economics_of_money_banking__financial_markets

accommodating policy An activist policy in pursuit of a high employment target. 640

activist An economist who views the self-correcting mechanism through wage and price adjustment to be very slow and hence sees the need for the government to pursue active, discretionary policy to eliminate high unemployment whenever it develops. 592

adaptive expectations Expectations of a variable based on an average of past values of the variable. 147

adverse selection The problem created by asymmetric information before a transaction occurs: The people who are the most undesirable from the other party’s point of view are the ones who are most likely to want to engage in the financial transaction. 32

agency theory The analysis of how asymmetric information problems affect economic behavior. 175, 189

aggregate demand The total quantity of output demanded in the economy at different price levels. 537, 582

aggregate demand curve A relationship between the price level and the quantity of aggregate output demanded when the goods and money markets are in equilibrium.

577, 582

aggregate demand function The relationship between aggregate output and aggregate demand that shows the quantity of aggregate output demanded for each level of aggregate output. 541

aggregate income The total income of factors of production (land, labor, capital) in the economy. 20

aggregate output The total production of final goods and services in the economy. 9

aggregate price level The average price of goods and services in an economy. 10

aggregate supply The quantity of aggregate output supplied by the economy at different price levels. 582

aggregate supply curve The relationship between the quantity of output supplied in the short run and the price level.

588

American option An option that can be exercised at any time up to the expiration date of the contract. 320

“animal spirits” Waves of optimism and pessimism that affect consumers’ and businesses’ willingness to spend.

544, 586

annuities Financial contracts under which a customer pays an annual premium in exchange for a future stream of annual payments beginning at a set age, say 65, and ending when the person dies. 288

appreciation Increase in a currency’s value. 436

arbitrage Elimination of a riskless profit opportunity in a market. 313

asset A financial claim or piece of property that is a store of value. 3

asset management The acquisition of assets that have a low rate of default and diversification of asset holdings to increase profits. 208

asset transformation The process of turning risky assets into safer assets for investors by creating and selling assets with risk characteristics that people are comfortable with and then using the funds they acquire by selling these assets to purchase other assets that may have far more risk. 32

asset market approach An approach to determine asset prices using stocks of assets rather than flows. 93

asymmetric information The unequal knowledge that each party to a transaction has about the other party. 32 autonomous consumer expenditure The amount of consumer expenditure that is independent of disposable

income. 538

balance of payments A bookkeeping system for recording all payments that have a direct bearing on the movement of funds between a country and foreign countries. 467

balance-of-payments crisis A foreign exchange crisis stemming from problems in a country’s balance of payments.

476

balance sheet A list of the assets and liabilities of a bank (or firm) that balances: Total assets equal total liabilities plus capital. 201

bank failure A situation in which a bank cannot satisfy its obligations to pay its depositors and other creditors and so goes out of business. 260

bank holding companies Companies that own one or more banks. 245

bank panic The simultaneous failure of many banks, as during a financial crisis. 191

banks Financial institutions that accept money deposits and make loans (such as commercial banks, savings and loan associations, and credit unions). 8

bank supervision Overseeing who operates banks and how they are operated. 265

Basel Accord An agreement that required that banks hold as capital at least 8% of their risk-weighted assets. 265

Basel Committee on Banking Supervision An international committee of bank supervisors that meets under the auspices of the Bank for International Settlements in Basel, Switzerland. 265

G-2 Glossary

basis point One one-hundredth of a percentage point. 74 Board of Governors of the Federal Reserve System A

board with seven governors (including the chairman) that plays an essential role in decision making within the Federal Reserve System. 337

bond A debt security that promises to make payments periodically for a specified period of time. 3

branches Additional offices of banks that conduct banking operations. 244

Bretton Woods system The international monetary system in use from 1945 to 1971 in which exchange rates were fixed and the U.S. dollar was freely convertible into gold (by foreign governments and central banks only). 470

brokerage firms Firms that participate in securities markets as brokers, dealers, and investment bankers. 304

brokers Agents for investors; they match buyers with sellers.

