Money and banking
monetary policy affects
-interest rates charged paid on savings -the price of goods, services and resources -interest rates charged on loans
the federal reserve board of governors
-investigates the effect of banking laws -oversees research into domestic and international financial conditions
The part of the Federal Reserve that determines and implements the nation's monetary policy and controls the money supply to promote stable prices and economic growth is the
Federal Open Market Committee.
knowing how much money an economy has matters because it helps determine
interest rates and prices
The federal reserve operates independently within the government because:
- Once a fed governor is confirmed by the senate, a president cannot decide to remove the governor from his or her position - the federal open market committee meets behind closed doors -the federal reserve does not rely on congress to fund its operations -the president of congress does not order the federal reserve to pursue specific course of action
which of the following do all banks have a crucial role in determining
-money supply -interest rate
during the great depression
-the money supply shrank by 24% despite an increase in actual currency -total deposits decreased from almost 60 billion in 1930 to 14.5 billion in 1933 -the total number of banks decreased from 25330 in 1929 to 14642 in 1933 -many people wanted to hold their currency instead of deposit it
___ demand depends on how much output people buy, which is based on their incomes; and how expensive output is, which is based on ___ level
-transaction -price
we graph the supply of money with the interest rate on the ___ axis and the quantity of money on the ___ axis
-y -x
The reserve requirement is determined by the
Board of Governors
Suppose that Karen deposits $500 into her checking account at the bank. The reserve requirement for Karen's bank is 12%. Assume the bank does not want to hold any excess reserves of new deposits. 1) Why are deposits considered liabilities for a bank?
Change in Reserves: $60 Change in Deposits: $500 Change in Loans: $440 Deposits can be withdrawn at any time
Open market operations are determined by the
Federal Open Market Committee
To make sure banks meet the daily needs of customers, the Federal Reserve enforces a
Reserve requirement
because transaction money demand is independent of the interest rate, it is a ___
Vertical line
Suppose the reserve requirement is initially set at 10%. a. At a reserve requirement of 10%, what is the value of the money multiplier? b. If the reserve requirement is 10% and the Fed increases reserves by $20 billion, what is the total increase in the money supply? c. Suppose the Fed raises the reserve requirement to 16%. What is the value of the money multiplier now? d. Assume the reserve requirement is 16%. If the Fed increases reserves by $20 billion, what is the total increase in the money supply? e. Raising the reserve requirement from 10% to 16% ___ the money multiplier and ___ the money supply.
a. 10 b. 200 billion c. 6.25 d. 125 billion e. decreases, decreases
The federal reserve bank serves as the ___ bank for the united states
central
every time this lending cycle occurs, the increase in loans ___
decreases
Total money demand is
downsloping as a result of asset demand
the asset demand for money
downsloping line beginning at 25% (interest rate)
in a world with no inflation the nominal interest rate is ___ to the real interest rate
equal
the federal reserve act of 1913
established the federal reserve system
the ___ value of the bond is the amount paid to the bondholder when the bond is repaid in full
face
When the federal funds rate increases, banks make
fewer loans to ensure they do not run low on reserves
a banking system where only a fraction of bank deposits are actually cash on hand and are availbable for withdraw is known as
fractional reserve banking
the first time money represented value instead of being intrinsically valuable, like a gold coin was:
in the Chinese Song Dynasty during the 11th century
you can write a check for goods and services, the check itself
is not money
The interest rate
is the price of money
unit of account
measure used to set prices and used as a yardstick for comparing value of different goods and services
___ is an item that both buyers and sellers will accept in exchange for goods and services
money
as ___ evolves, so does our ability to specialize and trade
money
If the Fed were to decrease the discount rate, banks will borrow
more reserves, causing an increase in lending and the money supply
the majority of the money in the U.S. economy is
nothing tangible you can hold, but is instead merely a computer entry
the interest rate paid to lenders and savers when the expected rate of inflation equals zero is the ___ interest rate
real
infinite geometric series
see above
Asset money is sloping downwards because it is
sensitive to interest rates
suppose the current quantity of money in the economy is $100 billion suppose the federal reserve decreases the money supply by $40 billion, the new money supply will
shift to the left $40 billion
Suppose the equilibrium interest rate is 13% but the usury law prohibits charging more than 10% in this case, a ________ will arise
shortage
a ___ is a situation where quantity supplied is less than quantity demanded at the current market price
shortage
an increase in the money ___ all else equal will cause interest rates to fall
supply
the money ___ in an economy is largely determined by a central monetary authority
supply
money multiplier
