Key Terms

Key Terms

bank run when depositors race to the bank to withdraw their deposits for fear that otherwise they would be lost basic quantity equation of money money supply × velocity = nominal GDP central bank institution which conducts a nation’s monetary policy and regulates its banking system contractionary monetary policy a monetary policy that reduces the supply of money and loans countercyclical moving in the opposite direction of the business cycle of economic downturns and upswings deposit insurance an insurance system that makes sure depositors in a bank do not lose their money, even if the bank goes bankrupt discount rate the interest rate charged by the central bank on the loans that it gives to other commercial banks excess reserves reserves banks hold that exceed the legally mandated limit expansionary monetary policy a monetary policy that increases the supply of money and the quantity of loans federal funds rate the interest rate at which one bank lends funds to another bank overnight inflation targeting a rule that the central bank is required to focus only on keeping inflation low interest rate on reserve balances (IORB) the interest the Federal Reserve pays banks on their reserves held at their Federal Reserve bank lender of last resort an institution that provides short-term emergency loans in conditions of financial crisis loose monetary policy see expansionary monetary policy open market operations the central bank selling or buying Treasury bonds to influence the quantity of money and the level of interest rates quantitative easing (QE) the purchase of long term government and private mortgage-backed securities by central banks to make credit available in hopes of stimulating aggregate demand reserve requirement the percentage amount of its total deposits that a bank is legally obligated to either hold as cash in their vault or deposit with the central bank tight monetary policy see contractionary monetary policy velocity the speed with which money circulates through the economy; calculated as the nominal GDP divided by the money supply

Key Concepts and Summary

15.1 The Federal Reserve Banking System and Central Banks

The most prominent task of a central bank is to conduct monetary policy, which involves changes to interest rates and credit conditions, affecting the amount of borrowing and spending in an economy. Some prominent central banks around the world include the U.S. Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England.

15.2 Bank Regulation

A bank run occurs when there are rumors (possibly true, possibly false) that a bank is at financial risk of having negative net worth. As a result, depositors rush to the bank to withdraw their money and put it someplace safer. Even false rumors, if they cause a bank run, can force a healthy bank to lose its deposits and be forced to close. Deposit insurance guarantees bank depositors that, even if the bank has negative net worth, their deposits will be protected. In the United States, the Federal Deposit Insurance Corporation (FDIC) collects deposit insurance premiums from banks and guarantees bank deposits up to $250,000. Bank supervision involves inspecting the balance sheets of banks to make sure that they have positive net worth and that their assets are not too risky. In the United States, the Office of the Comptroller of the Currency (OCC) is responsible for supervising banks and inspecting savings and loans and the National Credit Union Administration (NCUA) is responsible for inspecting credit unions. The FDIC and the Federal Reserve also play a role in bank supervision.