26

bubble A situation in which the price of an asset differs from its fundamental market value. 164

budget deficit The excess of government expenditure over tax revenues. 12

budget surplus The excess of tax revenues over government expenditures. 12

business cycles The upward and downward movement of aggregate output produced in the economy. 9

call option An option contract that provides the right to buy a security at a specified price. 322

capital account An account that describes the flow of capital between the United States and other countries. 467

capital adequacy management A bank’s decision about the amount of capital it should maintain and then acquisition of the needed capital. 208

capital market A financial market in which longer-term debt (generally with original maturity of greater than one year) and equity instruments are traded. 27

capital mobility A situation in which foreigners can easily purchase a country’s assets and the country’s residents can easily purchase foreign assets. 445

cash flow The difference between cash receipts and cash expenditures. 141, 190

central bank The government agency that oversees the banking system and is responsible for the amount of money and credit supplied in the economy; in the United States, the Federal Reserve System. 12, 230

closed-end fund A mutual fund in which a fixed number of nonredeemable shares are sold at an initial offering, then traded in the over-the-counter market like common stock.

299

coinsurance A situation in which only a portion of losses are covered by insurance, so that the insured suffers a percentage of the losses along with the insurance agency. 293

collateral Property that is pledged to the lender to guarantee payment in the event that the borrower is unable to make debt payments. 172

commodity money Money made up of precious metals or another valuable commodity. 48

common stock A security that is a claim on the earnings and assets of a company. 5

compensating balance A required minimum amount of funds that a firm receiving a loan must keep in a checking account at the lending bank. 219

complete crowding out The situation in which expansionary fiscal policy, such as an increase in government spending, does not lead to a rise in output because there is an exactly offsetting movement in private spending. 571, 587

consol A perpetual bond with no maturity date and no repayment of principal that periodically makes fixed coupon payments. 67

durable items such as automobiles and household appliances. 617

consumer expenditure The total demand for (spending on) consumer goods and services. 536, 585

consumption Spending by consumers on nondurable goods and services (including services related to the ownership of homes and consumer durables). 620

consumption function The relationship between disposable income and consumer expenditure. 538

costly state verification Monitoring a firm’s activities, an expensive process in both time and money. 182

cost-push inflation Inflation that occurs because of the push by workers to obtain higher wages. 639

coupon bond A credit market instrument that pays the owner a fixed interest payment every year until the maturity date, when a specified final amount is repaid. 63

coupon rate The dollar amount of the yearly coupon payment expressed as a percentage of the face value of a coupon bond. 64

creditor A holder of debt. 188

credit rationing A lender’s refusing to make loans even though borrowers are willing to pay the stated interest rate or even a higher rate or restricting the size of loans made to less than the full amount sought. 220

credit risk The risk arising from the possibility that the borrower will default. 208

credit view Monetary transmission mechanisms operating through asymmetric information effects on credit markets.

618

currency Paper money (such as dollar bills) and coins. 44

currency board A monetary regime in which the domestic currency is backed 100% by a foreign currency (say dollars) and in which the note-issuing authority, whether the central bank or the government, establishes a fixed exchange rate to this foreign currency and stands ready to exchange domestic currency at this rate whenever the public requests it. 492

currency swap The exchange of a set of payments in one currency for a set of payments in another currency. 328

current account An account that shows international transactions involving currently produced goods and services.

467

current yield An approximation of the yield to maturity that equals the yearly coupon payment divided by the price of a coupon bond. 70

dealers People who link buyers with sellers by buying and selling securities at stated prices. 26

debt deflation A situation in which a substantial decline in the price level sets in, leading to a further deterioration in firms’ net worth because of the increased burden of indebtedness. 192

deductible The fixed amount by which the insured’s loss is reduced when a claim is paid off. 292

default A situation in which the party issuing a debt instrument is unable to make interest payments or pay off the amount owed when the instrument matures. 120

default-free bonds Bonds with no default risk, such as U.S. government bonds. 121

default risk The chance that the issuer of a debt instrument will be unable to make interest payments or pay off the face value when the instrument matures. 120

defensive open market operations Open market operations intended to offset movements in other factors that affect the monetary base (such as changes in Treasury deposits with the Fed or changes in float). 398

