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2013 Unit-4 Macro Review Money, Money Supply, Bank Accounting, & Fiscal and Monetary Policy MONEY Types of Money Commodity money Fiat money 3 Functions of Money • Medium of exchange (Std. of value) • Unit of account • Store of value Measuring Money Supply M1 - most liquid M2 - slightly less liquid M3 = least liquid (cash, checking deposits, travelers checks, etc…) (M1 + savings acct., money markets,…) (M2 + large time deposits (over $100,000) ) Fractional Reserve Banking System Banks Create Money by lending Example: – $100 Deposit – 10% Reserve Ratio Bank Balance Sheet Assets Required Reserves $10 Excess Loans Reserves $90 Total Assets $100 Excess Reserves can be lent out by bank Liabilities Deposits $100 This loan causes money creation Total Liabilities $100 Money Multiplier = 1/R First National Bank Assets Reserves $10.00 Liabilities Deposits $100.00 Loans Second National Bank Assets Reserves $9.00 Liabilities Deposits $90.00 Loans $90.00 Total Assets Total Liabilities $100.00 $100.00 Reserve Requirement = 10% $81.00 Total Assets $90.00 Total Liabilities $90.00 Money Multiplier = 1/10% = 10 Money Supply Change = Money Multiplier X Initial Excess Reserves $90 * 10 = $900 of “new” money Money Market Loanable Funds Real Interest Rate -------------- ------------- R1 S1 Q1 Private + Public Savings E1 D1 Qty Loanable Funds Use for Gov’t Debt Use for Fed’s Monetary Policy Label Real interest rates Label Nominal interest rates Not an actual market Supply of Money fixed by Fed Model of National Savings & Private Investment Short term interest rate (federal funds rate) Supply = National Savings Demand = Investment (borrow $) CROWDING OUT Loanable Funds S2 Real Interest Rate 1) Government Borrowing reduces Supply of Loanable Funds -------------- ------------- R1 S1 Q1 2) Real Interest Rates rise E1 3) Private Investor is “crowded out” of debt market D1 Qty Loanable Funds • The Fed has 3-tools to implement monetary policy: 2 Types of Monetary Policy Expansionary Contractionary Contractionary Policy Nominal Interest Rate – reserve requirement – discount rate – open-market operations (currently 10.0%) (currently Currently6.25%) 0.75% Currently5.25% 0.0%target) target (currently Sell Bonds, raise discount rate & reserve requirement MS2 MS1 Price Level LRAS1 SRAS1 Affects AD i2 --------- i1 --------------MD AD2 Qty of $ MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓ Real GDP AD1 Quantity Theory of Money MV = PQ where: V = velocity P = the price level Q = real GDP M = the quantity of money Velocity of money is relatively constant Real GDP is fixed in short run ↑ MS only => ↑Price Level Monetary changes have no affect in LONG RUN Money is NEUTRAL! DEMAND FOR MONEY Demand for money is downward sloping The Money Market is not the Loanable Funds market! (It is a much broader market) Money Market Nominal Interest Rate MS Demand for Money: MD Transactions Demand Precautionary Demand Speculative Demand Qty $ Price Level changes shifts Demand Curve for Money ↑ Px level shifts MD right ↓Px level shifts MD left
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