Macro Test 3
Things that change the quantity demanded (movement ALONG the curve) of loanable funds?
As a result of a change in interest rate
Things that SHIFT the supply of loanable funds?
As a result of a change in savings increase in disposable income (Y-T) leads to an increase in the supply increase in expected future income decreases the supply increase in wealth decreases the supply As a result of a change in default risk The higher the default risk, the smaller supply
Fed's Balance Sheet
Assets: Government securities (ex: bonds) Loans to depository institutions (ex: banks) Liabilities: Federal Reserve notes ($ bills, not coins) Depository institution deposits (ex: banks)
Why did banks not care how risky the mortgages were?
Because they were not going to hold the mortgages themselves. They would be sold to the Wall Street banks.
Shadow banks
Borrow funds in the very short-term market (overnight)
the main component of the demand for loanable funds is
Business investment
Things that are NOT money?
Credit cards (it's a loan - doesn't settle final debt) Shares of stock Gold - a commodity Checks and debit cards (no extra money while check in circulation) The test of whether an asset is money is whether it serves as a means of payment.
M1
Currency (Firms & individuals - not banks) Traveler's checks Checking deposits (Firms & individuals only - not govt.)
Currency drain ratio?
Currency drain ratio = currency/deposits
Demand for Loanable Funds
Demand for investment and funds to finance it depends on the Real interest rate and Expected profit
How does the Fed affect the federal funds rate?
Equilibrium in the market for reserves determines the actual federal funds rate. By using open market operations, the Fed adjusts the supply of reserves to keep the federal funds rate on target.
What does Fannie Mae do?
Fannie Mae purchaes mortgages from banks and bundles them together and sells them to investors. If they lump together a bunch of very safe mortgages or loans, where the risk of default is very low, then the income stream is very safe.
Money Neutrality steps:
Fed increases MS Interest rates decrease AD shifts upwards Output and prices increase in SR (inflationary gap) Eventually wages and other factor prices increase SRAS shifts left Real output unchanged, price level higher Changes in the quantity of money affect nominal variables such as the price level but not real variables such as output. The AD shifts right, but the SRAS shift left in response eventually to close out the inflationary gap and return to equilibrium at LRAS, but the equilibrium point is now higher up (increased price level).
Monetary Policy Transmission example
Fed lowers fed funds rate Other short-term interest rates fall Quantity of money & Supply of LF increase, Long-term real interest rate decreases C, I and X-M increase AD increases, real GDP increases, inflation increases
illiquidity
Firms assets exceed credits, but loans made are long-term, with a sudden demand for repayment.
Government Sponsored Mortgage Lender
Government-sponsored enterprises that bought mortgages from banks, packaged them into mortgage-backed securities, and sold them. Frees up original lender to lend again. Ex: Fannie Mae: Federal National Mortgage Association Freddie Mac: Federal Home Loan Mortgage Corporation
Sources of Investment Funds (I)
Household saving (S), Government budget surplus (T-G where T=taxes and G=government spending), and Borrowing from rest of world (M-X). Equation: I= S + (T-G) + (M-X)
real money regarding price and wage increases
Nominal money/price level QD of real money stays the same. Real money is independent of the price level
Fed's tool box:
Open Market Operations: Buying/selling govt. securities, which controls size of money supply Set the discount rate Set the minimum reserve ratio Gives interest on bank deposits at the Fed; expected to help prevent inflation
Influences on Money Holding
Price level Nominal interest rate Real GDP Financial innovation
The wealth effect:
Price level increases Real wealth decreases People want to restore wealth Savings increases Consumption and AD decreases
Financial institution purposes:
Provide liquidity Provide loans Serve as middle man Buy securities Mortgages lenders buy mortgages from banks and sell them to investors Insurance companies pool risk Also the Fed
Discount rate
Rate at which an eligible financial institution may borrow funds directly from a Federal Reserve bank. Used when reserves fall below federal requirement. A last resort for banks, which usually borrow from each other. Influences other short term interest rates.
Fed funds rate
Rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. Used to control the supply of available funds and hence, inflation and other interest rates. Raising the rate makes it more expensive to borrow. That lowers the supply of available money, which increases the short-term interest rates and helps keep inflation in check.
Prime rate
Rate at which banks will lend money to their most-favored customers.
Supply of funds available for lending depends on
Real interest rate Disposable income Expected future income Wealth Default risk Savings is the main component of the supply of loanable funds. A rise in the real interest rate increases the quantity of loanable funds supplied. A fall in the real interest rate decreases the quantity of loanable funds supplied.
How do short term and long term rates differ in their patterns?
Short-term rates move closely together and follow the federal funds rate. Long-term rates move in the same direction as the federal funds rate but are only loosely connected to the federal funds rate.