defined-benefit plan A pension plan in which benefits are set in advance. 294

defined-contribution plan A pension plan in which benefits are determined by the contributions into the plan and their earnings. 294

demand curve A curve depicting the relationship between quantity demanded and price when all other economic variables are held constant. 87

demand-pull inflation Inflation that results when policymakers pursue policies that shift the aggregate demand curve. 639

deposit outflows Losses of deposits when depositors make withdrawals or demand payment. 208

deposit rate ceiling Restriction on the maximum interest rate payable on deposits. 238

depreciation Decrease in a currency’s value. 436

Glossary G-3

devaluation Resetting of the fixed value of a currency at a lower level. 472

dirty float See managed float regime. 462

discount bond A credit market instrument that is bought at a price below its face value and whose face value is repaid at the maturity date; it does not make any interest payments. Also called a zero-coupon bond. 64

discount loans A bank’s borrowings from the Federal Reserve System; also known as advances. 203

discount rate The interest rate that the Federal Reserve charges banks on discount loans. 210, 359

discount window The Federal Reserve facility at which discount loans are made to banks. 400

discount yield See yield on a discount basis. 71 disintermediation A reduction in the flow of funds into the

banking system that causes the amount of financial intermediation to decline. 238

disposable income Total income available for spending, equal to aggregate income minus taxes. 538

diversification Investing in a collection (portfolio) of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets.

32

dividends Periodic payments made by equities to shareholders. 26, 142

dollarization The adoption of a sound currency, like the U.S. dollar, as a country’s money. 493

dual banking system The system in the United States in which banks supervised by the federal government and banks supervised by the states operate side by side. 231

duration analysis A measurement of the sensitivity of the market value of a bank’s assets and liabilities to changes in interest rates. 221

dynamic open market operations Open market operations that are intended to change the level of reserves and the monetary base. 398

e-cash Electronic money that is used on the Internet to purchase goods or services. 51

econometric model A model whose equations are estimated using statistical procedures. 659

economies of scale The reduction in transaction costs per dollar of transaction as the size (scale) of transactions increases. 30

economies of scope The ability to use one resource to provide many different products and services. 248

Edge Act corporation A special subsidiary of a U.S. bank that is engaged primarily in international banking. 255

rational expectations to financial markets. 149

G-4 Glossary

e-finance A new means of delivering financial services electronically. 8

electronic money (or e-money) Money that exists only in electronic form and substitutes for cash as well. 51

equation of exchange The equation MV PY, which relates nominal income to the quantity of money. 518, 583

equities Claims to share in the net income and assets of a corporation (such as common stock). 26

equity capital See net worth. 180

equity multiplier (EM) The amount of assets per dollar of equity capital. 214

Eurobonds Bonds denominated in a currency other than that of the country in which they are sold. 28

Eurocurrencies A variant of the Eurobond, which are foreign currencies deposited in banks outside the home country.

28

Eurodollars U.S. dollars that are deposited in foreign banks outside the United States or in foreign branches of U.S. banks. 28

European option An option that can be exercised only at the expiration date of the contract. 320

excess demand A situation in which quantity demanded is greater than quantity supplied. 90

excess reserves Reserves in excess of required reserves. 204,

359

excess supply A situation in which quantity supplied is greater than quantity demanded. 90

exchange rate The price of one currency in terms of another.

435

exchange rate overshooting A phenomenon whereby the exchange rate changes by more in the short run than it does in the long run when the money supply changes.

454

exchanges Secondary markets in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades. 27

exercise price The price at which the purchaser of an option has the right to buy or sell the underlying financial instrument. Also known as the strike price. 320

expectations theory The proposition that the interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond. 129

expected return The return on an asset expected over the next period. 86

expenditure multiplier The ratio of a change in aggregate output to a change in investment spending (or autonomous spending). 543

face value A specified final amount paid to the owner of a coupon bond at the maturity date. Also called par value.

