Chapter 14 Money Problems...continued
The Financial Crisis of 2008
-subprime loans during the U.S. housing bubble of the mid 2000s spread through the financial system via securitization -Housing bubble burst leading to widespread collapse in the financial system --the Fed and the US treasury ----expanded lending to bank and nonbank institutions -----provided capital through the purchase of bank shares -----purchased private debt General 2008 regulation changes: -Systemically important institutions subjected to bank-style regulation -The federal government has right to seize troubled financial institutions -Make the risks taken by financial institutions more transparent. TED spread: measure of a country's banking stability
More Problems
4. Indicate whether each of the following is part of M1, M2, or neither: a. $95 on your campus meal card -- neither b. $0.55 in the change cup of your car -- M1 c. $1,663 in your savings account --M2 d. $459 in your checking account --M1 e. 100 shares of stock worth $4,000 --neither f. A $1,000 line of credit on your Sears credit card --neither
Probs on quiz
9. What will happen to the money supply under the following circumstances in a checkable-deposits-only system? a. The required reserve ratio is 25%, and a depositor withdraws $700 from his checkable bank deposit. --$700 is gone from reserves/checking deposits. Bc checking deposits went down, the reserve requirement has also gone down by (700 x .25) = $175. $700 - $175 = $525, so the bank must reduce lending/checking bank deposits by ($525/.25) = $2,100. So Money Supply decreased by $2,100. b. The required reserve ratio is 5%, and a depositor withdraws $700 from his checkable bank deposit. --$700 is taken from reserves/checking deposits, so MS decreases. The reserve requirement has also gone down by ($700 x .05) = $25. $700 - $25 = $675, so the bank must reduce lending/checking bank deposits by ($675/.05) = $13,500. c. The required reserve ratio is 20%, and a customer deposits $750 to her checkable bank deposit. --MS increases. (250 x .2) = $150 is added to the reserves, which means that (750-150) = $600 is not tied to any check accounts (so we have $600 in excess reserves). We can increase MS by lending out (600/.2) = $3000. So Answer: $3000 increase in Money Supply d. The required reserve ratio is 10%, and a customer deposits $600 to her checkable bank deposit. --Money supply increases. (600 x .1) = $60 is added to the reserves, which means that ($600 - $60) = $540 is not tied to any check accounts (so we have $540 tied to excess reserves). We can increase MS by lending out ($540/.1) = $5,400. So: Money Supply increases by $5,400. Remember, banks can lend out more than their excess reserves. *If MS is going to decrease because a depositor is withdrawing, do: (($withdrawl amount)(1-reserve requirement) )/ (reserve requirement)*
Chapter 13 Practice Problem
Assume a country is debating between increasing social security payment by $100M and increasing funding on EPA programs by the same amount. Assume an MPC of 0.75. A) Show the impact on GDP of both policies as it cycles through three economic rounds. Be sure to show the exact amount in each round and which component of GDP is changing. EPA funding = G SS = transfer If money spent on EPA: --Round1: $100 G --Round2: $100 x .75 = $75 C --Round3: $75 x .75 = $52.65 C If money spent on SS: --Round1: $100 x .75 = 75 C --Round2: $75 x .75 = $52.65 C --Round3: $52.65 x .75 = $42.19 C *If spending is defined as a service, is counts as G and then cycles as C. If spending is defined on a transfer, it starts of and stays as C.* B) Calculate the final impact on GDP from both policies. If the answers are the same, explain why that is. If the answers are different, explain why this is the case. --Final impact if spending on EPA= 100 x (1/(1-.75)) = $400 --Final impact on SS: (100 x .75) x (1/1-MPC) = $300. --Why different? In both cases, the government is spending the exact same amount. However, when spent on a transfer to citizens, some of the money is saved; not all of it is spent in the first round. Thus, spending on SS causes an initial savings, and thus that savings doesn't impact today's GDP.
Bank Regulations
Deposit insurance: guarantees that a bank's depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account The FDIC currently guarantees the first $250,000 of each account Reserve Requirements: rules set by the Federal Reserve that determine the minimum reserve ratio for a bank. For example, in the United States, the minimum reserve ratio for checkable bank deposits is 10%. The discount window is an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble. The Fed charges a fee to banks for lending them money when in trouble aka a discount rate. This is because we don't want banks to behave recklessly, as its tax payer money that bails the banks out.
