Macro Chapter 14

M1

. More than half of the narrow definition of money (M1) consists of checkable deposits.

A money aggregate consisting of M1 plus savings deposits, small-denomination time deposits, money market mutual funds, and other near-monies

30 percent of all consumer purchases

The bank must be in a position to satisfy all depositor demands, even if many ask for their money at the same time

A bank loses reserves whenever a depositor withdraws cash, writes a check that gets deposited in another bank, or uses a debit card that ultimately shifts deposits to another bank.

balance sheet

A financial statement at a given point in time showing assets on one side and liabilities and net worth on the other side; because assets must equal liabilities plus net worth, the two sides of the statement must balance, hence the name

M2

A money aggregate consisting of M1 plus savings deposits, small-denomination time deposits, money market mutual funds, and other near-monies

asymmetric information

A situation in which one side of the market has more reliable information than the other side

claim

About half of Federal Reserve notes are held abroad

checkable deposits

Checkable deposits are the liabilities of the issuing banks

Round Three

Merchants Trust now has $900 more in reserves on deposit with the Fed. After setting aside $90 as required reserves, or 10 percent of your college's checkable deposit increase, the bank has $810 in excess reserves.

M2

Money market mutual fund accounts, mentioned in Chapter 13, are another component of money when defined more broadly. Savings Dep Time dep

Required Reserves

Required Reserves = Checkable Deposits * Req.Reserve Ratio

RESERVES

Reserves = Checkable Deposits - Loans

The current reserve requirement is 10 percent on checkable deposits (other types of deposits have no reserve requirement).

Reserves are held either as cash in the bank's vault, which earns the bank no interest, or as deposits at the Fed, where reserves earn interest.

currency circulating in the United States consists mostly of Federal Reserve notes, which are produced by the U.S. Bureau of Engraving and Printing and are issued by and are liabilities of the 12 Federal Reserve banks

Roughly one-third of the Fed's liabilities consist of Federal Reserve notes. The Fed spends about $730 million a year printing, storing, and distributing notes.

Banks attract deposits from savers to lend to borrowers, earning a profit on the difference between the interest paid depositors and the interest charged borrowers

Savers need a safe place for their money, and borrowers need credit; banks try to earn a profit by serving both groups

M2

Some other financial assets perform the store-of-value function and can be converted into currency or to checkable deposits. Because these are so close to money, they are called near-monies and are included under a broader definition.

required reserves

The dollar amount of reserves a bank is obligated by regulation to hold as cash in the bank's vault or on account at the Fedcheckable deposits multiplied by the required reserve ratio.

money multiplier

The maximum possible effect is to reduce the money supply by the original reduction in bank reserves times the simple money multiplier, which again equals 1 divided by the reserve requirement, or 1/r.

M1 money supply

The narrow measure of the money supply, consisting of currency and coins held by the nonbanking public, checkable deposits, and traveler's checks

October 2008, the Fed began paying banks interest on reserves

This encourages banks to hold reserves in excess of the required minimum. It also sets an effective floor on interest rates as banks are unlikely to make loans to private customers at a lower rate than they can receive by depositing funds at the Fed.

You can also see that the Fed held deposits of the U.S. Treasury, a reminder that the Fed is the federal government's banker.

Thus, nearly all the Fed's assets earn interest, whereas one of the Fed's primary liabilities—Federal Reserve notes—requires no interest payments by the Fed. The Fed is therefore both literally and figuratively a money machine. It is literally a money machine because it supplies the economy with Federal Reserve notes; it is figuratively a money machine because most assets earn interest, but a main liability requires no interest payments.

Through open-market operations, the Fed influences bank reserves and the federal funds rate, which is the interest rate banks charge one another for borrowing excess reserves at the Fed, typically just for a day or two.

To increase the money supply, the Fed directs the New York Fed to buy U.S. bonds. This is called an open-market purchase. To reduce the money supply, the New York Fed is directed to carry out an open-market sale.

