Unit 4

I. Uses of Money

a.) Medium of exchange (bartering/trading) : able to buy goods and services

b.) Unit of account : establishes economic worth

c.) Store of value : money holds its value over a period of time

II. Types of Money

a.) commodity money - swapping cake

b.) representative money - I.O.U

c.) fiat money - money because government says

III. Characteristics of Money

a.) durability

b.) portability

c.) divisibility

d.) uniformity

e.) scarcity

f.) acceptability

IV. Money Supply

a.) M1 money - consists of currency in circulation, checkable deposits (demand deposits), travelers checks

b.) M2 money - consists of M1 money, savings account, money market accounts, deposits held by banks outside U.S

Fractional Reserve Banking

• process by banks of holding a small portion of their deposits in reserve and loaning out the excess 

Required Reserve Ratio

• % of demand deposit required by Fed to be kept in vault by banks
• determined money multiplier (1/reserve ratio)
• decreasing ratio increases rate of money creation in banking system: expansionary
• increasing ratio decreases rate of creation : contractionary
• 10% = reserve ratio

Money Multiplier

• shows impact of change in demand deposit on loans
• money multiplier indicates total number of dollars created in banking system by each $1 addition to the monetary base (bank reserves and currency in circulation)
• money multiplier = 1/required ratios

Three Types of Multiple Deposit Expansion Question

1. Type 1: calculate initial change in excess reserve ; (aka) amount a single bank can loan from initial deposit
2. Type 2 : calculate the change in loans in banking system 
3. Type 3 : Calculate change in money supply ; sometimes type 2 & 3 will have the same result
4. Type 4: Calculate change in demand deposit

Required Reserve

• = amount of deposit * required reserve ratio

Excess Reserve

• = total reserves - required reserves 

Maximum Amount a Single Bank can Loan

• the change in excess reserves caused by a deposit

Total Change in Loans

• = amount single bank can lead * money multiplier

Total Change in $ Supply

• = total change in loans  $ amount of Fed action

Total Change in Demand Deposits 

• = total change in loans + any cash deposited

Prime Rate

• The interest rate bank charges to their credit worthy customers

Fiscal Policy VS. Monetary Policy

Fiscal Policy [Congress]

1. Tax or
2. Spend

Monetary Policy [FED]

1. Open market operation - OMO: buy or sell bonds
2. Reserve Requirement: bank's mass requirement
3. Discount Rate: interest rate charged by the Fed for overnight loans to commercial banks
4. Federal Fund Rate: interest rate charged one commercial bank for overnight loans to another commercial bank. 

• The Fed has several tools to manage the money supply by manipulation the excess reserves held by banks, a practice known as monetary policy

Loan-able Funds Market

• Market where savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)
• The demand for loan-able funds, or borrowing comes from households, firms, government and the foreign sector. The demand for loan-able funds is in fact the supply of bonds.
• The supply of loan-able funds, or savings comes from households, firms, government, and the foreign sector. The supply of loan-able funds is also the demand for bonds.

Changes in the Demand For Loan-able Funds

• Remember that demand for loan-able funds = borrowing (i.e. supply bonds)
• More borrowing = more demand for loan-able funds (--->)
• Ex.)
•  Government deficit spending = more borrowing = more demand for loan-able funds .: Dlf --> .: r% increases
• - Less investment demand = less borrowing = less demand for loan-able funds .: Dlf <-- .: r% decreases 

Changes in the Supply of Loan-able Funds

• Remember that supply of loan-able funds = saving (i.e. demand for bonds)
• More saving = more supply of loan-able funds (-->)
• Less saving = less supply of loan-able funds (<--)
• Ex.) 
•  Government budget surplus = more saving = more supply of loan-able funds .: Slf --> .: r% decreases
• - Decrease in consumers MPS = less saving = less supply of loanable funds .: Slf <-- .: r% increases.