63

federal funds rate The interest rate on overnight loans of deposits at the Federal Reserve. 393

Federal Open Market Committee (FOMC) The committee that makes decisions regarding the conduct of open market operations; composed of the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and the presidents of four other Federal Reserve banks on a rotating basis. 337

Federal Reserve banks The 12 district banks in the Federal Reserve System. 337

Federal Reserve System (the Fed) The central banking authority responsible for monetary policy in the United States. 12

fiat money Paper currency decreed by a government as legal tender but not convertible into coins or precious metal. 48

financial crisis A major disruption in financial markets that is characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. 189

financial derivatives Instruments that have payoffs that are linked to previously issued securities, used as risk reduction tools. 233, 309

financial engineering The process of researching and developing new financial products and services that would meet customer needs and prove profitable. 232

financial futures contract A futures contract in which the standardized commodity is a particular type of financial instrument. 312

financial futures option An option in which the underlying instrument is a futures contract. Also called a futures option. 321

financial intermediaries Institutions (such as banks, insurance companies, mutual funds, pension funds, and finance companies) that borrow funds from people who have saved and then make loans to others. 7

financial intermediation The process of indirect finance whereby financial intermediaries link lender-savers and borrower-spenders. 29

financial markets Markets in which funds are transferred from people who have a surplus of available funds to people who have a shortage of available funds. 3

financial panic The widespread collapse of financial markets and intermediaries in an economy. 39

fiscal policy Policy that involves decisions about government spending and taxation. 12

Fisher effect The outcome that when expected inflation occurs, interest rates will rise; named after economist Irving Fisher. 100

fixed exchange rate regime A regime in which central banks buy and sell their own currencies to keep their exchange rates fixed at a certain level. 470

fixed investment Spending by firms on equipment (computers, airplanes) and structures (factories, office buildings) and planned spending on residential housing. 539

fixed-payment loan A credit market instrument that provides a borrower with an amount of money that is repaid by making a fixed payment periodically (usually monthly) for a set number of years. 63

float Cash items in process of collection at the Fed minus deferred-availability cash items. 365

foreign bonds Bonds sold in a foreign country and denominated in that country’s currency. 28

foreign exchange intervention An international financial transaction in which a central bank buys or sells currency to influence foreign exchange rates. 462

foreign exchange market The market in which exchange rates are determined. 5, 435

foreign exchange rate See exchange rate. 5

forward contract An agreement by two parties to engage in a financial transaction at a future (forward) point in time.

310

forward exchange rate The exchange rate for a forward transaction. 436

forward transaction A transaction that involves the exchange of bank deposits denominated in different currencies at some specified future date. 436

free-rider problem The problem that occurs when people who do not pay for information take advantage of the information that other people have paid for. 176

fully funded Describing a pension plan in which the contributions to the plan and their earnings over the years are sufficient to pay out the defined benefits when they come due. 294

futures contract A contract in which the seller agrees to provide a certain standardized commodity to the buyer on a specific future date at an agreed-on price. 233

futures option See financial futures option. 321

gap analysis A measurement of the sensitivity of bank profits to changes in interest rates, calculated by subtracting the amount of rate-sensitive liabilities from the amount of rate-sensitive assets. 221

goal independence The ability of the central bank to set the goals of monetary policy. 347

gold standard A regime under which a currency is directly convertible into gold. 469

goodwill An accounting entry to reflect value to the firm of its having special expertise or a particularly profitable business line. 275

government budget constraint The requirement that the government budget deficit equal the sum of the change in the monetary base and the change in government bonds held by the public. 643

government spending Spending by all levels of government on goods and services. 537, 585

gross domestic product (GDP) The value of all final goods and services produced in the economy during the course of a year. 12, 20

Glossary G-5

hedge To protect oneself against risk. 233, 309

hedge fund A special type of mutual fund that engages in “market-neutral strategies.” 299

high-powered money The monetary base. 359 hyperinflation An extreme inflation in which the inflation

rate exceeds 50% per month. 47

hysteresis A departure from full employment levels as a result of past high unemployment. 597

incentive-compatible Having the incentives of both parties to a contract in alignment. 185

income The flow of earnings. 45

indexed bond A bond whose interest and principal payments are adjusted for changes in the price level, and whose interest rate thus provides a direct measure of a real interest rate. 82

inflation The condition of a continually rising price level. 10 inflation rate The rate of change of the price level, usually

