Unit 4; Day 4 Notes

Three Tools of Monetary Policy
Reserve requirement-

• Only small % of bank deposit is safe. Rest is loaned out. “Fractional Reserve Banking”
• FED sets amount that banks must hold
• The reserve ratio is % of the deposits banks must hold
• When FED increases money supply, it increases money held in bank deposits 

If there is a recession, what should FED do to the reserve requirement?
Decrease reserve ratio
   Banks hold less $, more ER
   Banks create money by loaning out ER
   Money supply increases, interest fall, AD ^
If there is inflation, what should FED do to RR?
Increase RR
   Banks hold $, less ER
   Banks create less money
   MS decreases, Interest up, AD down

The Discount Rate-
   Interest rate that the FED charges commercial banks

Ex. If bank needs 10 mil, the borrow from US treasury(FED controls) but they must pay back with interest
To increase MS, FED decreases Discount rate(Easy money policy)
To Decrease MS, FED increases discount rate(Tight money policy)

Open Market Operations(OMO)-
   FED buys/sells govt bonds(securities)
Most important and widely used monetary policy
To increase MS, FED buys Govt securities
To decrease MS, FED sells govt securities


Federal Funds Rate-
   FDIC member banks loan each other overnight funds instead of FED.
Prime Rate-
Interest rates banks give to their most creditworthy customers

Unit 4; Day 3 Notes

Banks-
   A bank is a financial intermediary
   Uses liquid assets( bank deposits) to finance the investments of borrowers.
      AKA Fractional reserve banking
      a System in which depository institutions hold liquid assets less than the amount of deposits.
   Can take the form of:
      Currency in bank vaults
      Bank reserves- deposits held at the federal reserve
      T-Account (Balance sheet)
      Statements of assets and liabilities
   Assets (amount owned)
      Items which a bank holds legal claim
      The uses of funds by financial intermediaries
   Liabilities (amounts owed)
      Legal claims against a bank
      Sources of funds for financial intermediaries
Federal Reserve(FED)
   7 members appointed by president; terms are staggered
Functions-
Ctrl money supply
Issue paper currency
Set reserve requirements; holds reserves of banks
Lend money to banks; charge interest
Check clearing service for banks
Acts a personal bank for government
Supervises member banks

Reserve Requirements-
Fed requires banks to have some money readily avail for consumer.
Amount set by fed is Required Reserve Ratio (RRR)
RRR- % of demand deposits(checking account balances that must not be loaned out)
Typically 10%
Three types of Multiple deposit expansion Questions
Type 1- Calculate initial change in ER (amount of single bank can loan from initial deposit)
Type 2: Calc. change in loans in banking system
Type 3: Calc. change in money supply
Sometimes type 2 and 3 will have same result(i.e. no fed involvement)

Unit 4; Day 2 Notes

Time Value of Money (3/9)
Is a dollar today worth more than a dollar tomorrow?
YES; Opportunity cost and inflation. This is reason for charging and paying interest.
v = future value of $
p = present value of money
r= Real interest rate(nominal- inflation) expressed as decimal
n= years
k= number of times interest is credited per year

Simple interest rate~ v=(1+r)^n * p
Compound interest rate~ v=(1+ r/k)^nk *p

Money Demand
   Demand for money has inverse relationship between nominal interest rates and the quantity of money demanded.
   What happens when quantity demanded of money when interest rates rise? demand falls because individuals prefer to have interest earning assets instead of borrowed liabilities.
   What happens when interest rates decrease? demand increases, no incentive to convert cash to interest earning assets

3 Things that cause money demand to shift:
change in price level
change in income
Change in taxation that affects investment
Financial Sector
Assets vs. Liabilities- Assets= Owned; Liabilities= Owe
Interest rate- The cost of borrowing money
Stocks vs. Bonds-  stocks are risky money, bonds are safe. loan money to gov, gov pays you back.

Unit 4; Day 1 Notes

Money
   Uses of money
      Medium of exchange- Trade/Barter
      Unit of account- Establishes economic worth in exchange process
      Store of value- Money holds its value over a period of time whereas products may not
   Types of money
      Commodity money- Gets its value from the type of material from which it is made. Ex.             Silver/Gold coins
      Representative money- Paper money backed by something tangible that gives it value. Ex. IOU
      Fiat money- Money because the government says so.
      Characteristics of money
      Durable
      Portable
      Scarce
      Divisible
      Acceptable
      Uniform
      Money Supply
      M1 Money-75% of all money, most liquid (easy to convert to cash)
      Currency- Coins, cash
      Checkable deposits- Demand deposits/Checking accounts
      Traveler’s Checks
      M2 Money= M1 Money + Savings accounts+ Money Market Accounts + Deposits held by banks outside US.
      M3 Money= M2 Money+ Certificates of Deposits(CDs)

increase money supply > Decreases interest rate > Investment increases >AD increases
Decrease money supply > increase interest rate > Investment decreases > AD decreases

Unit 4: Project Video

Answers/ Rough Outline of Video
A. Federal funds rate-  Rate at which banks lend/store money into other banks overnight for those banks to meet their reserve requirement
Goal is to lower Excess Reserves(money left over after holding the required reserves), lower ER= more money being made through loans. These overnight loans are no exception
B. Buying securities as part of an expansionary policy to get more money into the money supply. Since these securities become ER, banks will want to lower the fed funds rate to get rid of excess easier. Selling bonds as part of a tight policy will cause the opposite effect
C. $10 mil= ER * 1/.5=2 monetary mult. = $20 mil. change in loans throughout the banking system, as the ER of 10 mil will become a Direct Deposit of another bank. 20 mil would be the maximum sum of all of these deposits.
D. Nominal interest rate would decrease
E. Real interest decrease due to an increase in inflation but a decrease in nominal interest. Keep in mind Real interest= nominal - inflation, so if nominal goes down but inflation goes up, you are at a net decrease.