Financial Sector: every key term you need

Money Functions

Medium of exchange, store of value, unit of account. Enables trade, saving, pricing. Fiat money: backed by government, not commodity.

Money Supply (M1, M2)

M1: currency + checking accounts (immediate spending). M2: M1 + savings, money market (less immediate).

Central Bank (Fed)

Controls money supply, sets interest rates, regulates banking. In US: Federal Reserve. Independent agency.

Monetary Policy

Fed controls money supply/interest rates to achieve goals: stable prices, full employment. Expansionary (↑ money) or contractionary (↓ money).

Open Market Operations (OMO)

Fed buys/sells government securities. Buy = inject money (expansionary). Sell = remove money (contractionary).

Discount Rate

Interest rate Fed charges banks. High rate = discourages borrowing (contractionary). Low rate = encourages borrowing (expansionary).

Reserve Requirement

Percentage of deposits banks must hold as reserves (can't lend). Decrease = banks lend more (expansionary). Rare tool now.

Interest Rates & Inflation

Real interest rate = nominal rate - inflation. Fed targets nominal; real affected by inflation expectations.

Yield Curve

Plot interest rates vs. maturity. Normal: upward (longer = higher rate). Inverted: downward (signals recession).

Bank Multiplier

Deposit multiplies through banking system. If reserve requirement 20%, multiplier = 5. $100 deposit → $500 money creation.

Unit 4 Summary

Money enables trade. Central bank controls supply via OMO, discount rate, reserves. Monetary policy affects interest rates, inflation, employment.

More AP Macroeconomics guides

• Basic Economic Concepts
• Supply, Demand, Elasticity
• National Income & Price
• Long-Run Growth