Money

Board of governors

7 governors 14 year terms every 2 years new member is appointed by Pres. confirmed by Senate acts independently within gov but is not independent of it

QQ: Jill is waiting to loan ben 3000 for on year. She wants a 6% real interest rate. She and ben agree that the inflation rate will be 2% over the course of the year. The nominal interest is

8%

Change in Money supply formula

= 1/rr * change in reserves

Money multiplier equation

= Change in Ms ------------------------ Change in reserves

QQ: Which of the following committees determines and implements monetary policy

Federal Open market committee

Liquidity

the degree to which an asset can be readily converted into currency

Discuss the structure of the Federal Reserve

the fed res system, often abbreviated as the Fed, is the central bank of the US There are 12 district banks named for the city they operate managed by a board of governors in Washington DC

Reserve requirement

the fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the federal reserve

Discount rate

the interest rate at which banks can borrow money directly from the feds

QQ: If the demand for money decreases, the interest rate:

decreases

QQ: If the money supply increases, the interest rate

decreases

QQ: the banking system has 2 million in checkable deposits and actual reserves of 600,000. The reserve requirement is 20%. the banking system can potentially increase the money supply by

$1,000,000

M1 Money Supply: Whats included

- Demand Deposits (checking accounts) - Travelers Check( money dominated certificates) - Other checkable deposits (deposits that automatically transfer money from savings to checking) - Actual Currency ( cash in hand )

Research at the Fed:

-Domestic and international financial conditions - the health of the economy - impact of banking laws - other issues that consumers and businesses face

M2 money supply: what included

-M1 - Savins deposits - small denominations time deposits - retail money funds

Banking supervision

-Supervise member banks -identify banks in trouble and avoid a run on banks - create regulations to promote a stable banking system second primary function of feds

Financial Services

-clearing checks - Transferring funds - Receiving and delivering currency - managing wire transfers - Performing automated clearing house services 3rd function; the automated clearing house is the primary system agencies use for electronic funds transfers

The Fed basics

-consists of 12 member banks -board of governors oversees the fed reserve system - Is the central bank of the United states

The fed series as the bank for the federal gov and

-maintains accounts for the department of treasury - processes government checks, postal money orders, and US saving bonds - Collects federal tax payments

3 characteristics of money

1- unit of account 2- medium of exchange 3- Store of value

QQ: the surety bank has excess reserves of $10,000. It checkable deposits are $120,000. If the reserves requirement is 20% total reserves equal:

35,000

Fractional reserve banking

A banking system in which banks only have to keep a fraction of checkable deposits on hand and available for withdrawal

The money multiplier

An increase in reserves in banking system will generally lead to an even larger increase in the money supply With more reserves on hand, banks will have additional excess reserves and will make more loans When banks make more loans they create even more money

Money

Any item that both buyers and sellers will generally accept in exchange for goods and services facilities trade and thus enables specialization DOES NOT EQUAL WEALTH

Compare and contrast the assets and liabilities of a bank

Assets for a bank include reserves, buildings and loans banks have an incentive to make as many loans as possible to increase their profits bank liabilities include checkable deposits and savings these funds are deposited in the bank for safe keeping and are the assets of the owners or depositors. Banks can loan part of the deposits to other customers. When this happens, banks create money (as M1 included currency in circulation and increases in checkable deposits

QQ: Which of the following statements about bonds is accurate?

Bond prices and yields move in opposite directions

If money supply Increases then

Demand remains unchanged Surplus occurs Interest rate decreases

Excess reserves equation

Excess= Total - Required

Explains what happens to the interest rate if the money supply increases or decreases and the money demand remains unchanged and vice versa

If the supply of money increases and the demand for money remains unchanged a surplus exists i the market and the interest rate falls IF the supply of money decreases and the demand for money remains unchanged, a shortage exists and interest rate increases

Explain the equilibrium adjustment process that occurs in the money market

In the money market the supply curve is vertical because the money supply is independent of interest rate The demand curve for money is downwardsloping bc as the interest rate (price of money) decreases, the quantity of money demanded increases vice versa If the interest rate is too low then the quantity of money demand is greater than the quantity of money supplied. A shortage results, putting upward pressure on the interest rate. If the interest rate is too high the quantity of money demanded is less than the quantity of money supplied A surplus occurs placing downward pressure on the interest rate. As the interest rate changes in response to surpluses and shortages, an equilibrium interest rate will emerge that equates the money supply and money demand

QQ: Supposes the reserves requirement is 10%. Jennifer writes a check of $500 to purchase a new laptop. After the checks clear:

Jennifer's bank loses reserves and deposits in the amount of $500

Two ways to track the Money supply:

M1 and M2

QQ: Which of the following statements about the money supply is true?

M2 included money market mutual funds

QQ: Which function of money does transaction demand align with?

Medium of exchange

Activities of the Fed

Monetary Policy Banking Supervision Financial Services

The Demand for Money

Money is often hold for two reasons - Transaction demand: to buy and daily transactions - Asset demand: to hold money as a form of savings for the future

Monetary Policy Tools

Open market operations Discount rates Reserve requirement

Required reserves equation

Reserves = Deposits * R R

Monetary Policy

The actions of a country's central bank to influence the supply of money and credit in the economy the first primary function of the fed is monetary policy which impacts prices and also interest rates, which influences levels of investment, unemployment, inflation, and economic growth

Excess reserves

The amount of reserves that a bank can lend out to earn interest equal to total reserves minus required reserves

reserve requirement

The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposits with the federal reserve

