Unit 4 - Money (3-29-16)

Fiscal vs Monetary Policy

From the worksheet  "Countercyclical Policies:Keynesian Fiscal Policy vs Monetary Policy" and notes 

-Note: Check ^ for full notes (this is more or less Abbreviated) [side note]-wording is key

 In the early 21st century, here in the USA, an efficient, "full employment" economy will probably have:

• Annual unemployment rate 4-5%
• Annual inflation rate 2-3%

If the economy goes into a recession:

• The real GDP decreases for at least 6 months
• Unemployment rate increases to 6% or more
• Inflation rate decreases to 2% or less

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:

• The policy will try to improve C or G (parts of AD)
• Congress will cut federal taxes
• Congress will increase job and spending programs
• The federal budget will probably create a deficit
• Due to changes in Money Demand, interest rates will increase (Crowding out might occur, but Keynesians don't care)

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then: 

• The policy will target improvement in Ig (part of AD)
• The Fed will target a lower Fed Fund Rate
• The Fed can lower the discount rate
• The Fed can buy bonds (Open Market Operations)
• The Fed can (theoretically) lower the reserve requirement, but probably won't because it is too complex for the banks.
• These Fed policies will lower the interest rates through changes in the Money Supply
• These options should increase Ig

If the economy suffers from too much demand-pull inflation or cost-push inflation, then:

• The unemployment rate will go to 4% or less 
• The inflation rate will probably go to 4% or more

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then: 

• The policy will try to decrease C or G (parts of AD)
• Congress will increase federal taxes
• Congress will decrease job and spending programs
• The federal budget will probably create a surplus
• Due to changes in Money Demand, interest rates will decrease

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:

• The policy will target decreases in Ig (part of AD)
• The Fed will target a increased Fed Fund Rate
• The Fed can increase the discount rate
• The Fed can sell bonds (Open Market Operations)
• The Fed can (theoretically) raise the reserve requirement, but probably won't because it is too complex for banks
• These Fed policies will decrease the interest rates through changes in the Money Supply
• These options should decrease Ig

Unit 4 - Money (3-21-16)

Key Concepts

#1 Reserve Requirement - Only a small % of your bank deposit is in the safe. The rest of your money has been loaned out. 

- Called "Fractional Reserve Banking" -

FED sets amount banks must hold -RR is the % of deposits that banks must hold in reserve and NOT loan out -FED increases the MS it Increases the amount of money held in bank deposits

1)Recession - what should FED do to RR? -Decrease the RRatio banks hold less money more ER banks create more money loaning out excess MS increases, interest rate fall, AD increases

2)Inflation - Banks hold more money less ER banks create less money MS decreases, interest rate increases, AD decreases

#2 Discount Rate - is the interest rate that the FED charges commercial banks

-To increase the MS, the FED should decrease the discount Rate (Ex:Monetary Policy)

-To decrease the MS, the FED should increase the Discount Rate (Ex:Tight Money Policy)

#3 Open Market Operations (OMO)

-FED buys/sells gov't bonds (securities)

-This is money important and widely used monetary policy

-Increase the MS FED should BUY gov't securities

-Decrease the MS FED should SELL gov't securities

Unit 4 - Money (3-11-16)

Unit - 4 Banking System

from the worksheet "Here are the Components and Definitions" and notes

Note- Money supply is affected by the money market graph and AD/AS graph.

Money Supply

• Affects AD when increased: -> r down, Ig up, AD up (Vertical)
• Decreases - Goes Left: MS down, r up, Ig down, AD down

Financial Sector

• Fin. Assets - Stocks and bonds provide expected future benefits
• Benefits owner from issuer of asset meeting certain obligations
• Fin. Liabilities - Incurred by issuer of fin. asset to stand behind issued asset
• Interest Rate - $ paid to use fin. asset
• Stocks - Fin. asset that represent ownership in a company
• Bonds - Promise to pay $ and interest in the future

Banks

• Fin. Intermediary - use liquid assets to fund investments of borrowers -> Fractional Reserve Banking
• Liquid assets include currency in bank vaults and bank reserves
• Banks create money by lending out deposits that are used multiple times
• When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY
• It only changes...
• The composition of money
• Excess Reserves
• Required Reserves
• Changes in Money Supply for....
• Single Bank
• Loan money from ER
• Banking System
• ER x Money multiplier (1/RR) -> Total Money Supply
• When the FED buys or sells bonds, ER is created

-Basic  accounting (cont.)

• Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary
• Included in assets
• Required Reserves - % of DD in vault
• Excess Reserves - Remaining % of DD used for loans
• Property - Statement of a bank's property values
• Securities or Bonds - Previously purchased bonds held by the banks as investments
• Loans - Previously loaned funds now owed back to the bank
• Liabilities (Amounts owed) - Legal claims against a bank; sources of funds.
• Included in liabilities
• Demand Deposits - Cash deposits from the public to the bank
• Part of MS if from person's cash holdings
• Becomes new $ if from a bond -> MS up
• Owner's equity or stock shares - Values of the bank stocks as held by the public
• DD = RR + ER

• Reserve Requirement - Fed needs banks to always have $ to meet demand
• Amount = Reserve Ratio - % of DD locked to bank

Scenario 1

A private citizen takes cash that they possess and put it into a bank account

• The cash placed into the bank is already part of the money supply
• The deposit is counted as a bank liability
• A % must be placed into required reserve
• The remainder is placed into excess reserve
• The bank will want to lend all of the ER, if possible
• The amount in ER is multiplied by the monetary multiplier
• This will be assumed to become new loans in the banking system
• This will be counted as the change in money supply

Scenario 2

• The Fed buys bonds back from the public
• The public now has new cash
• This new cash is new loans
• Assume that the public puts the cash into demand deposits
• A set percentage is placed into required reserve
• The remainder becomes excess reserve
• Excess reserve is multiplied by the money multiplier (1/RR)
• This amount becomes new loans and is new money supply
• The total change in money supply is the amount of demand deposits plus the new loan amounts

Scenario 3

• The Fed buys bonds back from the member banks
• The banks now have new ER
• No money is needed to be placed in RR, since this is not owed to the public
• All of these ER are multiplied by the monetary multiplier
• This amount becomes new loans
• This amount is the change in the money supply

Unit 4 - Money (3-10-16)

Unit 4-Federal Reserve Bank (FED)

Wording is Key

Functions of the FED: presidential appointment

1. Issues paper money
2. Sets Reserve Requirements and holds reserves of the bank
3. Lends money to the banks and charges them interest
4. Check clearing service for banks
5. Acts as personal bank for the gov't
6. Supervises member banks
7. Controls the Money Supply

Unit 4 Money (3-9-16)

Unit 4 Time Value of Money

• Is a dollar today worth more than a dollar tomorrow? - Yes

• Why? - Opportunity costs & inflation -Reason for charging and paying interest 

Let 

v = future value of $ 

p = Present value of $

r = real interest rate (nominal - inflation rate) expressed as decimal

n = years

k = # of times interest is credited per year

Formulas

• Simple Interest Formula - -v = (1 + r)^n x p 
• Compound Interest Formula - - v = (1 + r / k)^nk x p

Money demand has an inverse relationship between nominal interest rates and the quantit of money demanded

1. What happens to the quantity demanded of money when interest rates increases?- Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities. 
2. What happens to quantity demanded when interest rates decrease? - Quantity demanded increases, there is no incentive to convert cash into interest earning assets

What happens if price level increases?

• Money demand Shifters that affects investment 1. Changes in Price Level 2. Changes in Income 3. Changes in Taxation

Increasing the Money Supply

- If the FED increases the money supply a temporary surplus of money will occur at 5% interest. The Surplus will cause the interest rate to fall to 2%

How does this affect AD

Money supply (increase) -> interest rate(decrease) -> Investment (increases) -> Increases AD

Decreasing the Money Supply

Money supply (decreases) -> interest rate (increase) -> investment (decrease) -> Decrease AD

Financial Sector

Financial Assets (Own) vs Financial Liabilities (Owe)

Financial Assets -

-Stocks or bonds that provide expected future benefits

-Benefits the owner only if the issuer of the asset met certain obligations

Financial Liabilities

-Incurred by the issuer of a financial asset to stand behind/by the issued asset

Interest Rate - price paid for use of a financial asset

Stocks vs Bonds

Stocks

- Financial assets that convey ownership in a corporation

Bonds

-Promise to pay a certain amount of money plus interest in the future

What Banks do

• A bank is a financial intermediary - uses liquid assets (i.e. bank deposits) to finance the investment of borrowers
• Process kown as Fractional Reserve Banking - system which depository institutions hold liquid assets less than the amount of deposits

- Can take the form of: 1. Currency in bank vaults. 2. Bank Reserves - deposits held at the Federal Reserve

Basic accounting review

-T- Account (Balance sheet) - statement of assets and liabilities

Ex image:

- Assets (Amounts owned) - items to which a bank holds legal claim - the uses of funds by financial intermediaries

-Liabilities ( Amounts owed) - the legal claims against a bank - the sources if funds for financial intermediaries

Unit 4 Money (3-6-16)

Unit 4 Use's of Money

("Outershell')

I. Uses of Money

• Medium of Exchange - To barter/trade

• Unit of Account - Establishes economic worth in the exchange process

• Store of Value - Money holds its value over a period of time, whereas products do not

II. Types of Money

• Commodity Money - Gets its value from the type of material from which it is made. EX: Gold/Silver coins

• Representative Money - Paper money backed up by something tangible that gives it value EX: IOU

• Fiat Money - Money because the gov't says so EX: US Money

III. Characteristics of Money

• Portable - Money is portable

• Durable - Money is durable

• Scarce - Bills

• Divisible - Dollar - breaks down

• Acceptable - Everywhere in [US]

• Uniform - Everywhere you go

IV. Money Supply

• M1 [75% most liquid] <- (easy to convert to cash) - (Currency) [cash/coins] (checking accounts) -> Checkable deposits/Demand deposits + Travelers checks

• M2 [Not as liquid to convert to cash] - Consists of M1 money along w/ saving accounts, common market accounts, and deposits held by banks outside of US.

• M3 [withdraw early = penalty] - Consists of M2 money + Certificates of Deposits (CD's) Held by private institutions

unit 4 monetary policy