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