measured as a percentage change per year. 11

initial public offering (IPO) A stock whose firm is issuing it for the first time. 303

insolvent A situation in which the value of a firm’s or bank’s assets has fallen below its liabilities; bankrupt. 192 instrument independence The ability of the central bank to

set monetary policy instruments. 347

interest parity condition The observation that the domestic interest rate equals the foreign interest rate plus the expected appreciation in the foreign currency. 445

interest rate The cost of borrowing or the price paid for the rental of funds (usually expressed as a percentage per year). 4

interest-rate forward contract A forward contract that is linked to a debt instrument. 310

interest-rate risk The possible reduction in returns associated with changes in interest rates. 78, 208

interest-rate swap A financial contract that allows one party to exchange (swap) a set of interest payments for another set of interest payments owned by another party. 328

intermediate target Any of a number of variables, such as monetary aggregates or interest rates, that have a direct effect on employment and the price level and that the Fed seeks to influence. 414

intermediate-term With reference to a debt instrument, having a maturity of between one and ten years. 26

organization created by the Bretton Woods agreement whose objective is to promote the growth of world trade by making loans to countries experiencing balance-of- payments difficulties. 470

G-6 Glossary

international policy coordination Agreements among countries to enact policies cooperatively. 428

international reserves Central bank holdings of assets denominated in foreign currencies. 462

inventory investment Spending by firms on additional holdings of raw materials, parts, and finished goods. 539

inverted yield curve A yield curve that is downwardsloping. 127

investment banks Firms that assist in the initial sale of securities in the primary market. 26

IS curve The relationship that describes the combinations of aggregate output and interest rates for which the total quantity of goods produced equals the total quantity demanded (goods market equilibrium). 551

January effect An abnormal rise in stock prices from December to January. 156

junk bonds Bonds with ratings below Baa (or BBB) that have a high default risk. 124

Keynesian A follower of John Maynard Keynes who believes that movements in the price level and aggregate output are driven by changes not only in the money supply but also in government spending and fiscal policy and who does not regard the economy as inherently stable. 582

large, complex banking organizations (LCBOs) Large companies that provide banking as well as many other financial services. 248

law of one price The principle that if two countries produce an identical good, the price of this good should be the same throughout the world no matter which country produces it. 439

lender of last resort Provider of reserves to financial institutions when no one else would provide them in order to prevent a financial crisis. 402

leverage ratio A bank’s capital divided by its assets. 265 liabilities IOUs or debts. 24

liability management The acquisition of funds at low cost to increase profits. 208

liquid Easily converted into cash. 27

liquidity The relative ease and speed with which an asset can be converted into cash. 47, 86

liquidity management The decisions made by a bank to maintain sufficient liquid assets to meet the bank’s obligations to depositors. 208

liquidity preference framework A model developed by John Maynard Keynes that predicts the equilibrium interest rate on the basis of the supply of and demand for money. 105

liquidity preference theory John Maynard Keynes’s theory of the demand for money. 521

liquidity premium theory The theory that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the longterm bond plus a positive term (liquidity) premium. 133 LM curve The relationship that describes the combinations of interest rates and aggregate output for which the quan-

tity of money demanded equals the quantity of money supplied (money market equilibrium). 551

load funds Open-end mutual funds sold by salespeople who receive a commission that is paid at the time of purchase and is immediately subtracted from the redemption value of the shares. 299

loanable funds The quantity of loans. 92

loanable funds framework Determining the equilibrium interest rate by analyzing the supply of and demand for bonds (loanable funds). 92

loan commitment A bank’s commitment (for a specified future period of time) to provide a firm with loans up to a given amount at an interest rate that is tied to some market interest rate. 219

loan sale The sale under a contract (also called a secondary loan participation) of all or part of the cash stream from a specific loan, thereby removing the loan from the bank’s balance sheet. 223

long position A contractual obligation to take delivery of an underlying financial instrument. 309

long-run aggregate supply curve The quantity of output supplied in the long run at any given price level. 590

long-run monetary neutrality See monetary neutrality. 576 long-term With reference to a debt instrument, having a

maturity of ten years or more. 26

M1 A measure of money that includes currency, traveler’s checks, and checkable deposits. 52

