Chapter 16: The Monetary System

Refer to Table 29-6. Metropolis National Bank is holding 2% of its deposits as excess reserves. Assume that no banks in the economy want to maintain holdings of excess reserves and that people only hold deposits and no currency. The Fed makes open market purchases of $10,000. The person who sold bonds to the Fed deposits all the funds in Metropolis National Bank. If the bank now loans out all its excess reserves, by how much will the money supply increase?

$200,000

Suppose the banking system currently has $400 billion in reserves, the reserve requirement is 8 percent, and excess reserves amount to $5 billion. What is the level of deposits?

$4,937.5 billion

Term Auction Facility (2007-2010)

- Fed sets a quantity of reserves it will loan, then banks bid against each other for these loans.)

medium of exchange

- Item that buyers give to sellers when they want to purchase goods and services

The banking system currently has $10 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 12.5 percent and at the same time buys $1 billion worth of bonds, then by how much does the money supply change?

It falls by $12 billion.

John and Jane decide to go on a vacation. As a result, they withdraw $2,500 from their savings account to purchase $2,500 worth of traveler's checks. As a result of these changes,

M1 increases by $2,500 and M2 stays the same.

why do we use money?

Money is any item that both buyers and sellers will generally accept in exchange for goods and services.

commodity money

Money that takes the form of a commodity with intrinsic value -The item would have value even if it were not used as money -Gold coins, cigarettes in POW camps

the Fed establishes reserve requirements

Regulations on the minimum amount of reserves that banks must hold against deposits. - Banks may hold more than this minimum: excess reserves.

1. Regulate banks and ensure the health of the banking system

Responsibility of the Fed -Monitors each bank's financial condition -Facilitates bank transactions -A bank's bank: makes loans to banks; lender of last resort

cryptocurrencies

Use the tools of cryptography to create a medium of exchange that exists only in electronic form - Rely on a technology called blockchain to maintain a decentralized, public ledger that records transactions -E.g., Bitcoins (2009)

gold standard

When an economy uses gold as money (or uses paper money that is convertible into gold on demand), it is said to be operating under a _______________.

a barter requires

a double coincidence of wants: unlikely occurrence that two people each have a good the other wants waste of resources: people spend time searching for others to trade with

Capital Requirement

a government regulation specifying a minimum amount of bank capital Intended to ensure banks will be able to pay off depositors and debts

T-account

a simplified accounting statement that shows a bank's assets and liabilities. Banks' liabilities include deposits Assets include loans and reserves. Notice that R = $10/$100 = 10% How much is the money supply now?

store of value

an item that people can use to transfer purchasing power from the present to the future -hold money or non-monetary assets wealth - The total of all stores of value, including both money and non-monetary assets liquidity -The ease with which an asset can be converted into the economy's medium of exchange

The money supply increases when the Fed

buys bonds. The increase will be larger, the smaller is the reserve ratio.

The federal funds rate is the

interest rate at which banks lend reserves to each other overnight.

Refer to Table 29-3. If the bank faces a reserve requirement of 6 percent, then the bank

is in a position to make new loans equal to a maximum of $18,000.

You pay for cheese and bread from the deli with currency. Which function of money does this best illustrate?

medium of exchange

money has three functions

medium of exchange, unit of account, store of value distinguishes money from other assets

fiat money

money without intrinsic value that is used as money because of government decree

You saved $500 in currency in your piggy bank to purchase a new laptop. The $500 you kept in your piggy bank illustrates money's function as a _______. The laptop's price is posted as $500. The $500 price illustrates money's function as a _____. You use the $500 to purchase the laptop. This transaction illustrates money's function as a ______.

store of value, unit of account, medium of exchange

M2

everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few minor categories

When conducting an open-market sale, the Fed

sells government bonds, and in so doing decreases the money supply.

barter

the exchange of one good or service for another

If a bank with a required reserve ratio of 15 percent receives a deposit of $600, it now has a

$510 increase in excess reserves and a $90 increase in required reserves.

The Fed lends to banks because

- Not only to control the money supply but also to help financial institutions when they are in trouble - 2008 and 2009, a fall in housing prices throughout the U.S. Sharp rise in mortgage defaults and many financial institutions holding those mortgages ran into trouble The Fed provided many billions of dollars in loans to financial institutions in distress.

currency

- Paper bills and coins in the hands of the (nonbank) public

Banks borrow from Fed's discount window

- Paying an interest rate called the discount rate - Increasing reserves in the banking system, and increasing the money supply - If the Fed lowers the discount rate: encourages banks to borrow more, increasing the quantity of reserves and the money supply

The Fed does not control...

- The amount of money that households choose to hold as deposits in banks - The amount that bankers choose to lend

responsibilities of the fed

1. Regulate banks and ensure the health of the banking system 2. Monetary policy by Federal Open Market Committee (FOMC)

fractional reserve banking

Banks create money The Fed's control of the money supply is indirect

Are bitcoins commodity or fiat money? Does it perform the three functions of money?

