Macro Chapter 9
What does a balance sheet show?
A balance sheet shows assets, liabilities, and net worth.
What are the assets of a bank? What are its liabilities?
A bank's assets consist of things of value that it owns such as its reserves, loans it has made, bonds it holds, and even the value of its building. A bank's liabilities consist of money it owes others. A bank's main liability is usually the money it owes its depositors. It may also owe money to others from whom it has borrowed money, such as the Federal Reserve.
In many casinos, a person buys chips to use for gambling. Within the walls of the casino, these chips can often be used to buy food and a drink or even a hotel room. Do chips in a gambling casino serve all three functions of money?
As long as you remain within the walls of the casino, chips fit the definition of money; that is, they server as a medium of exchange, a unit of account, and a store of value. Chips have little value once they leave the casino.
A bank has deposits of $400. It holds reserves of $50. It has purchased government bonds worth $70. It has made loans of $500. What is the banks worth?
Assets: Liabilities and Net Worth: Reserves= $50 Deposits= $400 Bonds= $70 Net worth= $220 Loans= $500
Why is a bank called a financial intermediary?
Banks are an intermediary between savers and borrows. Savers earn interest without having to find people to borrow their money.
How do banks create money?
Banks create money by accepting deposits and then loaning out their excess reserves. When the excess reserves loaned out are deposited in another bank, new deposits are created. New deposits imply a bigger money supply.
Explain why the money listed under assets on a bank balance sheet may not actually be in the bank?
Cash in a bank's vault is in the bank, but most of their assets are not. These include reserves that the bank holds at the Federal Reserve Bank, loans made to customers, and bonds.
What is the risk if a bank does not diversify its loans?
If the bank had made mostly one type of loan, say loans to home builders, then its assets will be wiped out if that industry collapses. That is one aspect of the most recent financial crisis. Home builders suffered large losses and were unable to repay their bank loans. Banks that "specialized" in loans to home builders were devastated.
What would the money multiplier be if banks were not required to keep reserves?
If the banks were not required to keep reserves, the reserve requirements would be zero. That means the money multiplier would be 1/10, which is undefined. As the reserve requirement approaches zero, the money multiplier approaches infinity. If this were to happen banks would still hold some reserves.
Explain what will happen to the money multiplier process if there is an increase in the reserve requirement.
If the reserve requirement increases, then the money multiplier will be smaller. That means that any given increase in excess reserves will have a smaller effect on the money supply.
If the reserve requirement is 5% and the banking system acquires $500 million in new excess reserves, by how much can the money supply increase?
If the reserve requirement is 5%, then the money multiplier is 1/0.05 = 20. The money supply can increase by 20x$500 million = $10 million.
The Bring it Home Feature discusses the use of cowrie shells as money. Although cowrie shells are not longer used as money, do you think other forms of commodity monies are possible? What role might technology play in our definition of money?
In the past, many different commodities have served as money. For example, salt tobacco, cattle, and large stones have been used as money. New technologies have already affects what we consider to be money; think about Bitcoin and other "crypto-currencies."
How does the existence of money simplify the process of buying and selling?
Money eliminates the need for barter. Money eliminates the requirement for a double-coincidence of wants that must exist in a barter system. Barter makes a sophisticated economy almost impossible.
How can a bank end up with negative net worth?
Loans and bonds go bad. This happens when people "default", do not pay the bank what they owe.
What components of money are counted as part of M1?
M1 consists of currency, traveler's checks, and all checkable accounts owned by the non-bank public.
What components of money are counted in M2?
M2 consists of M1 plus savings accounts, money market funds, certificates of deposit, and other time deposits.
Can you name some item that is a store of value, but does not serve the other functions of money?
Many physical items that a person buys at one time but may sell at another time, things like a house, land, art, rare coins or stamps.
If you are out shopping for clothes and books, what is easier to spend, money in your checking account or money in a certificate of deposit?
Money in a checking account, which is part of M1, is easier to spend, money in a certificate of deposit. Money in a certifacte of deposit is part of M2.
What are the three functions of money?
Money serves as a medium of exchange, a unit of account, and as a store of value.
What is the asset-liability time mismatch that most banks face?
Most of a bank;s liabilities are deposits, and these can usually be withdrawn quickly. Most of a bank's assets are in the form of loans and bonds that may take years to be repaid. This creates a problem:if interest rates rise, it will have to pay higher interest rates to its depositors, but it will only receive the old, lower interest rate on its existing loans; the bank may therefore lose money.
The total amount of U.S. currency in circulation divided by the U.S. population comes out to about $3,500 per person. That is more than most of us carry. Where is all the cash?
Most of the cash is in one of three places: 1. Cash is used in the underground economy (such as drug trade) because it does not leave a trail. 2. Countries with high inflation rates, many people hold dollars as a store of value rather than their domestic currency. 3. There are a few countries around the world (such as Ecuador) that use the U.S. dollar as their currency.
If you take $100 out of your piggy bank and deposit it in your checking account, how did M1 change? Did M2 change?
Neither M1 nor M2 changed. All that happened was that the form of M1 changed; you have less currency but a larger checking account.
Explain why you think the Federal Reserve Bank tracks M1 and M2.
One main task of the Federal Reserve is to control the size of the money supply. Changes in the money supply will affect aggregated demand as well as cause inflation. The Fed must measure the money supply yo see if it is too big or too small.
What is a double-coincidence of wants?
The double-coincidence of wants required for barter. Each person must find someone who wants what they have AND has what they want before they can trade. That means that trade can consume most of one's time.
What is the formula for the money multiplier?
The money multiplier equals 1 divided by the reserve requirement. If, for example, the reserve requirement is 20%, then the money multiplier equals 1/0.2=5.
How do you calculate the net worth of a bank?
The net worth of a bank is equal to the value of its assets minus the value of its liabilities. If a bank has $10 billion in assets and $9 billion in liabilities, its nets worth is $1 billion.
Explain the difference between how you would characterize bank deposits and loans as assets and liabilities on your own personal balance sheet versus a bank.
To me, bank deposits are assets and my bank loans are liabilities and for the bank its vice versa.
Imagine that you are a barber in a world without money. Explain why it would be tricky to obtain groceries, clothing, and a place to live.
You would have to find people who have these things who also want a haircut. Plus, it is unlikely that the person who has the place to live would need enough haircuts for you to pay the rent. This is and illustration of why the double-coincidence of wants required for barter can be a major problem.
Indicate if they are M1, M2, or neither: a. Your $5,000 line of credit on your Bank of America card b. $50 dollars' worth of traveler's checks you have not used yet c. $1 in quarters in your pocket d. $1200 in your checking account e. $2000 you have in a money market account
a. Neither b. M1 and M2 c. M1 and M2 because currency is out in the public hands d. M1 and M2 e. M2
Someone finds a stash of currency worth $20 million and deposits it all into Humongous Bank. a. By how much has the money supply changed as a result of the initial deposit? b. Suppose Humongous Bank is required to hold 5% of its deposits as reserves, and to loan out the rest. By how much will the money supply increase after the first round of loans? c.The Banking system in this economy has several banks. By how much could the money supply increase with the original loan from Humongous Bank?
a. The money supply would not change; it would just change forms from currency to deposits. b. The bank loans out 95% of the $20 million, or $19 million. When the check it issues is deposited, the money supply will rise by $19 million. c. The money supply can increase by the money multiplier times the new excess reserves. In this case the money multiplier is 1/0.05=20. The new excess reserves are $19 million. So the money supply could increase by 20x$19 million= $380 million.
