The Financial Sector
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Table of Contents
This section covers the following topics:
- Financial assets
- Characteristics of money
- The money market and loanable funds market
- The Federal Reserve
- Monetary policy
Section Summary
When you make a purchase, you are exchanging a real asset (like pants) for a financial asset (generally money). In the economic world, however, the term “money” has a broader definition. Money is something that acts as a medium of exchange, unit of account and store of wealth. “Money” is subdivided into two categories: M1 and M2. Remember, credit cards are not money, because they create debt when you use them.
A stock is an ownership stake in a company. A bond is a loan to another group; you are paid interest.
The price of a financial asset is the interest rate. Interest rates are often adjusted for inflation: the real interest rate = nominal interest rate – inflation.
Short-term interest rates (the money you pay to borrow a financial asset for a short period of time) are determined in the money market, which has a vertical supply curve (there’s only so much money in the system). The loanable funds market sets long-term interest rates and has a traditional, upward sloping supply curve.
Banks are institutions that take in money as deposits and lend it out as loans (for which they are paid interest). A balance sheet or T account gives a snapshot of the bank’s finances: assets (what the bank owns) are on one side and liabilities (groups that have claims on the assets) are on the other.
Money deposited into a bank is loaned out, spent, and often ends up being deposited into a bank again. Each time this cycle repeats, the money multiplies. The person who made the initial deposit has money in the bank, but so do all of the other people who make deposits later in the cycle.
The Federal Reserve (“The Fed”) is the central bank in the United States. The Fed’s most important job is conducting monetary policy,... Sign up to continue reading The Financial Sector >
