Unit 4: Financial Sector Money & monetary policy

1. If the FED increases the reserve requirement the money supply will __↓__ and interest rates ___↑___.

.

3 Functions of Money

1. A Medium of Exchange- Money can easily be used to buy goods and services. Don't have to barter 2. A Unit of Account- Money measures the value of goods and services and measures value 3. A Store of Value-Money allows you to store purchasing power for the future

Shifters of Demand for loanable funds

1. Changes in perceived business opportunities 2. Changes in government borrowing

3 shifters of money demand

1. Changes in price level- Inflation requires consumer to hold more cash for financial transactions. 2. Changes income- Sustained economic growth in the economy leads to a increase in the demand for money 3. Changes in taxation that affects personal investment- Government policies such as changing the capital gains tax would change the demand for money

Shifters of supply for loanable funds

1. Changes in private savings behavior 2. Changes in public savings 3. Changes in foreign personal investment 4. Changes in expected profitability

Assume the reserve requirement is .10. If the Fed buys $10 billion worth of bonds the money supply will ______ by $___ billion.

1. increase 2. 100 Billion

If the MS increased the IR will ___1_ and investment will __2__

1.decrease 2.Increase

Money Multiplier Equation

1/ reserve requirement

What is the maximum possible increase in the money supply if the bank loaned out all its excess reserves?

30,000 ( 3,000 X 10)

What happens to the real IR if the government runs a deficit?

Demand increases so IR increases

The money supply includes all assets like cash, demand deposits, bonds, and real estate.

F

Relationship between IR and money demanded

Interest rate ↑, the quantity of money demanded __↓__ Interest rate ↓, the quantity of money demanded __↑__

Transaction Demand for Money

People demand money to make everyday purchases. This is not affected by the interest rate

Fractional Reserve Banking

Process where banks hold a portion of deposits in reserve and loan the rest of the money out

An increase in saving would cause real IR to ____ investment _____ and economic growth ___

Real IR dec investmetn inc economic growth inc

IF lenders decide to lend less real IR ____ investment ____ and economic growth ___

Real IR inc investment dec economic growth dec

If the reserve requirement is .1 (or 10%) how much is this bank's required reserves and excess reserves?

Req: 2,000 Excess: 3,000

3 shifters of money supply

Reserve ratio-the the percent of deposits that banks must hold in reserve (the % they can NOT loan out) *To increase money supply, decrease the reserve ratio *To decrease money supply, increase the reserve ratio 2. Discount Rate- the interest rate that the FED charges commercial banks *To increase money supply, decrease the discount rate *To decrease money supply, increase the discount rate 3. Open Market Operations- when the FED buys or sells government bonds (securities) *To increase money supply, the FED buys bonds *To decrease money supply, the FED sells bonds

T or F When the interest rate is high, the opportunity cost of holding money increases so the quantity of money demanded will decrease.

T

What is FED and what does it do?

The Fed is the central bank of the United States and it regulates commercial banks and adjusts the money supply to adjust interest rates to meet economic goals. This is called Monetary Policy.

Excess Reserves

The amount banks are legally free to loan out. Excess reserves and required reserves make up total reserves

Federal Funds Rate

The federal funds rate is the interest rate that banks charge each other for loans. The Fed uses open market operations to hit this target rate.

Identify three options this bank has to avoid defaulting other than asking borrows to pay back loans.

They can sell treasury bonds, borrow money from the Fed, or borrow money from another bank

Monetary policy is when the central banks changes the interest rates by changing the money supply

True

Asset Demand for money

When people demand money as a liquid asset because they prefer it to other non-liquid assets like bonds

Demand Deposits

bank deposits that can be withdrawn at any time ex- checking account

Unexpected inflation causes the demand for money to ____ and the IR to ___

both will increase

Assume the reserve requirement is .20. If the Fed sells $10 billion worth of bonds the money supply will ______ by __$__ billion.

decrease 50 billion

Assume the reserve requirement is .25. If the Fed sells $2 billion worth of bonds the money supply will ______ by $__ billion.

decrease 8

Assume the reserve requirement is .50. If the Fed sells $5 billion worth of bonds the money supply will ________ by $__ billion.

decrease 10

If the $5,000 deposit is placed in reserve, how much is demand deposits and excess reserves?

demand: 25,000 excess: 7,500

Assume the reserve requirement is .10. If the Fed buys $5 billion worth of bonds the money supply will ________ by $__ billion.

increase 50 billion

Assume a customer deposits $5,000 into this bank, what is the initial change in the money supply?

there is no initial change