Bitcoins are neither commodity or fiat money. -People can hold bitcoins as a store of value and use bitcoins to buy things from vendor who is willing to accept them. However, its dollar value has fluctuated wildly.

The Federal Reserve System consists of:

Board of Governors: 7 members, 14-year terms, located in Washington, DC, appointed by the president 12 regional Federal Reserve Banks located around the U.S.

the Fed can change the money supply by

Changing quantity of reserves Changing the reserve ration and money multiplier

Bank Reserves

Deposits that banks have received but have not loaned out are reserves.

100 percent reserve banking

If banks hold all deposits in reserve, banks do not influence the supply of money.

Suppose the entire economy has: $150 dollars kept in coffee cans and wallets $300 in saving accounts $200 in credit card limits $20 in traveler's checks $350 in checking accounts $400 in money market mutual funds Calculate M1 and M2`

M1 = Currency + Demand deposits + Traveler's checks + Other checkable deposits. M1 = 150 + 350 + 20 + 0 = $520 M2 = M1 + Savings deposits + Small time deposits + Money market mutual funds + A few minor categories. M2 = 520 + 300 + 0 + 400 + 0 = $1,220

to increase bank reserves and the money supply:

The Fed buys a government bond from a bank • Pays by depositing new reserves in that bank's reserve account. • With more reserves, the bank can make more loans, increasing the money supply

The Federal Reserve (Fed)

The central bank of the United States

the money stock

The quantity of money in the economy

Bank Capital (Owner's Equity)

The resources a bank obtains by issuing equity to its owners Equals bank assets minus bank liabilities

A bank loans Kellie's Print Shop $350,000 to remodel a building near campus to use as a new store. On their respective balance sheets, this loan is

an asset for the bank and a liability for Kellie's Print Shop. The loan increases the money supply.

The leverage ratio is calculated as

assets divided by bank capital.

When the Fed decreases the discount rate, banks will

borrow more from the Fed and lend more to the public. The money supply increases.

Which of the following is included in both M1 and M2?

currency, demand deposits, and other checkable deposits

Which list ranks assets from most to least liquid?

currency, stocks, fine art

If the reserve ratio is 5 percent, then $500 of additional reserves would ultimately generate

$10,000 of money

The manager of the bank where you work tells you that the bank has $300 million in deposits and $255 million dollars in loans. If the reserve requirement is 8.5 percent, how much is the bank holding in excess reserves?

$19.5 million

A bank has $8,000 in deposits and $6,000 in loans. It has loaned out all it can, given the reserve requirement. It follows that the reserve requirement is

25 percent

The manager of the bank where you work tells you that your bank has $6 million in excess reserves. She also tells you that the bank has $400 million in deposits and $362 million in loans. Given this information you find that the reserve requirement must be

8 percent

The reserve ratio, R

= fraction of deposits that banks hold as reserves = total reserves as a percentage of total deposits Now suppose that the bank has a reserve ratio of 1/10, or 10 percent.

Federal Open Market Committee (FOMC)

All 7 members of the Board of Governor And 5 of the 12 regional bank presidents --All 12 regional presidents attend each FOMC meeting, but only 5 get to vote Open-Market Operations (OMO) --Buy U.S. government bonds from the public to increase the money supply --Sell U. S. government bonds to the public to decrease the money supply

central bank

An institution designed to oversee the banking system and regulate the quantity of money in the economy

demand deposits

Balances in bank accounts that depositors can access on demand by writing a check or swiping a debit card.

Financial crisis of 2008-2009

Banks find themselves with too little capital to satisfy capital requirements Credit crunch: the shortage of capital induced the banks to reduce lending

assets

Reserves, loans, securities (stocks and bonds)

money stock

The quantity of money circulating in the economy

money

The set of assets in an economy that people regularly use to buy goods and services from other people

fractional reserve banking system

banks keep a fraction of deposits as reserves and use the rest to make loans

Which of the following does the Federal Reserve not do? Conduct monetary policy Act as a lender of last resort Conduct fiscal policy Serve as a bank regulator

conduct fiscal policy

2. Monetary policy by Federal Open Market Committee (FOMC)

control the money supply: quantity of money available in the economy

liabilities

deposits, debt, and equity

Refer to Table 29-3. Suppose the bank faces a reserve requirement of 10 percent. Starting from the situation as depicted by the T-account, a customer deposits an additional $60,000 into his account at the bank. If the bank takes no other action it will

have $64,000 in excess reserves.

M1 money supply

includes all currency, demand deposits, traveler's checks, and other checkable deposits

If the Federal Reserve increases the interest rate on bank deposits at the Fed, banks will want to hold

more reserves, so the reserve ratio will rise.

Open-Market Operations (OMOs)

the purchase and sale of U.S. government bonds by the Fed

unit of account

the yardstick people use to post prices and record debts

leverage

The use of borrowed funds to supplement existing funds for investment purposes

reserve requirement

regulations on the minimum amount of reserves that banks must hold against deposits

Dollar bills, rare paintings, and emerald necklaces are all

stores of value