2281 · 3.1
Money and banking flashcards
Revision flashcards for Cambridge 2281 Money and banking (syllabus 3.1). Flip, recall, then mark a real past-paper question.
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Three functions of money?
Medium of exchange, store of value, unit of account (measure of value).
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How do banks create credit?
Fractional reserve banking — new loans create new deposits, expanding broad money supply (subject to reserve requirements).
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Central bank role?
Lender of last resort, sets base interest rate, controls base money, supervises banking system, inflation target.
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Open market operations?
Central bank buys/sells government securities to change reserves and influence interbank interest rates.
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What is quantitative easing (QE)?
Central bank creates money to buy financial assets (usually bonds) when conventional rate cuts are exhausted — lowers long-term rates, boosts asset prices.
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Monetary policy transmission to AD?
Rate cut → cheaper borrowing → ↑ C and I → AD rises; also exchange rate channel (lower rates → currency depreciates → ↑ X).
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What is the 'lender of last resort' function?
The role of the central bank to provide funds to commercial banks facing short-term liquidity shortages. This prevents bank failures and systemic financial crises, maintaining confidence in the banking system.
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Define 'credit creation'.
The process by which commercial banks increase the money supply by making loans. When a bank lends money, it creates a new deposit, effectively creating 'new' money (in the form of bank deposits) in the economy.
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What is the money multiplier formula and what does it show?
The formula is 1 / liquidity ratio (or reserve ratio). It shows the maximum potential increase in the total money supply resulting from an initial new deposit into the banking system.
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Distinguish between a 'store of value' and a 'standard for deferred payment'.
'Store of value' means money can be saved and used for future purchases, retaining its value over time. 'Standard for deferred payment' means money is an accepted way to settle a debt in the future, making borrowing and lending possible.
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What is Quantitative Easing (QE)?
A monetary policy tool where the central bank purchases assets, typically government bonds, from commercial banks. This increases the money supply and the liquidity of banks, aiming to lower long-term interest rates and stimulate lending and economic activity.