Single Bank and Banking system

When a customer deposits cash or withdrawals cash from their demand deposit account, it has no effect on money supply. It only changes: 

1.    The composition of money

2.    Excess reserves

3.    Required reserves

Single Bank

·   Loan from your excess reserves. (ER)

Banking system 

•   Money increases by the multiple in the change of ER; ER * multiplier.

FED

When the FED buys or sells bonds, ER is created. # bought/sold * multiplier

Fiscal policy vs Monetary policy

n the early 21st century, here in the USA: 

An efficient, "full employment" economy will probably have: 

1.    An annual unemployment rate of 4-5%.

2.    An annual inflation rate of 2-3%.

If the economy goes into recession: 

3. The real GDP will decrease for at least 6 months.

4. The real unemployment rate will go to 6% or more.

5. The inflation rate will probably go to 2% or less.

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

6. The policy will try to improve C, or G (parts of AD0 

7.Congress will out federal taxes.

8. Congress will increase job and spending programs.

9. The federal budget will probably create a deficit.

10. Due to changes in Money Demand, interest rates will increase.

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

11. The policy will target improvements in IG (part of AD)

12. The Fed will target a lower federal fund rate.

13. The Fed can lower the discount rate.

14. The Fed can buy bonds (Open Market Operations).

15. The Fed can lower the reserve requirement, but probably wont because it is too complex for the banks. 

16. These Fed policies will lower the interest rates through changes in the Money Supply.

17. These options should increase Ig.

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

18. The unemployment rate will go to 4% or less.

19. 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:

20. The policy will try to decrease C, or G (parts of AD)

21. Congress will increase federal taxes. 

22. Congress will decrease job and spending programs.

23. The federal budget will probably create a surplus.

24. Due to the changes in Money Demand, interest rates will decrease.

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

25. The policy will target decreases in IG (part of AD).

26. The Fed will target a higher federal fund rate.

27. The Fed can increase discount rate.

28. The Fed can sell bonds (Open Market Operations).

29. The Fed can raise the reserve requirement, but probably wont because it is too complex for the banks. 

30. These Fed policies will raise the interest rates through changes in Money Supply.

31. These options should decrease Ig.

Crowding Out

What is it?

•   A critique falls of Keynesian policies that are applied to fight a recession. (An expansionary policy)

Why does it happen?

·   The policy of cutting taxes and raising spending will create a budget deficit.

So?

•   The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)

This money comes from? 

•   Mostly from US citizens and companies and investment firms.

Therefore?

·      Money that could be spent on consumption or used for Private Savings is now being used to buy bonds.

On the Money Market?

·      This will cause the $ demand curve to shift outward. Remember this is a Fiscal event!

On the Loanable Funds Market? 

•   This will cause the supply curve to shift inward because we are not saving money privately anymore.

Also, on the Loanable Funds?

•   This can cause the demand curve to shift outward because the private and public demand for $ increases.

On both graphs?

•   The nominal and real interest rate will increase.

Therefore, on the investment D graph

•   The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive? 

•   Yes

Why do it? 

•   Fiscal Policy supporters (Keynesians) insist that gains in consumption (C) and spending (G) will outweigh any loss in the future Ig.

Why?

•   C and G are greater than IG and they are short run improvements. IG is longer run and Keynesians don't worry about that. In the long run we are all dead.

Anymore?

Yes, this is summarized on the Aggregate Model. The AD will move outward due to the increases in C and G and the "maybe" move inward due to a loss of IG, but not as much as the increase. Therefore, the economy improves.

Tool of Monetary Policy

1. The Reserve Requirement

•   Only a small percent of your bank deposits is in the safe. The rest of your money has been loaned out. This is called Fractional Reserve Banking.

•   FED sets amount that banks must hold.

•   The RR is the percent of deposits that banks must hold in reserve and NOT loan out.

•   When the FED increases the money supply it increases the amount of money held in bank deposits.

1. Decreasing Reserve Ratio

1.Banks hold less money and have more excess reserves

2.Banks create more money by loaning out excess

3.Money supply increases, interest rates fall, AD goes up

2. Increasing Reserve Ratio

•   Banks hold more money and have less excess reserves

•   Banks create less money

•   Money supply decreases, interest rates increase, AD goes down

2. The Discount Rate- The interest rate that the FED charges commercial banks.

To increase the money supply, the FED should decrease the discount rate. (Easy money supply)

To decrease money supply, the FED should increase the discount rate. (Tight money supply)

3. Open Market Operations

•   The FED buys/sells government bonds. (securities)

•   To increase money supply, the FED should buy government securities.

•   To decrease money supply, the FED should sell government securities.

Reserve Requirement

The FED requires  banks to have money to meet customers demands for cash  the amount requierd is the reserve ratio.
The required reserve ratio the old demand deposits checking account balances must not be loaned out typically reserve ratio is 10%

Financial Sector

Financial Assets- stocks or bonds that provide expectations  of future benefits. It benefits the owner only if the interest rate if the assessment certain obligation

Financial liabilities- it is in curved by the issuer of the asset which liability is owned
interest rate- the price paid for the use of a financial asset.

Stocks - financial assets that convey a assets in a corporation
Bond- is the promise to pay a certain amount of money plus interest

A bank is a financial intermediate uses  liquid assets  (bank deposits) to finance  the investments of the borrowers. In a process known as fractional reserve
Banking- a system in which depositors institution  hold liquid assets  less then the amount of deposits can take the form of currency in banks vaults
Banks Reserve- deposits held at the Federal Reserve

Money And Demand

What happens to the quantity demanded of money when interest rates increases?
 Quantity demanded falls because  its would prefer to have interest earning assets of borrowed liabilities

What happens to the  quantity demanded when interest rate decreases?
quantity demanded increases there is no incenitive to convert cash into interest if the price level increases
 M2 shifts to the right:

• Changes in PL
• Changes in income 
• changes taxtation that affects investments 

If the FED increses the money supply a temporary surplus of money will occur at 5% interest.
The surplus will cause the interest rate will fall Increase MS > deccrease
If the FED decreases Money supply
Decrease MS> increase interest rate > decrease investment> decrease AD

Money

3 Uses of money

1. Medium of exchange
2. Unit of account - establish economic worth in exchange process
3. To barter or trade - money holds value over a period of time products do not

Types of money

1. Commodity Money - Value is from the type of material its made from. (ex gold coins)
2. Representative Money- Paper money backed up by something tangible that gives it value
3.  Fiat Money- Money cause the government says so

Characteristics of Money
1.portable          2.Durable
 3.scarce             4. Divisible
5. Acceptable       6. Uniform
Money supply
M1- consist of currency ( cash and coins) Checkable deposits most liquid travelers check
M2- consist of M1 money along with savings account market and deposits held by banks out side U.S and is not liquid
M3 - consist of M2 + certificate\ of deposit held by an private institution
A dollar today is worth more than one tomorrow because of inflation this the reason for paying interest Time value of money Let V= future value nof money P= present value of money R= real interrest rate nominal - interest rate
n=years
K number of times intrest is credited per year
Simple interest V=(1+r\k)^n*p
compound interest V=(1+r\k)^nk*P

Demand for money Has an inverse relationship between nominal intrerest rates and the Quanity of money demanded.