M2 A measure of money that adds to M1: money market deposit accounts, money market mutual fund shares, small-denomination time deposits, savings deposits, overnight repurchase agreements, and overnight Eurodollars. 52

M3 A measure of money that adds to M2: large-denomination time deposits, long-term repurchase agreements, and institutional money market fund shares. 53

macro hedge A hedge of interest-rate risk for a financial institution’s entire portfolio. 315

managed float regime The current international financial environment in which exchange rates fluctuate from day to day but central banks attempt to influence their countries’ exchange rates by buying and selling currencies. Also known as a dirty float. 462

marginal propensity to consume The slope of the consumption function line that measures the change in consumer expenditure resulting from an additional dollar of disposable income. 538

margin requirement A sum of money that must be kept in an account (the margin account) at a brokerage firm. 318

marked to market Repriced and settled in the margin account at the end of every trading day to reflect any change in the value of the futures contract. 318

market equilibrium A situation occurring when the quantity that people are willing to buy (demand) equals the quantity that people are willing to sell (supply). 90

market fundamentals Items that have a direct impact on future income streams of a security. 152

matched sale–purchase transaction An arrangement whereby the Fed sells securities and the buyer agrees to sell them back to the Fed in the near future; sometimes called a reverse repo. 400

maturity Time to the expiration date (maturity date) of a debt instrument. 26

mean reversion The phenomenon that stocks with low returns today tend to have high returns in the future, and vice versa. 157

medium of exchange Anything that is used to pay for goods and services. 45

micro hedge A hedge for a specific asset. 315

modern quantity theory of money The theory that changes in aggregate spending are determined primarily by changes in the money supply. 584

monetarist A follower of Milton Friedman who sees changes in the money supply as the primary source of movements in the price level and aggregate output and who views the economy as inherently stable. 582

monetary aggregates The various measures of the money supply used by the Federal Reserve System (M1, M2, and M3). 52

monetary base The sum of the Fed’s monetary liabilities (currency in circulation and reserves) and the U.S. Treasury’s monetary liabilities (Treasury currency in circulation, primarily coins). 358

monetary neutrality A proposition that in the long run, a percentage rise in the money supply is matched by the same percentage rise in the price level, leaving unchanged the real money supply and all other economic variables such as interest rates. 453

monetary policy The management of the money supply and interest rates. 12

monetary theory The theory that relates changes in the quantity of money to changes in economic activity. 10,

517

monetizing the debt A method of financing government spending whereby the government debt issued to finance government spending is removed from the hands of the public and is replaced by high-powered money instead. Also called printing money. 644

money Anything that is generally accepted in payment for goods or services or in the repayment of debts. 8

Glossary G-7

money center banks Large banks in key financial centers (New York, Chicago, San Francisco). 212

money market A financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded. 27

money multiplier A ratio that relates the change in the money supply to a given change in the monetary base.

374

money supply The quantity of money. 8

moral hazard The risk that one party to a transaction will engage in behavior that is undesirable from the other party’s point of view. 33

multiple deposit creation The process whereby, when the Fed supplies the banking system with $1 of additional reserves, deposits increase by a multiple of this amount.

366

NAIRU (nonaccelerating inflation rate of unemployment)

The rate of unemployment when demand for labor equals supply, consequently eliminating the tendency for the inflation rate to change. 429, 590

national banks Federally chartered banks. 231

natural rate level of output The level of aggregate output produced at the natural rate of unemployment at which there is no tendency for wages or prices to change. 575,

590

natural rate of unemployment The rate of unemployment consistent with full employment at which the demand for labor equals the supply of labor. 412, 590

net exports Net foreign spending on domestic goods and services, equal to exports minus imports. 537, 585

net worth The difference between a firm’s assets (what it owns or is owed) and its liabilities (what it owes). Also called equity capital. 180

no-load funds Mutual funds sold directly to the public on which no sales commissions are charged. 299

nominal anchor A nominal variable such as the inflation rate, an exchange rate, or the money supply that monetary policymakers use to tie down the price level. 487

nominal interest rate An interest rate that does not take inflation into account. 79

nonaccelerating inflation rate of unemployment See NAIRU. 429, 590

nonactivist An economist who believes that the performance of the economy would be improved if the government avoided active policy to eliminate unemployment. 592 nonborrowed monetary base The monetary base minus dis-

count loans. 381

notional principal The amount on which interest is being paid in a swap arrangement. 328

