UNIT 4

T-account: 

• Statements of assets and liabilities 

Assets (amounts owned)

• Items to which a bank holds legal claim 
• Uses of funds by financial intermediaries

Liabilities (amounts owed)

• Legal claims against a bank
• Sources of funds for financial intermediaries  

Federal Reserve Bank

• Uses paper currency
• Holds reserves of the banks
• Lends money and charges interests
• Check clearing service for the bank
• Personal bank for the government  
• Supervises members  of banks  
• Control money supply in economy  

Reserve Requirement

• Federal requires bank to always have some money readily available to meet consumer's demand for cash 
• Amount set by the federal is required reserve
• The required reserve ratio is the % of demand deposits (checking account balance) that must not be loaned out 
• Typically its 10% 

Three types of multiple deposit expansion question

• Calculate the initial change in excess reserves:  aka the amount a single bank can loan from the initial deposit 
• Calculate the change in the money supply
• Calculate the change in the money supply: sometime type 2 and type 3 will have the same result  (if no Fed involvement)

The Reserve Requirement

• Only a small % of your bank deposit is in the safe the rest of your money has been loaned out
• This is called "Fractional Reserve Banking"
• The FED sets the amount that banks must hold
• The reserve requirement (reserve ratio) is the % 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  
• If there is a recession, what should the FED do to the reserve requirement, what should the FED do to the reserve requirement?  

 Decrease the RR 

• Banks hold less money and have more ER
• Banks create more money by loaning out excess 
• Money increase, interest rates fall, AD goes up  
• If there is inflation what should the FED do to the reserve requirement, what should the FED do to the reserve requirement?  

 Decrease the RR 

•  Banks hold more  money and have less ER 
• Banks create less money 
• Money Supply decrease, interest rates rise, AD goes down   

 The Discount Rate

• Discount Rate is  the interest rate that the FED charges commercial banks 
•  Ex: If the banks of America needs $10 million, they borrow it from the U.S Treasury (which the FED controls, but they must pay it back with interest)
• To increase the Money Supply, FED should DECREASE the Discount Rate (Easy Money Policy)
• To Decrease the Money Supply, the FED should INCREASE the Discount Rate (Tight Money Policy) 

Open Market Operations

• FED buys/sell government bonds (securities)
• This is the most important and widely used monetary policy
• To increase the MS, the FED should BUY government securities
• To decrease the MS, the FED should SELL government securities  

Monetary policy

• Expansionary: buy bonds, decrease discount rate, decrease RR = increase in loan, AD increases, GDP increase, MS increases. interest rate decreases 
• Contractionary: sell bonds, increase discount rate, increase RR= loans decrease, AD decrease. GDP decrease, MS decrease, interest rate increases   
• Federal Fund Rate: where FDIC member bank loans each other overnight funds
• Prime Rate: interest rate that banks give to their most credit- worthy customers  

UNIT 4 MONEY

Uses of Money: 

• Medium of exchange: trade or barter
• Unit of account: establishes economic worth in the exchange process -Store of value: money has its value over a period of time, where products may not  

Types of Money: 

• Commodity money: gets it value from the type of material from which it is made
•     ex: gold and silver coins 
• Representative money: paper money backed up by something tangible that it gives it value  
• Fiat Money: money because government says it is money and that is used in the U,S  

Characteristics of money: 

• portable 
• durable
• uniform
• scarce
• acceptable 
• divisible  

Money Supply:

• M1 money: currency (cash, coins, checkable deposits/ checking account, traveler's checks, and demand deposits) 
• 75% of money in circulation and it mostly liquid because it easy ti convert to cash  
• M2 money: consists of M1 money  + savings accounts and deposits held by banks held outside of the U.S

Time value of money:

Is a dollar today worth more than a dollar tomorrow?

 YES

Why?

• Opportunity cost and inflation
• Let v= future value of money
• Let p= present value of  money
• Let r= real interest rate (nominal rate- inflation rate) expressed as a decimal  
• Let n = years
• Let k= # of times interest is credited per year
• Simple interest forumla: v=  (1+r)^n * p 
• Compound interest forumla: v= (1+r/k)^nk *p 
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded  

What happened to the quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest rate assets instead of borrowed liabilities

What happens to the quantity demanded when interest rates decrease? 

• Quantity demanded increase, there is no incentive to convert cash into interest earning assets      
• Demand for money 

Money demand shifters:

• Change in price level
• Change in income 
• Change in taxation of investments

How money supply affects AD? 

• Money supply increases= decrease in interest rates, increase in investments, and decrease in AD
• Money supply decreases = increase in interest rate, decrease in investment, decrease in AD
• Financial Assets vs Financial Liabilities 
• FA: assets such as stocks and bonds provide expected future benefits 
• It benefits the owner, based upon the issue of the asset meeting certain obligations
• FL: liabilities incurred by financial asset to stand behind the issued asset  
• Interest rate: price paid for a financial asset 

Stocks vs Bonds: 

• Stocks: assets that convey ownership in a company
• Bonds: promise to pay a certain amount of money + interest in the future

What banks do?

• It is a financial intermediary  
• Uses liquid assets (i.e. bank deposits) to finance the investments of borrowers
• Process known as Fractional Reserve Banking
• A system in which depository institutions hold liquid assets > the amount of deposits  
• Can take form of currency in bank vaults 

          UNIT 4 MONETARY POLICY VIDEO