Download Required Reserves

Final Exam Review
Macroeconomics
Econ EB222
WIN 2013
Inst. Shan A . Garib
Mohawk College
Final Exam Macroeconomics
Date: Monday, April 15th 2013
Time: 12:30pm – 2:00pm
In-Class
Review ALL Quizzes given in class
Consumption, Investment and
the Multiplier: Chapter 9
Consumption (Continued)
• The consumption functions states
–As income rises, consumption (C)
rises, but not as quickly
Income = Consuption + Saving + taxes
Y = C + S + t and,
Disposible Income = Consuption + Saving
Yd = C + S or,
Yd = Y - t
Therefore, consumption varies with disposable income (DI)
Marginal Propensity
to Consume (MPC)
MPC =
CHANGE
in Consumption
CHANGE
in Income
$6000
?
$1000
45
$1000
$6000
Saving = $300
$6000
C
5700
$3000
$2700
Saving = =
- $300
Dissaving
$300
$2700
$6000
Y,GDP0 = $10,000bn
(C0) is $8,600 bn.
MPC = 0.25
Note: In mathematics, Dx = “Change in”
At a Y, GDP1 of $9,000bn, how much would be saved? (Assume there is no taxes
in the economy)
DxC = MPC x DxDI
DxDI = $9,000bn - $10,000bn = -$1,000bn
DxC = 0.25 x -$1,000bn = -$250bn.
Since C0 was $8,600bn, the DxC of -$250bn will bring consumption down to
C1 = $8,350bn (= $8,600bn - $250bn).
If, S = DI – C1
At a national income of $9,000bn
(S) = $9,000bn of DI - $8,350bn of C
= $650bn.
Fiscal Policy and the
Public Debt
Chapter 10&11
Instructor Shan A. Garib, WIN 2013
9
Expansionary fiscal policy
• If budget is initially balanced, moves it towards
a budget deficit during recession
• Increased government spending (G) and/or
lower taxes
• Aim to stimulate economic activity and to move
the economy out of a recession
Let’s say, there is a war and the
government buys planes and guns, “G”
• AD = C + I + G + (X-N)
goes up
LRAS
c
P2
P1
b
AD2
AD1
Y1 Y2
Price Level
Price Level
SRAS
P2
P1
Higher P,
and
wages,
costs
SRAS shift
left
LRAS
d
SRAS2
SRAS1
c
b
AD2
AD1
Y1
Contractionary fiscal policy
• If budget is initially balanced, moves it towards
a budget surplus during an inflationary period
• Decreased government spending and/or
higher taxes
• Aim to control demand and reduce
demand-pull inflation
Let’s say, there is a war and the half
the population dies, “C” goes down
LRAS
b
P2
P1
c
AD1
AD2
Price Level
Price Level
SRAS
P2
P1
Lower P,
and
wages,
costs
SRAS shift
right
LRAS
SRAS1
SRAS2
b
c
AD1
d
AD2
Y2 Y1
Government Budgets and Finances
• Government’s budget balance is amount of
revenue it recieves minus its spending
Balanced budget is when:
Revenues = Spending
0 = Revenue – Spending
Budget Surplus is when
Revenues > Spending
0 > Revenue – Spending
Budget Deficit is when
Revenues < Spending
0 < Revenue – Spending
Money and the Banking System
Chapter 12
Instructor Shan A. Garib, WIN 2013
13
Defining Money (cont'd)
• The transactions approach to
measuring money: M1
􀂃 Currency
􀂃 Deposits you can write a check for
􀂃 Traveler’s checks
Defining Money (cont'd)
• The liquidity approach: M2 is equal to
M1 plus
1. Savings & time deposits
2. Balances in retail money market
mutual funds
3. MMDAs
Money Creation and Deposit
Insurance
Chapter 13
Instructor Shan A. Garib, WIN 2013
16
Reserves
• Reserves
– deposits held by BOC for chartered banks like
BMO, plus their vault cash
Reserves
• Legal Reserves
– Anything that the law permits banks to claim as
reserves—for example, deposits held at BofC and
vault cash
Reserves
• Required Reserves
– The value of reserves that a depository institution
must hold in the form of vault cash or deposits
with the BofC
Reserves
• Required Reserve Ratio
– The percentage of total transactions deposits that
the Fed requires depository institutions to hold in
the form of vault cash or deposits with the Fed
Required reserves = Demand deposits  Required reserve ratio (M)
Reserves
• Excess Reserves
– The difference between legal reserves and
required reserves
Excess reserves = Legal reserves – Required reserves
The Money Multiplier (cont'd)
1
Potential money multiplier =
Required reserve ratio
Actual change
in the money
supply
=
Actual money
multiplier

Change in
total reserves
The Money Multiplier (cont'd)
• Example
– Fed buys $100,000 of government securities
– Reserve ratio = 10%
Potential change
1
in the money = $100,000
= $1,000,000
x
.10
supply
Scotia Bank has NO excess reserves
Bank of Canada purchases $10,000 of bonds with a check from a man named Mr. Harper
Mr. Harper deposits this check into his account in Scotia Bank
NOTE: If the BofC buys bonds from a chartered bank eg CIBC then there will be NO change in
Demand Deposits because that money is not available to the public!
If the required reserve ratio (M) is 25%
The maximum amount of money Scotia can loan out?
What is the TOTAL potential change in the money supply?
Excess reserves
= Reserves - Required Reserves
But, Required Reserves = M * Demand Deposits
Required Reserves = 0.25 * $10,000
Required Reserves = $2500
Therefore,
Excess reserves = Reserves - Required Reserves
Excess reserves = $10,000 - $2500
= $7500
Resultant change in the money supply the banks can create:
= 1/m x Dx(Excess Reserves)
= (1/.25) x $7500 = 4 x $7,500 = $30,000
Then, the TOTAL change in money supply is:
= initial demand deposit + Dx(money supply banks can create)
= $10,000 + $30,000
= $40,000
BMO has $160 million of reserves
The M = 20%, The Bank of Canada then lowers M to 16%.
How much can BMO lend out?
BMO is ALL LOANED UP ie. it cannot make any additional loans so it has 0 excess reserves.
Excess Reserves = Reserves - Required Reserves
Since excess reserves = 0 then,
reserves = required reserves = $160 million
Required Reserves = M x Demand Deposits
$160 million = 20% x Demand Deposits
$160 million/.20 = Demand Deposits
$800 million = Demand Deposits
By lowering the required reserve ratio to 16%, required reserves will be reduced and excess reserves will
increase as some required reserves are converted into excess reserves.
Now,
Required Reserves = 16% x $800 million
= .16 x $800 million
= $128 million.
Excess Reserves = Reserves - Required Reserves = $160 million - $128 million = $32 million, the amount BMO
may now lend out.