Graph 12 - Crowding Out

Graph 11- Loanable Funds or Bond Market

Graph 10 - Money Market

Important Formulas

• Required Reserves = Amount of Deposit x Required Reserve Ratio.
• Excess Reserves = Total Reserves - Required Reserves.
• Maximum amount a single bank can loan = the change in excess reserves caused by a deposit.
• The money multiplier = 1 / required reserve ration.
• Total Change in Loans = Amount single bank can lend x Money Multiplier.
• Total Change in the money supply = Total change in loans + $ Amount of Fed action.
• Total change in demand deposits = Total change in loans + Any cash deposited.

Unit 4 - Video Notes

Part 1: Types and Functions of Money.

Three Types of Money 
1. Commodity - goods that has other purposes. Not as durable as coins, primitive type of money. (ex: Native Americans uses cows)
2. Representative - whatever you are using as currency represents a specific quantity; (ex: Gold/silver)

3. Fiat - money not backed by metal. Money that must be accepted by transactions; backed by government. 

Functions of Money
1. Medium of Exchange - through money that exchanges happen. (Buying things)
2. Store of Value - when you store money, you expect it to be stable and still have value.
3. Unit of Account - price implies worth (something expensive, it is said to have a higher quality).

Part 2: Money Market Graphs.

Negative slope because demand for money slows down (rate is high, quantity is low and vice versa).

Supply for money is vertical because it does not various based on the interest rate.

To stabilize interest rates, increase the money supply.

If the interest rate is unstable, it is not possible to predict the level of investment, manipulate AD, and predict the level of spending. 

Part 3: Fed’s Tools of Monetary Policy.

1. Expansionary (Easy $)

• RR : lowered.
• Discount Rate (rate that banks can borrow from the FED): lowered. Used to give banks incentive, doesn't mean it will work.
• Buy/sell government bonds/securities: FED buys bonds (public gets money, which causes the money supply to go up).

2. Contractionary (Tight $)

• RR : raised.
• Discount Rate : raised.
• Buy/sell government bonds/securities: sell bonds (federal open market committee makes open market decisions).

• RR - the percentage of banks total deposits that they must hang on to.
• Federal Funds Rate - rate that banks can borrow money from each other. A downward pressure is put on to the rate, when the FED buys bonds.

Part 4: The Loanable Funds Market.

The graphs shows the effect of government deficit.

•  SLF - comes from the amount of money in banks. (Dependent on savings).
•  Government deficit in loanable funds market can shown two ways: increase in demand or decrease in supply.

Part 5: Money Creation and Multiple Deposit Expansion.

• Banks create money by making loans.
• One of the Feds tool is adjust and control RR.
• Ex.)The RR is 20% and the bank makes a loan of $500. How much money will be created?
• 1 / .20 = 5(500) = $2500. We got from $500 to $2500 due to multiple deposit expansion 
• Example of how multiple deposit expansion works - Bob gets $500 to bank. The bank loans $400 to Joe and then Joe puts that money in his bank. The bank then makes a loan of $320 to Susie and so on. This process can go on until nothing is left. If all of these loans are added, it would total $2500 (RR is 20% and no excess reserves). 
• If banks hold excess reserves (banks keeping more than the 20%), the total of $2500 is reduced.

Part 6: Relating Money Market, Loanable Funds Market, and AS & AD Model.

• Change in supply of money is equivalent to change in price.
• Fisher Effect - interest and price level are connected. As interest goes up, price level also goes up. 
• Ex.) 1% increase in interest = 1% increase in price level.

Graphs show the impact of deficit spending

Unit 4 - Mar 19

	Expansionary	Contractionary
OMO	Buys Bonds	Sell Bonds
Discount Rate	Decrease	Increase
Federal Fund Rate	Decrease	Increase
Required Reserves Ratio	Decrease	Increase

• Single Bank - amount of money single bank can create (loan out) = ER
• AR - RR = ER 
• $1000 - $100 = $900

• Banking System - can create money by a multiple of its initial ER 
• Deposit Multiplier = 1 / RR = 1 /.1 = 10

• System New Money = Deposit Multiplier X Initial ER
•   10 X 900 = $9000 

• Total change in Money Supply as a result of the deposit 
• Initial deposit (if new) + Banking system created money
• $1000 + $9000 = $10,000 

Unit 4 - Mar 17 (Monetary Money)

Monetary Policy - controlled by the Fed (Federal Reserve Bank)

• Influencing the economy through changing and reserve which influence the money supply and available credit.
• Banker's bank.

