Unit 4- Money Supply

Calculating Money Supply

• When a customer deposits cash or withdraws cash from their deposit account it has no effect on money supply it only changes: the composition of money, excess reserves, and required reserves
• When the fed buys or sells bonds, the money goes to ER

• Required Reserve = Amount of deposit x required reserve ratio
• Excess Reserves = Actual Reserves - Required Reserves
• Maximum amount a single bank can loan = the bank's ER
• Money multiplier = 1 / reserve ratio
• Total Change in Loans = ER x money multiplier
• Total Change in the money supply = (ER x money multiplier) + securities bought by FED

Unit 4- Tools of Monetary Policy

Reserve Requirement

• Only a small percent of your bank deposits is in the safe; the rest of your money has been loaned out; this is called "Fractional Reserve Banking". 
• FED sets the amount that banks must hold. 
• The 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.
• Recession- Decrease the Reserve Ratio;  Money supply increases, interest rates decrease, Aggregate Demand increases
• Inflation- Increase the Reserve Ratio; Money supply decreases, interest rates increase, Aggregate Demand decreases

Discount Rate

• Interest rate that the FED charges commercial banks
• To increase money supply, FED should decrease the discount rate
• To decrease money supply, FED should increase the discount rate

Open Market Operations

• The FED buys/sells government bonds 
• most important and widely used tool monetary policy.
• To increase money supply, FED buys bonds.
• To decrease money supply, FED sells bonds

Unit 4- Banks and the FED

Function of Banks

• A bank is a financial intermediary- uses liquid assets to finance the investments of borrowers.
• Fractional Reserve Banking- depository institutions hold liquid assets less than the amount of deposits; can take the form of currency in bank vaults or bank reserves deposits held at the Federal Reserve

• T-Account (Balance Sheet)- statements of assets and liabilities
• Asset (Amounts owned)- items to which a bank holds legal claim; the use of funds by fiancial intemediares
• Liabilities(Amounts owed)- the legal claims against a bank; the source of funds for financial intermediaries

Function of the FED

• issues paper currency
• sets reserve requirements and holds reserves of the bank
• lends money to bank and charges interest
• check clearing service for banks
• acts as a personal bank for government
• supervises member banks
• controls money supply

Reserve Requirement

• FED requires bank to always have some money readily available to meet consumers' demand for cash, this amount is set by the FED is the required reserve ratio
• the required reserve ratio is the percentage of demand deposits that must not be loaned out
• required reserve ratio usually = 10%

Unit 4- Demand of Money and Money Market

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

Financial Sector

• Financial Asset- something an individual owns
• Financial Liabilities- something an individual owes
• Interest Rate- cost of borrowing money
• Stock- financial assets that convey ownership in a company 
• Bonds- Money paid to the government with a promise to pay back with interest.

Unit 4- Time Value of Money

Time Value of Money

• Is a dollar today worth more than a dollar tomorrow? Yes
• Why? Opportunity cost and inflation, this it the reason for charging and paying interest

Symbols and Notations

• v = future value of $
• p = present value of $ 
•  r = real interest rate (nominal interest rate - inflation rate) 
• n = # of years
• k = # of times interest is credited throughout the year

Forms

• Simple Interest Form- v = (1+r)^n x p
• Compound Interest Form- v= (1+ (r/k))^(nk) x p

Unit 4- Introduction to Money

Uses of Money

• Medium of exchange- used to barter/trade
• Unit of Account- establishis economic worth in an  exchange process
• Store of Value- money holds its value over a period of time while products may not

Types of Money

• Commodity Money- gets it value from the type of material its made from
• Representative Money- paper money that is backed by something tangible (gold standard)
• Fiat Money- money backed by the word of the government

Characteristics of Money

• Portable, durable, uniform, scarce, acceptable, divisible

Money Supply

• M1 Money-currency(cash and coins), checkable deposits/demand deposits (checking accounts), traveler's checks; M1 is most liquid money, makes up 75% of money. Liquid money is easy to convert to cash
• M2 Money- consists of M1 money and saving accounts and deposits held by banks outside of US. M2 is not as liquid as M1 money
• M3 Money- consists of M2 money and certificate of deposits (CD's); any money that is withdrawn must be paid with interest

Monetary Policy Video