Round One

To start, suppose the Fed buys a $1,000 U.S. government bond from a securities dealer, with the transaction handled by the dealer's bank—Home Bank. The Fed pays the dealer by crediting Home Bank's reserve account with $1,000, so Home Bank can increase the dealer's checking account by $1,000.

U.S. bond

U.S. bond is not money, but checkable deposits are, so the money supply increases by $1,000 in this first round.

Round Four and Beyond

We could continue the process with Fidelity Bank setting aside $81 in required reserves and lending $729 in excess reserves, but you get some idea of money creation by now. Notice the pattern of deposits and loans. Each time a bank gets a fresh deposit, 10 percent goes to required reserves

finance companies

are financial intermediaries that do not get their funds from depositors, so they can choose names aimed more at borrowers

The primary currency circulating in the United States consists of:

b. Federal Reserve notes.

Banks can cope better with asymmetric information in the market for loans than individual lenders can because:

b. banks have expertise in evaluating the creditworthiness of loan applicants.

The size of the money market multiplier is likely to reduce if _____.

b. banks let excess reserves sit idle

M2 includes:

b. money market mutual funds.

The Fed can increase the money supply by:

b. purchasing U.S. Treasury bonds.

Banks, as intermediaries

banks reduce the transaction costs of channeling savings to creditworthy borrowers.

By bringing together both sides of the money market

banks serve as financial intermediaries, or as go-betweens

Suppose the Fed injects $50 billion of new money by buying U.S. Treasury bonds from the public. If the required reserve ratio is 10 percent, banks convert all excess reserves into loans, and the public hold all their money in their checking accounts rather than in cash, then the money supply will increase by _____ due to this injection.

c. $500 billion

You have $1,000 in your checking account at Generous Savings and Loans (GSL). GSL holds $300 of your money in reserve and makes a $700 student loan to Wilma, who promises to repay the loan with interest. Wilma now has an additional $700 in her checking account. This implies that the M1 money supply has increased by _____.

c. $700

Which of the following correctly describes the difference between M1 and M2?

c. M1 includes currency, traveler's checks, and money in checkable accounts, whereas M2 includes M1 plus savings deposits, small-denomination time deposits, and money market mutual funds.

Which of the following is used by the Fed to control the money supply?

c. The required reserve ratio.

Which of the following is true of checkable deposits?

c. These are included in the narrow definition of money.

The money multiplier is the multiple by which the:

c. money supply increases as a result of an increase in the banking system's reserves.

A state bank must apply to the _____ to obtain a charter or a right to operate. a. U.S. Comptroller of the Currency b. U.S. Ministry of Finance c. state banking authority d. Fed

c. state banking authority

When banks transform excess reserves into loans, _____.

c. the money supply increases

in its capacity as a bankers' bank, the Fed clears

clears checks for, extends loans to, and holds deposits of banks

_____ is a liability for a commercial bank.

d. A checkable deposit by a customer

Which of the following is likely to occur if the Fed conducts an open-market sale of U.S bonds?

d. Excess reserves of banks will decline and supply in the federal funds market will decline, leading to an increase in the federal funds rate and the short-term interest rate charged by banks.

Which of the following correctly identifies the difference between primary and secondary discount rates?

d. The primary discount rate is about one percentage point above the federal funds rate, while the secondary discount rate is about one-half a percentage point higher than the primary discount rate.

Which of the following is a feature of time deposits?

d. Time deposits earn a fixed interest rate if held for a specific period of time.

_____ are included in the narrow definition of money.

d. Traveler's checks

From the perspective of a bank, the objectives of _____ and _____ are at odds with one another.

d. liquidity; profitability

The simple money multiplier is the reciprocal of the _____.

d. required reserve ratio

DC

debit cards are safer than credit cards, which could be used more easily by a thief.

Savings Deposits

deposits that earn interest but have no specific maturity date

Banks are _____ that link lenders (depositors) to borrowers.

financial intermediaries

federal funds rate;

his is the rate the Fed targets as a tool of monetary policy

Where does the Fed get these reserves

makes them up—creates them out of thin air, out of electronic ethe

September 11, 2001,

people used their ATM cards and debit cards to load up on cash. Some hoarded cash. To ensure the banking system had sufficient liquidity, the Fed bought all the government securities offered for sale, purchasing a record $150 billion worth in two days.

