
• What is default risk?

  The risk the loan won't be repaid
• what is the liquidity risk?

  the risk that the asset cannot be exchanged for cash rapidly enough to prevent a loss
• what does a bank's balance sheet summarise?


  what the firm owns and what it owes to others
• how do you calculate net worth?

  assets - liabilities
• what are some examples of a banks' assets?

  - bank's deposits at the central bank (reserves)

  - loans to privates (households and firms)

  - other financial assets (bonds)
• what are reserves?


  bank's deposits at the central bank
• what are some examples of a banks liabilities?

  - household and firm's deposits

  - bank' borrowing from other banks and/or central bank
• what do commercial banks do?

  creates money by making loans
• is bank money an asset or liability to the bank and why?

  a liability because the cash has to be given back
• what bank is the only one that can print money?

  the central bank
• what is the money just printed called?

  base money/high-powered money/monetary base. given by cash + reserves
• when does the central bank print money?

  whenever commercial banks' deposits holders withdraw from their deposits.
• when does the central bank credit reserves?

  when the central bank buys bonds from or lends to commercial banks
• what does the central bank crediting reserves do?

  injects money into the economy
• what is an example of the central bank's assets?

  -loans to banks + domestic government (bonds)
• what is an example of the central bank's liabilities

  monetary base, that is currency in circulation (cash) + banks' deposits (reserves)
• What is monetary policy?


  Policies that control the supply of money, the price of money, and the availability of credit.
• what are the steps to the central bank setting the policy rate?

  1. choose the desired level of aggregate demand, based on labour market equilibrium and inflation

  2. estimate the real interest rate which is consistent with that level of aggregate demand

  3. calculate the nominal policy rate that will produce the appropriate market rate
• what is aggregate demand?

  the total demand for goods and services within a particular market
• what are the 4 channels in the monetary policy transmission?

  1. market interest rates

  2. asset prices

  3. expectations/confidence

  4. exchange rate
• when the interest rate goes down what happens to the price of assets?

  they go up
• what happens to households that own lots of assets when interest rates go down?


  they will be wealthier which will increase their consumption
• what are the expectations of monetary policy transmission?

  -consistent policy making and good communication with the public build confidence in the central bank

  -households may be confident that they will not lose their jobs, and they may increase their consumption

  - firms may expect higher demand and therefore increase investment
• What is an exchange rate?

  the price of one currency in terms of another
• what affects exchange rates and why?

  interest rates as that affects demand for home currency in the forex market, which then affects the exchange rate
• what do exchange rates affect?

  relative demand for home-produced goods, so affects net exports
• how do interest rates affect aggregate demand?

  through the market for financial assets