G-8 Glossary

off-balance-sheet activities Bank activities that involve trading financial instruments and the generation of income from fees and loan sales, all of which affect bank profits but are not visible on bank balance sheets. 223, 265

official reserve transactions balance The current account balance plus items in the capital account. 468

open-end fund A mutual fund in which shares can be redeemed at any time at a price that is tied to the asset value of the fund. 298

open interest The number of contracts outstanding. 315 open market operations The Fed’s buying or selling of

bonds in the open market. 340, 359

open market purchase A purchase of bonds by the Fed. 359 open market sale A sale of bonds by the Fed. 359 operating target Any of a set of variables, such as reserve

aggregates or interest rates, that the Fed seeks to influence and that are responsive to its policy tools. 415

opportunity cost The amount of interest (expected return) sacrificed by not holding an alternative asset. 106

optimal forecast The best guess of the future using all available information. 148

option A contract that gives the purchaser the option (right) to buy or sell the underlying financial instrument at a specified price, called the exercise price or strike price, within a specific period of time (the term to expiration). 320

over-the-counter (OTC) market A secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities “over the counter” to anyone who comes to them and is willing to accept their prices. 27

partial crowding out The situation in which an increase in government spending leads to a decline in private spending that does not completely offset the rise in government spending. 587

par value See face value. 63

payments system The method of conducting transactions in the economy. 48

pecking order hypothesis The hypothesis that the larger and more established a corporation is, the more likely it will be to issue securities to raise funds. 180

perpetuity See consol. 67

Phillips curve theory A theory suggesting that changes in inflation are influenced by the state of the economy relative to its production capacity, as well as to other factors.

429

planned investment spending Total planned spending by businesses on new physical capital (machines, computers, apartment buildings) plus planned spending on new homes. 536, 585

policy ineffectiveness proposition The conclusion from the new classical model that anticipated policy has no effect on output fluctuations. 663

political business cycle A business cycle caused by expansionary policies before an election. 353

preferred habitat theory A theory that is closely related to liquidity premium theory, in which the interest rate on a long-term bond equals an average of short-term interest rates expected to occur over the life of the long-term bond plus a positive term premium. 134

premium The amount paid for an option contract. 320 present discounted value See present value. 61

present value Today’s value of a payment to be received in the future when the interest rate is i. Also called present discounted value. 61

primary dealers Government securities dealers, operating out of private firms or commercial banks, with whom the Fed’s open market desk trades. 399

primary market A financial market in which new issues of a security are sold to initial buyers. 26

principal–agent problem A moral hazard problem that occurs when the managers in control (the agents) act in their own interest rather than in the interest of the owners (the principals) due to different sets of incentives. 181

printing money See monetizing the debt. 644 prudential supervision See bank supervision. 265

put option An option contract that provides the right to sell a security at a specified price. 322

quantity theory of money The theory that nominal income is determined solely by movements in the quantity of money. 519

quotas Restrictions on the quantity of foreign goods that can be imported. 441

random walk The movements of a variable whose future changes cannot be predicted (are random) because the variable is just as likely to fall as to rise from today’s value.

154

rate of capital gain The change in a security’s price relative to the initial purchase price. 76

rate of return See return. 75

rational expectations Expectations that reflect optimal forecasts (the best guess of the future) using all available information. 147

real bills doctrine A guiding principle (now discredited) for the conduct of monetary policy that states that as long as loans are made to support the production of goods and services, providing reserves to the banking system to make these loans will not be inflationary. 420

real business cycle theory A theory that views real shocks to tastes and technology as the major driving force behind short-run business cycle fluctuations. 597

real interest rate The interest rate adjusted for expected changes in the price level (inflation) so that it more accurately reflects the true cost of borrowing. 79