Macroeconomics Test 3
Inflation Rate
-Price x Real GDP/ Real GDP = P -- P-Nominal GDP /Price of Level
Value of money
1/ Price - As price rises, value of money falls
After Tax Real Interest Rate
After tax nominal interest rate - Inflation rate
Change in Demand Deposits
Change in First Deposit X 1/R
Menu Costs
Cost of changing Prices -Printing new menus, mailing new catalogs
Suppose $100 of currency is in circulation. There is fractional reserve banking system
Depositors have $100 in deposits(liability). borrowers have 90$ in currency.(asset) This creates money but not wealth.
Reserve Requirements
Established by Feds: it regulations on the minimum amount of reserves that banks must hold against deposits -- Reducing this lowers reserve ratio and increases money multiplier
Price Level
Money Suppy x Velocity/ Quantity of output
Real Wage
Nominal Wage/Price Level
Capital Gains
Profits made from selling an asset for more then its purchase point
classical dichotomy
Separation of real and nominal variables
Demand Deposits
balances in bank accounts that depositors can access on demand by writing a check
Fractional Reserve Banking System
banks keep a fraction of deposits as reserves and use the rest to make loans
High inflation is...
more variable and less predictable then low inflation
After Tax Nominal Interest Rate
nominal interest rate - (government tax rate X nominal interest rate)
Currency
paper bills and coins in the hands of the public(not banks)
Nominal Wage
price of labor
Relative Price
price of one good relative to another - Price of one/ the other
Open-Market Operations
purchase and sale of US government bonds by the Feds -if the Fed buys a government bond from a bank, it pays by depositing new reserves in that bank's reserve account.
Lower than expected Inflation transfers..
purchase power from debtors to creditors
Money Neutrality keeps W/P unchanged so so is..
quantity of labor supplied Quantity of labor demanded Total employment of labor
Money supply/Money stock
quantity of money available in economy has 2 assets --Money Multiplier X bank reserves
Banks with too little capital
reduce lending, causing a credit crunch
Shoe Leather Costs
rescources wasted when inflation encourages people to reduce their money holdings - Including Time and Transcation costs on more frequent bank withdrawels
If banks dont' hold excess reserves,
reserve ratio will be equal to reserve requirements.
Bank Capital
resources a bank obtains by issuing equity to its owners -- Banks assets- banks Liabilites
Inflation Tax
revenue from printing money. - Printing money causes inflation, which is like a tax on everyone who holds money
T account
simplified accounting statement that shows banks assets and liabilities -- Reserves/ Liabilites
For more reserves..
the bank can make more loans, increasing the money supply
Money
the set of assets that people regularly use to buy goods and services from other people
If real GDP is growing
then inflation rate is less than money growth rate
If real GDP is constant
then inflation rate= money growth rate
Tax Distortions
Inflation makes nominal income grow faster then real income - Taxes are based on nominal income, and some are not adjusted for inflation - Inflation causes people to pay more taxes even when their real incomes don't increase
Barter
exchange of one good or service for another. Happens when there's no money
Commodity Money
has Intrinsic Value --Gold coins, cigarrates in POW camps
To decrease bank reserves and money supply..
, Feds sell government bonds
Buying and Selling Bonds
- Buying bonds increase money supply - Selling bonds decreases money supply
Reserve Ratio
-- Reserves/deposits
Fisher Effect
--an increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate is unchanged. --when the Fed increases the rate of money growth, the long-run result is both a higher inflation rate and a higher nominal interest rate.
Quantity theory of money
--quantity of money available in an economy determines the value of money, and growth in the quantity of money is the primary cause of inflation. --price level depends on the quantity of money, and the inflation rate depends on the money growth rate.
Lessons of Quantity theory of money
-economic growth increases # of transactions. - some money growth is needed for these extra transactions. - excessive money growth causes inflation.