Financial Assets examples
Stocks, Bonds, Short-term securities, and Loans
What happens to LRAS and SRAS with an increase in potential GDP?
The LAS curve shifts rightward and the SAS curve shifts along with the LAS curve.
The Fed (what it is and its goals)
The central bank of the United States. Central banks: The bank for banks Regulators of depository institutions Control quantity of money Influence the economy Goals: Keep inflation in check Maintain full employment Moderate the business cycle Work towards long-term growth
The demand for bank reserves slopes downward because
The higher the interest rate, the more costly it is to hold reserves (forgone interest) - bank would rather loan them out because they could make more money off of interest payments at high interest rates. So the higher the rate, the smaller the amount of reserves held by the bank.
Market for Money axes
X axis is the quantity of REAL money Y axis is the NOMINAL interest rate
What are the axes in the loanable funds market?
X is the volume of loans made Y is the interest rate
AD equation
Y (AD) = C + I + G + X - M
If the interest rate increases, then the asset price ________ and the net worth _________.
decreases, decreases
Financial innovation that lowers the cost of switching between money and interest-bearing assets ________ the quantity of real money that people plan to hold.
decreases. an increase in Financial innovation --> a decrease in financial transaction costs --> a decrease in the demand for real money
the long term bond rate is ______ than the short term bill rate because it is riskier.
higher
Regarding loanable funds, funds flow into the country in which the real interest rate is ________ and out of the country in which the real interest rate is ________.
highest, lowest (makes sense because this way people get more return for their money which would otherwise just sit around)
what does an increase in the monetary base do to reserves?
increase in monetary base --> excess reserves --> banks lend excess reserves --> quantity of money increases --> new deposits are used to make payments --> money that remains on deposit OR currency drain --> excess reserves OR desired reserves increase
an increased interest rate results in a(n) _______ cost of loan, which results in a(n) ________ in profits, so the demand for funds ________, making the curve downward sloping
increased, decrease, decreases
an increased interest rate leads to a(n) _________ profit from loan, which leads to a(n) _________ supply of funds
increased, increased. this means that the supply curve is upwards sloping
Sudden _________ interest rate could lead to insolvency.
increases
When deposits increase, the amount of currency we desire to hold _________
increases
A government budget surplus _________ the supply of loanable funds. This causes the real interest rate and household savings to ________ and it causes investment to ________
increases, decrease, increase
A government budget deficit __________ the demand for loanable funds. This causes the real interest rate and household savings to ________ and it causes firm investment to ________
increases, increase, decrease (AKA crowding out)
In the money market, an increase in real GDP_______ the volume of expenditure, which ________ the quantity of real money that people plan to hold.
increases, increases. an increase in real GDP --> an increase in expenditures --> an increase in the demand for real money
In the short-run, there is a trade-off between:
inflation and interest rates Inflation and real GDP and employment
inflation rate equation
inflation rate = money growth rate - real GDP growth rate
money multiplier equation
initial cash deposit x (1/reserve ratio). the money multiplier actually changes the quantity of money
As the nominal interest rate increases, you want to hold ______ real money
less
What three sectors make up the loanable funds market?
loan market, bond market, and stock market
A decrease in the exchange rate_______the price of domestic goods and _________ exports
lowers, increases
When the Fed wants to avoid recession, it _______ the Federal funds rate. When the Fed wants to check rising inflation, it _______ the Federal funds rate.
lowers, raises
credit crunch/freeze
makes it harder for households and firms to borrow money
the real interest rate is determined in the
market for loanable funds
The nominal interest rate is determined in the
market for money
LRAS regarding price level
money wage rate adjusts to changes in price level, so a change in the price level does not change real GDP
An increase in the price level makes domestic goods ______ expensive relative to foreign goods, which decreases exports and increases imports
more
READ THE TWO ARTICLES ON THE TEST AND GO OVER THE OLD TEST AND THOR'S EMAIL!
plz
currency drain
when money exits the system
AD shifters:
Δ expectations Δ fiscal & monetary policy Δ world economy
What causes AS to shift?
Δ potential GDP Δ money wage rate Δ other factor prices Δ Expected inflation (only SR shifts) Deviation of UE from natural UE (only SR shifts)
What happens when the money wage rate increases?
↑ money wage rate ↑ firms' costs ↓ willingness to supply Shifts SR AS back
more accurate money multiplier equation
(1 + currency drain ratio) / (currency drain ratio + desired reserve ratio)
What does a monetary injection by the Fed do in the LR?
