Unit 4

I. Uses of Money

A.) Medium of Exchange

• Able to buy goods and services (bartering & trading)

B.) Unit of Account

• Establishes economic worth

C.) Store of Value

• Money holds it's value over a period of time

II. Types of Money

A.) Commodity Money 

• A good, swapping goods

B.) Representative Money

• Ex.) I.O.U

C.) Fiat Money

• Money because government said so

III. Characteristics of Money

A.) DurabilityB.) PortabilityC.) Divisibility D.) UniformityE.) ScarcityF.) Acceptibility

IV. Money Supply

A.) M1 Money

• Consist of currency in circulation
• Paper money and coins (we don't use gold)
• Checkable (demand deposits) checking accounts deposits
• Travelers checks

B.) M2 Money

• Consist of M1 money + savings accounts + money market accounts + deposits held by banks outside the U.S

Fractional Reserved Banking

• It is the process by banks of holding a small portion of their deposits in reserved and loaning out in excess.

Significance of a Fractional Reserve System

1. Banks can create money by lending more than their reserves
2. Required reserves don't prevent bank panics because banks must keep their required reserves (FDIC)
3. Reserved requirement gives the Feds contrl over how much money banks can create

Functions of FED (Federal Reserve Bank)

1. Control the nations money supply through monitory policy
1. Adjust interest rate
2. circulation of currency
2. Issue paper currency
3. Serve as a clearing house for checks
4. Regulate banking activity
5. Serve as a bank for banks

Balance Sheet

• A statement of assets and claims summarizing the financial position of a firm or a bank at some point in time 
• Must balance at all times
• Assets (own) = Liabilities + Net Worth (owe)

How Banks Work

Assets

• Reserves:
• Required Reserves (rr) - % required by Fed. to keep on hand to meet demand
• Excess Reserves (er) - % reserves over and above the amount needed to satisfy the minimum reserve ratio set by Fed.
• Loans to firms, consumers, and other banks (earns interest)
• Loans to govt. = treasury securities
• Bank property - (if bank fails, you could liquidate the building/property)

Liabilities + Equity

• Demand Deposits ($ put into bank)
• Timed Deposits (CD's)
• Loans from: Federal Reserve and other banks
• Shareholders equity - (to set up a bank, you must invest your own money in it to have a stake in the banks success or failure)

Reserve Requirement

• The Fed requires banks to always have some money readily available to meet consumers' demand for cash
• The amount, set by the Fed, is the required reserve ratio
• The required reserve ratio is the % of demand deposits (checking account balances) that must not be loaned out.

PRACTICE: Reserve ratio = 5%. You deposit $1000 in bank. How much is the bank required to add to its reserve.

-  (.05)($1000) = $50 in reserve ratio

- How much money can banks loan out? 1000 (deposited) - 50 (reserve ratio) = $950 loaned out to next borrower.

The Required Reserve Ratio

• The % of demand deposits that must be stored as vault cash or kept in reserve as Federal Funds in the banks account with the Federal reserve.
• The required reserve ratio determines the money multiplier = 1/reserve ratio 
• Decreasing the reserve ratio, increases the rate of money creation in the banking system is expansionary
• Increasing the reserve ratio decreases the rate of money creation in the banking system and is contractionary 
• Chasing the required reserve ratio is the least used tool, of monetary policy, and is usually held constant at 10%

The Money Multiplier

• Money multiplier shoes us the impact of a change in demand deposits on loans and eventually the money supply
• The money multiplier indicates the total number of dollar created in the banking system by each $1 addition to the monetary base (bank reserves and currency in circulation)
• To calculate the money multiplier divide 1 by the required reserve ratio
• money multiplier = 1/reserve ratio

The 3 Types of Multiple Deposit Expansion Question

Type 1

• Calculate the initial change in excess reserves
• a.k.a the amount a single bank can loan from the initial deposit

Type 2

• Calculate the change in loans in the banking system

Type 3

• Calculate the change in the money supply
• Sometimes type 2 & 3 will have the same result (i.e no fed involvement)

Type 4

• Calculate the change in demand deposits

Required Reserve

• = amount of deposit * required reserve ratio

Excess Reserve

• = total reserves - required reserves 

Maximum Amount a Single Bank can Loan

• the change in excess reserves caused by a deposit

Total Change in Loans

• = amount single bank can lead * money multiplier

Total Change in $ Supply

• = total change in loans  $ amount of Fed action

Total Change in Demand Deposits 

• = total change in loans + any cash deposited

Fiscal Policy VS. Monetary Policy

Fiscal Policy

• Congress

1. Tax or
2. Spend

Monetary Policy

• FED

1. OMO - Open market operation: buy or sell bonds
2. Reserve Requirement: bank's mass requirement
3. Discount Rate: interest rate charged by the Fed for overnight loans to commercial banks
4. Federal Fund Rate: interest rate charged one commercial bank for overnight loans to another commercial bank. 

• The Fed has several tools to manage the money supply by manipulation the excess reserves held by banks, a practice known as monetary policy.

Prime Rate

• The interest rate bank charges to their credit worthy customers

Loanable Funds Market

• Market where savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)
• The demand for loanable funds, or borrowing comes from households, firms, government and the foreign sector. The demand for loanable funds is in fact the supply of bonds.
• The supply of loanable funds, or savings comes from households, firms, government, and the foreign sector. The supply of loanable funds is also the demand for bonds.

Changes in the Demand For Loanable Funds

• Remember that demand for loanable funds = borrowing (i.e. supply bonds)
• More borrowing = more demand for loanable funds (--->)
• Ex.) - Government deficit spending = more borrowing = more demand for loanable funds .: Dlf --> .: r% increases
• - Less investment demand = less borrowing = less demand for loanable funds .: Dlf <-- .: r% decreases 

Changes in the Supply of Loanable Funds

• Remember that supply of loanable funds = saving (i.e. demand for bonds)
• More saving = more supply of loanable funds (-->)
• Less saving = less supply of loanable funds (<--)
• Ex.) - Government budget surplus = more saving = more supply of loanable funds .: Slf --> .: r% decreases
• - Decrease in consumers MPS = less saving = less supply of loanable funds .: Slf <-- .: r% increases.