Arbitrary Redistributions of Wealth
-high-than-expected inflation transfers purchasing power from creditors to debtors - Debtors get to repay their debt with dollars that aren't worth as much - Frequent when inflation is high
Percent change in Money Supply, Price Level, Inflation rate
100% x (new quantity of dollars- original quantity of dollars)/ og quantity of dollars
-Supply-demand Diagram - An equation
2 theories that asserts that the quantity of money determines the value of money
While cleaning your apartment, you look under the sofa cushion and find a $50 bill (and some leftover sesame chicken!) You deposit the bill in your checking account. The Fed's reserve requirement is 20% of deposits. -A. What is the maximum amount that the money supply could increase? -B. What is the minimum amount that the money supply could increase?
A: $200 -if it holds no excess reserves, money multiplier is 1/0.2=5 - So the max possible increase in deposits is 5 X $50 = $250 - But money supply also includes currency that falls by 50$ B: $0 If your bank makes no loans from your deposit, currency falls by $50, deposits increase by $50, money supply does not change.
Raising Interest Rate
Attract more such deposits, increases reserve ratio, lowers money multiplier
Assets of Money Supply
Currency Demand Deposits
Fed doubles the supply of money by printing some dollar bills and dropping them around the country from helicopters. (or, the Fed could inject money into the economy by buying some government bonds from the public in open-market operations.) What happens after such a monetary injection? How does the new equilibrium compare to the old one?
Decrease in value of money, increase in the price level, and increase in money supply
Reserves
Demand Deposits- loans
required Reserves
Demand deposits X required Reserve ratio
Liabilites
Deposits, Equity, Debt
M2
Everything in M1 plus saving deposits, small time deposits, money market mutual funds, certificates of deposits
Term Auction Facility
FED chooses the quantity of reserves it will loan, then banks bid against each-other for these loans
Fed funds Rate
FOMC uses OMOs to target
To Raises fed funds rate
Feds sell government bonds. -Removes reserves from the banking system - Reduces supply of federal funds - Soaks up cash from the financial system
Misallocation of rescources from relative-price variability
Firm don't all raise prices at the same time so relative prices can vary -distorts the allocation of rescources
The events from Run on Banks
Increase R, Reverse the process of money creation and cause money supply to fall
Confusion and Inconvenience
Inflation changes the yardstick we use to measure transaction - this complicates long-range planning and the comparison of dollar amounts over time
Nominal Interest Rate
Inflation rate + real interest Rate
Medium of Exchange
Item buyers give to sellers when they want to purchase goods and services ---Cash/Money
Assets
Loans and Reserves, securities
Nominal Variables
Measured in monetary units - nominal GDP - Nominal Interest Rate (Rate of Return in $) - Nominal Wage , $ per hour worked
A change in Money doesn't affect real GDP cuz
Money is neutral and real GDP is determined by technology and rescources
Quantity Equation
Money supply x Velocity = Price level x real GDP
Fiat Money
No intrinsic Value -- US
Expected Real Interest Rate
Nominal Interest Rate - Expected inflation Rate
Actual Real Interest Rate
Nominal Interest Rate- Actual Inflation Rate
Long-Run Nominal Interest Rate
Old nominal Interest Rate + Change in Inflation Rate
Nominal GDP
Price Level x Quantity of the item
Unit of Account
Provides buyers and sellers with a common value for goods and services -- US measures in dollars
Suppose $100 of currency is in circulation. But there is no banking system
Public holds the $100 as currency, so money supply is $100
Excess Reserves
Reserves- Required Reserves
5 steps to the theory of money
The velocity of money is relatively stable over time. Because velocity is stable, when the central bank changes the quantity of money , it causes proportionate changes in the nominal value of output . The economy's output of goods and services is primarily determined by factor supplies (labor, physical capital, human capital, and natural resources) and the available production technology. In particular, because money is neutral, money does not affect output. With output determined by factor supplies and technology, when the central bank alters the money supply and induces proportional changes in the nominal value of output , these changes are reflected in changes in the price level . Therefore, when the central bank increases the money supply rapidly, the result is a high rate of inflation.