Even More Probelms
For each of the following transactions, what is the initial effect (increase or decrease) on M1? or M2? a. You sell a few shares of stock and put the proceeds into your savings account. --M2 increases, M1 doesn't change b. You sell a few shares of stock and put the proceeds into your checking account. --M1 and M2 increase c. You transfer money from your savings account to your checking account. --M1 increases, M2 doesn't change d. You discover $0.25 under the floor mat in your car and deposit it in your checking account. --M1 doesn't change and M2 doesn't change e. You discover $0.25 under the floor mat in your car and deposit it in your savings account. --M1 decreases, M2 no change bc its going right back into savings
MB vs MS
Monetary base = the sum of currency in circulation and bank reserves Money supply = M1 = currency in circulation + checking deposits The amount of printed cash in society doesn't really impact society, what impacts society is the money supply
How banks create Money
Money = M1 = currency in circulation + checking deposits Reserves: physical cash held by a bank. So, when I deposit money, the bank only holds onto 10%, and they lend out the rest. ^^Given this circulation, the money supply increases. Reminder: The money supply is not the physical cash. Money is physical cash + checking deposits. This is why money supply balloons, because they put it in the bank. Excess reserves are bank reserves over and above its required reserves. When a bank has excess reserves, that means cash on hand is not tied to any loans, so the bank can loan out more money Ex: excess reserves of $100 -> can represent 10% of new loans. 100 = .1 x X where X = loans *X = 100/.1* X = 1000 in new loans can be made *new loans = (excess reserves / reserve requirement)*
Crisis in American Banking
Panic of 1907: a bank went under, and caused panic by those who were part of banks that weren't risky. So even those not at risk took money out. This situation was saved by 2 millionaires, rockefeller and jp morgan. The federal reserve was created to centralize holding of reserves, inspect banks books, and ensure that the money supply sufficiently responsive to varying econoic conditions
Reserve Requirements and the Discount Rate
The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves Assets: 10% cash, and 90% loans....the bank can't open the next day unless they have 10% cash. Liabilities: checkable bank deposits... All the banks across the nation are pretty much at 10%. Because if you're above 10%, you'll lend it out to banks who are below 10%. This is the federal funds market. -------------------------- The federal funds rate is the interest rate determined in the federal funds market If a bank is not able to get loans from other banks, which happens if they're late on payments, they have to borrow from the federal reserve. The federal reserve has a much higher interest rate! The discount rate is the rate of interest the Fed charges on loans to banks. _______________________________________
Last Problems
The government of Eastlandia uses measures of monetary aggregates similar to those used by the United States, and the central bank of Eastlandia imposes a required reserve ratio of 10%. Given the following information, answer the questions below. Bank deposits at the central bank (physical printed cash = MB) = $200 million Currency held by public (currency in circulation, printed cash that's MB and M1/MS) = $150 million Currency in bank vaults (reserves) = $100 million Checkable bank deposits (M1/MS) = $500 million Traveler's checks (M1/MS) = $10 million a. What is M1? --10 million + 500 million + 150 million = $660 million --M1 = currency in circulation + checking deposits + travelers checks b. What is the monetary base? --MB = currency in circulation + Bank reserves MB = currency held by public + currency in bank values + bank deposits at the central bank --150 million + 100 million + 200 million = $450 million c. Are the commercial banks holding excess reserves? If so, how much? --Let's find out what the required reserves are: *required reserves = (reserve ratio) x (checkable bank deposits)* --required reserves = .1 x 500 = $50 million required reserves --In this problem, the bank actually has cash in bank vaults + cash at central bank = $300 million --So excess reserves = $300 million - $50 million = $250 million excess reserves. d. Can the commercial banks increase checkable bank deposits? If yes, by how much can checkable bank deposits increase? --Yes, by ($250 million / .1) = $2,506 e. How do banks do this? --Loans. Banks can approve more loans if they have excess reserves, and they will loan out as much as they can, because that's how they make money.
Responding to Banking Crisis
The great Depression --widespread bank runs in the early 1930s The federal deposit insurance was created By 1933, banks had been separated into two categories: --commercial (covered by deposit insurance) --investment(not covered) --public acceptance of deposit insurance finally stopped the bank runs
The Savings and Loan Crisis of the 1980s
The savings and loan (thrift): --S&Ls engaged in overly risky speculation and incurred huge losses --Depositors compensated with taxpayer funds because they were covered by deposit insurance --the crisis caused steep losses in the financial and real estate sectors, resulting in a recession in the early 1990s Lesson? When you loosen regulations, companies may take advantage of this, not in a positive way
Problems
There are three types of money: commodity money, commodity-backed money, and fiat money. Which type of money is used in each of the following situations? a. Bottles of rum were used to pay for goods in colonial Australia. --commodity b. Salt was used in many European countries as a medium of exchange. --commodity c. For a brief time, Germany used paper money (the "Rye Mark") that could be redeemed for a certain amount of rye, a type of grain. --commodity backed d. The town of Ithaca, New York, prints its own currency, the Ithaca HOURS, which can be used to purchase local goods and services. --fiat
The Problem of Bank Runs
a bank run is a phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure Historically, they have often proved contagious, with a run on one bank leading to a loss of faith in other banks, causing additional bank runs
define money
any asset that can easily be used to purchase goods and services
define checkable bankn deposits
bank accounts on which people can write check
define currency in circulation
cash held by the public
The federal Reserve system
central bank: an institution that oversees and regulates the banking system and controls the monetary base the federal reserve is a central bank--an institution that oversees and regulates the banking system, and controls the monetary base the federal reserve system consists of the board of governors in Washington DC plus regional 12 federal reserve banks
Open-Market Operations
the principal tool of monetary policy the Fed can increase or reduce the monetary base by buying government debt from banks or selling government debt to banks aka playing around with treasury bills