A monetary injection by the Fed shifts the money supply curve to the right, creating an excess supply on money. People have more dollars in their wallets than they want. People try to get rid of this excess supply of money, either by buying goods and services or making loans to others or buying bonds. The injection of money increases the demand for goods and service, but not the supply of goods and services. This will cause the price of goods and services to rise - so the price level increases. The overall price level for goods and services adjusts to bring money supply and money demand in balance.
loose monetary policy (cheap money)
A monetary policy in which a central bank sets low interest rates so that credit is easily attainable.
Open market operations
A purchase or sale of securities by the Fed in the loanable funds market. Directly impacts bank reserves --> changes monetary base --> influences the quantity of money
Things that change the quantity supplied (movement ALONG the curve) of loanable funds?
A result of a change in interest rate
nominal interest rate
Actual % interest payment on principal
What happens in LR money neutrality?
Actual inflation = expected inflation Real GDP = potential GDP Money market, goods market, labor market, loanable funds market all in equilibrium In the LR, if Fed changes nominal supply of money, there is no impact on real GDP and employment because these are determined by labor demand, supply, and production function. There is also no impact on the real interest rate because it is determined in the loanable funds market. The price level changes by percentage equal to percentage change in the quantity of nominal money.
example of A Shift in Demand Loanable Funds (using expected profits)
An increase in expected profits increases the demand for funds today. The real interest rate rises. Saving and quantity of funds supplied increases.
Things that SHIFT the demand of loanable funds?
As a result of a change in expected profit: increased business cycle expansion increased new products/technology increased population/consumer demand increased consumer/business optimism
example of A Shift in Supply Loanable Funds (using increased saving)
If one of the influences on saving plans changes and saving increases, the supply of funds increases. The real interest rate falls. Investment increases.
Nominal money regarding price and wage increases
If prices and wages increase 10%, QD of nominal money increase 10%. Nominal money changes at the same rate as the price level
How can the Fed change the money supply?
If the Fed increases the supply of money (by buying bonds), the nominal interest rate will fall. And vice versa.
M2
M1 Time deposits Savings deposits Mutual funds
Marginal Propensity to Consume (MPC)
MPC is the proportion of additional income that an individual consumes. For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents.
Federal Open Market Committee
Main policy-making group. All members Board of Governors President of NY Fed Rotating 4 of other 11 Fed bank presidents Meets every 6 weeks to formulate monetary policy
Goals of Monetary Policy:
Maximum employment: Attain maximum sustainable growth rate of potential GDP Keep real GDP close to potential GDP Keep UE rate close to natural UE rate Moderate long-term interest rates: Keeping long-term nominal interest rates close to long-term real interest rates Stable prices: Keeping inflation low
Money functions as:
Means of Payment (settles a debt), Medium of Exchange, unit of account and a store of value
how does them monetary base influence the money supply?
Monetary base --> money multiplier --> money supply
Monetary Base vs. Money Supply
Monetary base = bank reserves + currency in circulation. Money supply = checkable deposits + currency in circulation. Money supply is larger than the monetary base. Bank reserves are part of the monetary base but aren't considered part of the money supply because it's not available for spending. Also, checkable bank deposits, which are part of the money supply because they are available for spending, aren't part of the monetary base.
Money Market Equilibrium: Short Run
Money supply determined by Fed & banks. Fixed at any moment in time (vertical line). Nominal interest rate will adjust to equilibrium. If the nominal interest rate is too high: More money is available than folks want to hold Demand for bonds will increase and sellers can offer lower interest rates If interest rate is too low: People want to hold more money and will sell bonds Demand for bonds decreases, interest rate must increase to get people to buy bonds
In SRAS:
Money wage rate, prices of other resources, potential GDP remain constant. If the price of a product increases while wages and cost of other inputs remains constant, producers can earn more profits by increasing supply.
Quantity of real GDP supplied definition in the aggregate market
Total quantity of goods and services firms plan to produce
Investment bank
buys many mortgages, perhaps 10,000, which generate $10 million in monthly payments.
Movement Along vs. Shift of Demand in the money market
change in QD of real money: a result of a change in nominal interest rate shift in the demand for real money: change in real GDP and financial innovation
money in the US is composed of which two categories?
currency (not held in a bank) and bank deposits
money supply
currency held by public and checking deposits
If the asset price increases, then interest rates _______
decrease
excess reserves equation
excess reserves = actual reserves - DESIRED reserves
Firms will borrow loanable funds only if
expected rate of return > interest rate
What equation determines the long-term real interest rate in the loanable funds market?
the nominal interest rate minus the expected inflation rate
real interest rate
the nominal rate adjusted for inflation. real = nominal - inflation
Money neutrality definition
the proposition that changes in the money supply do not affect real variables
A financial institution's net worth
total market value of what it has lent minus the market value of what it has borrowed.