Double Coincidence of wants
Unlikely occurrence that two people each have the good the other wants. - would be required in every transaction if there was no money
Velocity
Velocity = Price Level x Real GDP/ Money supply - Real GDP or quantity of output
If households hold onto their money as currency
banks have fewer reserves, make fewer loans, and money supply falls
changes in Fed Funds Rate
causes changes in other rates and have a big impact on the economy
Monetary Neutrality
changes in the money supply affect nominal variables but not real variables - Doubling money supply causes all nominal prices to double - increase in the rate of money growth raises the rate of inflation but does not affect any real variable
A lower discount rate...
increases Correct banks' incentives to borrow reserves from the Federal Reserve, there by increasing Correct the quantity of reserves in the banking system and causing the money supply to rise Correct .
When FEDS make loans..
increases money supply and reserves
hyperinflation
inflation exceeding 50% per month - Caused by excessive growth in money supply
Central Bank
institution that oversees the banking system and regulates the money supply
Discount Rate
interest rate on loans the FED make to banks to influence the amount of reserves banks borrow -"Traditional Method"
Federal Funds Rate
interest rates on banks
Store of Value
item people can use to transfer purchasing power from the present to the future -- Save your money
Real Variables
measured in physical units - Real GDp - Real interest Rate - Real wage - Physical Units/ Relative Prices
Leverage Ratio
ratio of assets to bank capital ---Assets/Capital Assets are Reserves, Loans, Securites
Run On Banks
under fractional-reserve banking, banks don't keep enough cash to pay off ALL depositors, hence banks may have to close. • as a strategy against this, banks may make fewer loans and hold more reserves to satisfy depositors
Leverage
use of borrowed funds to supplement existing funds for investment purposes
Feds can change the money supply by changing...
Bank Reserves Money Multiplier
Federal Reserve
Central Bank of US responsible for regulating the monetary system CONSISTS OF: - Board of Governors - 12 regional Fed Banks - Federal Open Market Committee
Monetary Policy
How policymakers in the central bank set the money supply
Suppose $100 of currency is in circulation. There is 100% reserve banking system (banks fold 100% of deposits as reserves so they cant make loans)
Public deposits the $100 at First National Bank. First National Bank holds 100% of deposits at reserves -- In 100% reserve banking system, banks do not affect size of money supply or increase amount of money in circulation
Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $100. Determine the money multiplier and the money supply for each reserve requirement listed in the following table. Reserve Requirement, Percent Simple Money Multiplier, Money Supply (Dollars)
The money multiplier is the reciprocal of the reserve ratio. Under the assumption that banks do not hold excess reserves, the reserve ratio will be equal to the reserve requirement set by the Federal Reserve. For a reserve requirement of 15%, the reserve ratio is 1/6.67, and the multiplier is, therefore, 6.67. When the multiplier is 6.67, a banking system with $100 in reserves can support in demand deposits. If the reserve requirement falls from 15% to 10%, the reserve ratio falls from 1/6.67 to 1/10, and the multiplier rises from 6.67 to 10. At the lower reserve requirement, the banking system's $100 in reserves supports in demand deposits. For a given level of reserves, a higher reserve requirement is associated with a smaller money supply. At the higher reserve requirement, banks must hold a larger fraction of their deposits as reserves. This keeps more reserves away from the money creation process (it keeps new loans from being made, which would lead to more deposits, which would lead to more loans, and so on). Therefore, the higher the reserve requirement, the fewer demand deposits are generated in the money creation process from a given change in reserves
Change in Required Reserves
amount deposited x Reserve Ratio. Excess Reserves is the percent that's left over
Money multiplier
amount of money the banking system generates for every dollar of reserves. -- 1/ Ratio Reserved
M1
currency, demand deposits, traveler's checks, other check-able deposits
Capital Requirement
government regulation that specifies a min amount of capital, intended to ensure banks will be able to pay off depositors and debts - The higher percent of assets a bank holds, the high capital requirement
Money Demand
how much wealth people want to hold in liquid form. -Negatively related to the value of money (as value of money goes down, quantity of money goes up) -Positively related to P