the amount by which a $1 change in reserves will change the money supply
the reserve requirement facing brians bank is 20% (1,500)
the bank must keep $300 on reserve This creates 1,200 in excess reserves the bank can lend $1,200
the fed operates independently within the government, but not independent of its because new members are aappointed by
the president and confirmed by senate
The money market is similar to all other markets in this respect, but slightly different in the sense that
the price of money is the interest rate
a ___ deposit is an interest-bearing deposit held by a bank or financial institution for a fixed term whereby the depositor can only withdraw the funds after giving notice
time
___ reserves are the total amount of reserves that a bank has, some of which it is required to keep on hand
total
the federal reserve, commonly called the fed
tracks the money supply
___ money demand is the demand for money to be used to purchase goods and services
transaction
because ___ checks are immediately convertible they are highly liquid and go into ___
travelers; m1
institutions can transfer large amounts of money in a timely manner by using
wire transfers
the ___ is equal to the net profit earned divided by the amount invested
yield
___ reserves, the amount the bank can lend out to earn interest, equal ___ reserves minus ___ reserves
-excess -total -required
transaction demand depends on
-how expensive output is -how much output people buy
Suppose the reserve requirement is 15%, banks hold no excess reserves, and there are no additional currency holdings. For each of the following scenarios, find the change in deposits, reserves, and loans for each bank. a. Mickey receives his paycheck of $2,000 for the week and deposits the check at First Bank. Use the table below to show the change in assets and liabilities at First Bank resulting from this transaction. b. Suppose that Austin gets a loan from First Bank in the amount from the "Loans" cell in the table in part a, and uses it to buy some jewelry from Jenny. Jenny takes the money from Austin and deposits it at Second Bank. Use the table below to show the change in assets and liabilities at Second Bank resulting from this transaction. c. Now suppose that Mary gets a loan from Second Bank in the amount from the "Loans" cell in the table in part b, and purchases a television from Jasper with the money. Jasper takes the money from the sale of the television and deposits it into Third Bank. Use the table below to show the change in assets and liabilities at Third Bank resulting from this transaction. d. This process continues with each additional change in deposits, reserves, and loans becoming smaller until no more loans can be made.
(a) Change in Reserves: $300 Change in Loans: $1,700 Change in Deposits: $2,000 (b) Change in Reserves: $255 Change in Loans: $1,445 Change in Deposits: $1,700 (c) Change in Reserves: $216.75 Change in Loans: $1,228.25 Change in Deposits: $1,445 (d) greater than
We construct the total demand for money by adding _____ and ______ demands at each interest rate.
-asset -transaction
generally, the federal reserve uses three tools to carry out public policy
-changes in discount rate -changes in reserve requirement -open market operations
during the great depression
-depositors took their funds out of their bank accounts -bank failures became commonpalce
medium of exchange
-anything that is used to determine value during the exchange of goods and services -asset used for trading goods and services
the federal open market committee
-determines and implements the nations monetary policy -promotes economic growth in the us economy -promotes stable prices -controls the money supply
store of wealth/Store of value
-means of holding purchasing power over time -Something that keeps its value if it is stored rather than used
the federal open market committee includes the board of governors the ___ of the new york fed, and ___ federal reserve bank presidents from other district banks, who serve on a rotating basis
-president -4
The demand for money comes from two sources
-saved for future use -used in daily transactions
Suppose the real interest rate is 3%. a. If people expect prices to rise by 4%, what would be the nominal interest rate for loans? b. Now suppose that people expect prices to rise by 6%. What would be the nominal interest rate for loans? c. The real interest rate is:
A. 7% B. INCREASE, 9% C. the amount earned to compensate people for postponing consumption.
suppose the transaction demand for money is $8 billion. graphically the transaction demand for money is
a vertical like at $8
M1 includes the following
a) Currency including coin in the hands of the public b) Travelers check c) Balances and Demands Deposits (Checking account) d) Balances with automatic transfer service (eg. ATM) e) Balances and N.O.W. accounts - Negotiable Order of Withdraw (Interest baring checking account) f) Balances and Credit Unions share draft accounts
M2 includes the following
a) Savings and small time deposits (Less than $100,000) at depository institutions b) Overnight Euro dollar deposits c) Overnight repurchase agreements d) Shares in money market, mutual funds held primarily by households and small business firms f) all of M1
Suppose the reserve requirement is currently 15%. a. Assume First Bank has deposits of $100 million. Calculate the required reserves for First Bank. b. At the end of the day, First Bank has $14 million of reserves. Will First Bank be a borrower or lender in the federal funds market?
a. $ 15 million b. First Bank will borrow reserves of $ 1 1 million in the federal funds market.