The federal funds market:

provides for day-to-day lending and borrowing among banks having excess reserves on account at the Fed.

federal funds market

provides for day-to-day lending and borrowing among banks of excess reserves on account at the Fed

two discount rates

rimary discount rate is usually one percentage point above the federal funds rate. secondary discount rate is usually about one-half a percentage point higher than the primary discount rate.

Fed's three oldest tools for controlling reserves:

(1) open-market operations, or the buying and selling of U.S. government bonds; (2) the discount rate, which is the interest rate the Fed charges for loans it makes to banks; and (3) the required reserve ratio, which is the minimum fraction of reserves that banks must hold against deposits.

To obtain a charter, or the right to operate,

, they must apply to the state banking authority in the case of a state bank or to the U.S. Comptroller of the Currency in the case of a national bank. The chartering agency reviewing the application judges the quality of management, the need for another bank in the community, the proposed bank's funding, and the likely success of the bank.

The assets of a bank include _____.

loans

rr

As noted already, the current reserve requirement is 10 percent on checkable deposits and zero on other deposits;

Checkable deposits

Bank deposits that allow the account owner to write checks to third parties; debit cards can also access these deposits and transmit them electronically

Time deposits

Bank deposits that earn a fixed interest rate if held for the specified period, which can range from several months to several years; also called certificates of deposit

Excess Reserve =

Excess Reserve = Reserves - Req. Reserves

Round Two

Home Bank approves your loan and increases your checking account by $900. Home Bank has converted your promise to repay the loan, your IOU, into a $900 checkable deposit. Because checkable deposits are money, this action increases the money supply by $900.

"open market" here means that securities dealers compete to do business with the Fed based on price in an open-market.

The Fed carries out open-market operations whenever it buys or sells U.S. government bonds in the open market

The Fed uses the discount rate

The Fed uses the discount rate more as a signal to financial markets about its monetary policy than as a tool for increasing or decreasing the money supply. The discount rate might also be thought of as an emergency tool for injecting liquidity into the banking system in the event of some financial crisis

If total deposits at Resolute Bank and Trust are $100 million, total loans are $70 million, and excess reserves are $20 million, then the required reserve ratio is _____

a. 10 percent

Which of the following statements is true?

a. An individual bank cannot lend an amount greater than its excess reserves.

Which of the following is most likely to happen if the Fed increases reserve requirements?

a. An individual bank's ability to create money will decrease.

Which of the following is true of debit cards but not of credit cards?

a. Funds that can be accessed by debit cards are included in M1.

_____ are measures of money supply that are defined by the Federal Reserve.

a. Money aggregates

Which of the following can be used by the Fed to initiate the process of money creation?

a. Purchasing a $2,500 bond from a bank.

One of the advantages of open-market operations is that they _____.

a. can be used in any amount chosen by the Fed

Open-market operations enable the Fed to control bank reserves and the _____.

a. federal funds rate

Suppose the money supply (as measured by checkable deposits) is currently $750 billion. The required reserve ratio is 30 percent, and banks do not hold excess reserves. If the Fed wants to decrease the money supply by $50 billion, it should ________ worth of U.S. government bonds approximately.

a. sell $15.0 billion

Liquidity

is the ease with which an asset can be converted into cash without a significant loss of value. The objectives of liquidity and profitability are at odds. For example, more liquid assets yield lower interest rates than less liquid assets do. The most liquid asset is cash in the bank's vault, but such reserves earn no interest.

The Fed also influences the money supply through reserve requirements

which are regulations regarding the minimum amount of reserves that banks must hold to back up deposits.

The second monetary policy tool available to the Fed is the discount rate

which is the interest rate the Fed charges for loans it makes to banks. Banks borrow from the Fed to satisfy their reserve requirements. A lower discount rate reduces the cost of borrowing, encouraging banks to borrow reserves from the Fed.

economy is more efficient because banks

xpertise in evaluating creditworthiness, structuring loans, and enforcing loan contracts.