Compare and contrast M1 and M2

The money supply is determined by several different measures, usually based on liquidity M1 is the most liquid measure of the money supply. It consists of checking deposits, travelers checks, and currency in circulation. These three items are immediately spendable (liquid) . Checking deposits can be accessed via a check or debit card at any time travelers checks are prepaid and v liquid Currency in circulation consists of paper money and coins in the publics hands which is liquid M2 is less liquid than M1 M2 consists of M1 plus saving deposits, small time, and retail money market mutual funds with the exception of M1, the components of M2 must be converted to cash by contacting the bank or financial institutions where the funds are on deposit

Explain the role of the expected rate of inflation in determining the nominal interest rate

The nominal interest rate is the rate on a loan document The real rate of interest is the reward to the lender and the cost to the borrower. The expected rate of inflation is added to the real rate of interest to determine the nominal interest rate quoted for a loan

QQ: The supply of money graphs as

a vertical line

QQ: John deposits 800 into his checking account. Susan also a customer receives a loan for 2000 these result in

an increase in the money supply of 2000

QQ: A banks reserves are

assets to the bank and liabilities to the district federal reserve bank holding them

Money v Bonds

bonds are an asset like money money can be used right away. Bonds cannot, but they promise future payments of greater amounts (they earn some interest) there is a risk associated with bonds if the payer defaults on the bond People should have a portfolio that optimally allocates their preference for risk with some mixture of money and bonds

If demand money decreases

surplus remains unchanged surplus occurs Interest rate decreases

Compare and contrast the effects to the money market and the bond market when the money supply increases

both the money market and the bond market react to changes in the money supply Individuals make tradeoffs between safety and risk when saving for the future this translates into a combination of assets that are less risky mixed with assets that entail more risks If the prevailing rate in the money market is 5% and the money supply increases relative to demand the interest rate will fall as a result of the surplus money Some of the money surplus will be used to purchase bonds, creating an increase in demand for bonds The shift in the demand curves for bonds increases the price of bonds and the quantity traded but the rate of return to the investor will be lower An increase in the money supply decreases the interest rate in the money market and the rate of return to investors in the bond market

M2

broader measure of the money supply which includes M1 plus some less liquid assets includes everyone in M1 plus some less liquid assets

QQ: The reserve requirement is 15% Bankers trust has $1 million of checkable deposits and actual reserves of $300,000. Banker's trust:

can loan up to $150,000

M1

consist of the most liquid assets

If Money supply Decreases

demand remains unchanged Shortage occurs Interest rate Increases

Medium of exchange

do people use it in transactions?

the Federal reserve does what

feds track the money supply measures like M1 and M2

Interest Rate

helps us make decisions about saving or borrowing comes from the interactions of all those involved in the market for money aka the interaction of supply and demand

The fisher equation

i= r + pi Nominal = real + interest

QQ: If the Fed decided to decrease the money multiplier, it needs to:

increase the reserve requirement

QQ: An increase in real GDP will:

increase the transaction demand and shift the demand for money to the right

Store of value

is it a way people can transfer wealth from the present to the future?

Unit of account

is it used to compare prices of goods and services?

Open market operations

the buyer or selling of government securities in the open market to change the money supply

QQ: John pays for a new smartphone by writing a check. In this instance money is functioning as a

medium of exchange

Two assets

money and bonds

Money

no interest and is safe

Transaction demand

not sensitive to interest rate

QQ: the purpose of the reserve requirement is to

provide a mechanism by which the Fed can exert some control over the lending ability of banks

Bonds

some interest and riskier

If demand money increases

surplus remains unchanged shortage occurs interest rate increases

Discuss why the money supply is vertical

the money market is different from other markets in most markets there is more than one supplier. In addition, the supply of money is independent of interest rates This explains why the supply of money is usually graphed as a vertical line at some fixed level of money Bank lending can influence the money supply but the fed uses the reserve requirement and other tools to control the expansion of the money supply via lending

How does a change in the money multiplier impact the money supply

the money multiplier has reduced as the reserve requirement increases. This makes sense, as banks now have to hold on to more of the money they take in and have less money to loan out. Thus, the process of creating money is somewhat stunted by the increased reserve requirement

Identify and explain the 3 functions of money

the three functions of money are to act as a unit of account, medium of exchange, and store of value Many tangible objects have served as money throughout history Paper is relatively new and has no inartistic value; it is only valuable to those willing and able to exchange goods, services, or resources for it. Money is functioning as a medium of exchange in this mode, as it facilitates the exchange process between buyer and seller and eliminates the cumbersome nature of barter money also serves as a unit of account prices of goods and resrouces are listen interns of whatever that economy uses as money. In the US, prices are listed in dollars. Buyers use prices as a measure of market value for varying goods and services. Finally, Money functions as a stone of value that allows individuals to transfer wealth from the present into the future. For example, you could deposit 300 for a vacation you're planning next year or keep a balance in case of some future emergency

Compare and contrast total reserves, excess reserves and required reserves

total reserves are the sum of excess reserves and required reserves. Required reserves are the amount of deposits that banks must keep on hand. The amount of required reserves is determined by the amount of deposits received times the reserve req with is determined by the Fed Excess reserves are the excess funds banks can lend after the required reserves are kept on hand. Excess reserves equal total reserves minus required reserves

QQ: A fractional reserve banking system is

vulnerable to bank panics

QQ: In the money market, the equilibrium interest rate occurs

where the demand for money equals the supply of money

QQ: Will receives a loan from Banker's Trust in the amount of $4,000. Instead of depositing the loan check in his checking account, he cashes the check and walker out of the bank. As a result, the potential money that could be created by the banking system

will increase

What is the interest rate?

you must forego interest earning when you hold money -Those interest earnings are an opportunity cost You can think of the interest rate as the price of money - I you borrowed someone else money it is the price you would have to pay to do so