Suppose the reserve requirement for the United States is 15%. a. Suppose the Federal Reserve wants to increase the money supply. What should it do to accomplish this goal? b. Now suppose the Fed wants to decrease the money supply. What should it do to accomplish this goal?
a. The Fed could make an open market purchase of $30 billion, resulting in a total increase in the money supply of $ 200 ± 1 billion. b. The Fed could make an open market sale of $40 billion, resulting in a total decrease in the money supply of $ 267 ± 1 billion.
a. Suppose there is a surge in consumer confidence that creates an increase in aggregate demand in the economy. The Federal Reserve estimates that a change in the money supply of $120 billion will adjust interest rates enough to offset the change in aggregate demand. If the reserve requirement is 25%, what action should the Fed take to reach the desired change in the money supply? b. Suppose there is a political crisis in Europe that causes a reduction in investment demand in the United States. To stimulate investment demand, the Federal Reserve decides the money supply needs to change by $150 billion. If the reserve requirement is 10%, what action should the Fed take to reach the desired change in the money supply?
a. The Fed should conduct an open market sale of $30 billion. b. The Fed should conduct an open market purchase of $15 billion.
a. Suppose that banks are nervous about the next election and hold more excess reserves, causing the amount of reserves at banks to increase. Show this change in the demand for reserves in the federal funds market. b. In order to keep the federal funds rate at the target rate, the Fed will need to conduct an ____________ so the quantity of reserves will ____________ to meet the change in reserve demand.
a. When banks hold more excess reserves, they need to borrow fewer reserves, which decreases the demand for reserves. This causes the demand for reserves curve to shift to the left. A new demand for reserves curve should be drawn to the left of the original curve, showing a decrease in the amount of reserves in the federal funds market. b. Because of the decreased demand for reserves, the Fed will need to decrease the amount of reserves in supply to keep the federal funds rate from decreasing. The Fed will conduct an open market sale, which will decrease the quantity of reserves supplied in the banking system.
The money market in the United States, the investment demand, aggregate demand, and aggregate supply curves are as shown in the graphs below. Currently, the Federal Reserve has a money supply of $100 billion and the money market is in equilibrium. a. Suppose the Federal Reserve increases the money supply by $40 billion. Use the money market, investment demand, and AD/AS graphs to show the effects of the increase in the money supply on interest rates and money demand, investment, and in the AD/AS model. b. When the Federal Reserve wants to increase the money supply, it uses expansionary policy, which lowers interest rates and causes prices to increase while in the short run real GDP rises .
a. money supply moves shifts to the right/investment demand shifts down the dotted line/new curve is perpendicular to AD line and called AD1
Suppose the reserve requirement is 20% and that the initial federal funds rate target is 5%. The federal funds market and the money market are in equilibrium as shown in the graphs below. a. Suppose the Federal Reserve wants to raise the federal funds rate from 5% to 7%. It will require a $30 billion open market sale to achieve this goal. Show the change in the supply of reserves curve and indicate the new quantity of reserves in the federal funds market. b. If the Federal Reserve makes an open market purchase of $30 billion, the total money supply will decrease by ___ billion. c. When the total money supply decreases, there will be an adjustment to the interest rate in the money market. Use the money market graph and show the change in the money supply and interest rates in the money market. d. When the Federal Reserve raises the federal funds rate target, reserves ___ , causing the money supply to ___ , and interest rates (for borrowing and lending money) will ___ .
a. supply curve shifts upward 3 b. 150 c. MS1 shifts to the left d. decrease, decrease, rise
institutions can make small transfers using
automated clearninghouse services
the yield on bond is
interest paymnet/ bond cost
The discount rate is the
interest rate at which banks can borrow reserves from the Federal Reserve