FINAL NOTES FOR UNIT 4

When a customer deposits cash or withdraws cash from their demand deposits acct, it has not effect on money supply

Single bank
- loan money Excess Reserves (ER)

Banking system
- ER X multiplier(total money supply)

It only changes:

1) the money composition of the money

2) excess reserves

3) required reserves

When the fed buys or sells bonds ER is created

MONETARY POLICY

1. Reserve requirement 

- only a small percent of your bank deposit is in the safe. The rest of your money has been loaned out "fractional reserve banking" .

-the FED sets amount the banks .must hold.

-the reserve requirement reserve ration is the % if deposites 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 money deposits.

If there is a recession rr=decrease

Decrease

-banks hold less money and have more excess reserves

-banks creates more money by loaning out excess

-money supply increases intrest rates fall, AD goes up

If the theres is inflation rr=increase

Increase

-banks hold money and have less excess reserve

-banks creates less money

-money supply decrease, interest rates up, AD down

2. Discount rate 

-The discount rate is the interest rate that the FED charges commercial banks

To increase the money supply the FED should decrease the discount rate

To decrease the money supply the FED should increase the discount rate

3. Open money operations

-the FED buys / sells government bonds (securities)

-this is the most important and widely used monetary supply

Increase money supply the FED should buy government securities

Decrease money supply the FED should sell government securities

Federal fund rate- FDIC member banks loan each other overnight funds 

Prime rate- Intrest rate that banks give to their most credit worthy customers

FEDERAL BANKS

Federal Reserve Banks
Functions
-Uses paper $
-Set reserve requirement and holds bank reserves
-Lends $ to banks and charges interest
-Check-clear service for banks
-Personal bank for government
-Supervises member banks
-Controls money supply in the economy

Reserve Requirement 

- Fed needs banks to always have $ to meet demand

Amount = Reserve Ratio - % of DD locked to bank

GRAPHS AND BANKING SYSTEM

Demand Graph

Demand for money increase inverse w/nominal interest rate and quantity of money (Q decreases, I increases and vice versa)

Shifters: Change in
-PL
-Income
-in taxation after investment

Money Supply
Affects AD when

Increased: -> r down, Ig up, AD up (Vertical)
Decreases - Goes Left: MS down, r up, Ig down, AD down

Financial Sector
Fin. Assets - Stocks and bonds provide expected future benefits
Benefits owner from issuer of asset meeting certain obligations
Fin. Liabilities - Incurred by issuer of fin. asset to stand behind issued asset
Interest Rate - $ paid to use fin. asset
Stocks - Fin. asset that represent ownership in a company
Bonds - Promise to pay $ and interest in the future

Banks
Fin. Intermediary - use liquid assets to fund investments of borrowers -> Fractional Reserve Banking
Liquid assets include currency in bank vaults and bank reserves
Banks create money by lending out deposits that are used multiple times
When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY

It only changes...
-The composition of money
-Excess Reserves
-Required Reserves
-Changes in Money Supply for....
-Single Bank
-Loan money from ER
-Banking System
-ER x Money multiplier (1/RR) -> Total Money Supply
-When the FED buys or sells bonds, ER is created

Basic Accounting Review

T-Account (Balance Sheet) - Lists assets and liabilities

Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary

Included in assets

-Required Reserves - % of DD in vault
-Excess Reserves - Remaining % of DD used for loans
-Property - Statement of a bank's property values
-Securities or Bonds - Previously purchased bonds held by the banks as investments
-Loans - Previously loaned funds now owed back to the bank
-Liabilities (Amounts owed) - Legal claims against a bank; sources of funds.

Included in liabilities
Demand Deposits - Cash deposits from the public to the bank
Part of MS if from person's cash holdings
Becomes new $ if from a bond -> MS up
Owner's equity or stock shares - Values of the bank stocks as held by the public
DD = RR + ER

Money

Uses of money

Medium of exchange

-borrow and trade 

Unit of account

-it establishes economic value 

-(cake for lessons)

Store of value

-money holds it value over a period of time where as products may not

Types of money

Commodity

-it gets its value from the type of material from which it is made

-(gold and silver coins)

Representative money

-it is paper money backed by somthing tangible that gives it value

Fiat money

-Money because government says so

Characteristics of money

1. Divisible

2. Portable

3. Uniform

4. Acceptable

5. Scarce

6. Durable

Money supply

M1 Money

-75% of money from circulation

-most liquid (easy to covert to cash)

Currency 

.Checkable deposits

.Demand deposited

.Travelers check

M2 Money

-M1 money, Savings account, and Deposits held by banks outside of the U.S

M3 Money

-M2 money and Cirtificate of Deposited (C.D)

-C.D: pull money by X ammount of time

Time value of money

Is a dollar today worth more than a dollar tomorrow? Opportunity cost and inflation reason for charging and paying Intrest

Let V = future value of money

      P= present value of money

      r= real intrest rate (nominal - inflation rate expressed as a decimal)

     n= years

      k= number of times intrest is credited per year

Simple intrest formula

V=(1+r)^n • p

Compound intrest rate

V= (1+(r/k)^nk • p

Demand for money has an inverse relationship between nominal interest rates  and the quantity of money demanded

What happens when quantity of money when interest rates increase?

-quantity demanded falls because individuals would prefer to have interest earning assets instead kf borrowed liabilities 

What happens to the quantity demanded when interest rate decrease?

-quantity demanded increases. There in no incentive to convert cash into interest earning assets

Financial sector

Financial asset- something that you own

Financial liability -something that you owe

Interest rate -cost of borrowing money

Stocks-share of a company

Bonds- lend money to the government and how much the owe you with intrest

What banks do

A bank is a financial intermediary

-uses liquid assets (i.e bank deposits) to finance the investments of borrowers

fractional reserve banking 

-A system in which depository institutions hold liquid assets less than the amount of deposites 

Can take form of

-currency in bank vault

-bank reserves-deposites held at the federal reserve

T account (balance sheet)

-statements of assets and liabilitys

Assets

-items to which the bank holds legal claim

-the uses of funds by financial intermediaries 

Liabilities

-the legal claims against a bank

-the sources of finds fir fianacial intermediary 

MONETARY POLICY