4 Options of  Monetary Policy

1. Reserve Requirement - % that set by the Fed of the minimum reserve a bank must have.
2. Discount Rate - banks borrow money from the Federal Reserve (last resort).
3. Federal Fund Rate - bank loan each other overnight funds.
4. OMO (Open Market Operation) - security/bonds. Fed doings (sells/buys) 
• Reserve Requirement, Discount Rate, Federal Fund Rate - Decrease : Expansionary Monetary Policy.             Increase : Contractionary Monetary Policy. 

Unit 4 - Mar 7 (Multiple Deposit Expansion)

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 - the percentage of demand deposit (checking account balances) that must not be loaned out
• Typically the Required Reserve Ratio is 10%.

The Money Multiplier

• Shows the impact of a change in demand deposits on loans and eventually the money supply
• Money multiplier = 1/ Required Reserve Ratio
• Example: If the reserve ratio is 25% then the multiplier is 4

The 3 types of Multiple Deposit Expansion

1. Type 1: calculate the initial change in excess reserves (the amount a single bank can loan from the initial deposit).
2. Type 2: calculate the change in loans in the banking system.
3. Type 3: calculate the change in money supply.

• Sometimes type 2 and type 3 will have the same results (I.e. No Fed involvement)

Example 1
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds. 
     Amount of new demand deposit - required reserve = the initial change in excess reserve
     $100 million - (20%)($100 million)
     $100 million - $20 million = $80 million in ER

Example 2
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal Reserve purchase of bonds.
     The initial change in excess reserves (the money multiplier)= max change in loans
     $80 million (1/20%)
     $80 million(5) = $400 million max in new loans

Example 3
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply from this Federal Reserve purchase of bonds. 
     The maximum change in loans + $ amount of federal reserve action
     $400 million + $100 million = $500 million max change in money supply

A Formula For All Seasons
<{[deposit - (rr% x deposit)] X 1 / rr%} + $ of OMO >
<Maximum change in money supply>
{ max change in loans in banking system}
[initial change in excess reserves]
(Required reserve)

• RR + ER = DD 

Unit 4 - Mar 6 (Money)

I. Uses of Money

• Mediums of Exchange -  can be used to trade/barter.
• Unit of Account - establishes economic worth.
• Store of Value - money holds its value over period of time.

II. Type of Money

• Commodity - gets value from the materials it is made from (gold/silver).
• Representative - backed by something tangible (paper $).
• Fiat - money because the government said so.

III. Characteristic of Money 

• Durability - last through many transaction (Can be used after washed).
• Portability - able to transport money in many ways (Wallet, purse, etc).
• Uniformity - even (All $5 looks the same).
• Divisibility - can divide bills into smaller units ($10 = two $5 bills)
• Scarcity - might not have money at that time (No change for a cashier).
• Acceptability - acceptable anywhere. 

M1 Money - 75% of $ circulation.

• Liquid - easier to convert to cash.
• Consists of :
• Currency - cash/coins.
• Checkable/Demand Deposit - checking account.
• Traveler's Check

M2 Money - 25% of $ circulation.

• Consists of :
• Savings Accounts
• Market Money Accounts
• CD - Certificate of Deposit.
• Deposits held by banks outside the U.S. + M1 Money.

How Banks and Thrifts (Savings & Loans institution) create money

•  Assets (own) = Liabilities (owed) + Net Worth.
•  Bank deposits are subject to a reserve requirement.
•  Reserve Ratio = reserve requirement / checkable deposit liabilities.
• Excess Reserve = Actual Reserve - Required Reserve.
• Assume 20% reserve requirement.
• Banks creates $ by 
• Lending excess reserves and destroy it by loan payments. 
• Purchasing bonds from the public also creates $.