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Econ Macroeconomics Chapter 16- Monetary System (money, money multipliers etc)

by: Katie Mulliken

Econ Macroeconomics Chapter 16- Monetary System (money, money multipliers etc) ECON2015

Marketplace > University of Georgia > Economcs > ECON2015 > Econ Macroeconomics Chapter 16 Monetary System money money multipliers etc
Katie Mulliken
GPA 3.91

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Econ Macroeconomics Chapter 16- Monetary System (money, money multipliers etc) notes from the textbook and in class
Study Guide
Econ, Macroeconomics, Money, monetary system
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This 5 page Study Guide was uploaded by Katie Mulliken on Wednesday April 13, 2016. The Study Guide belongs to ECON2015 at University of Georgia taught by JASON RUDBECK in Spring 2016. Since its upload, it has received 5 views. For similar materials see INTRODUCTION TO MACROECONOMICS in Economcs at University of Georgia.


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Date Created: 04/13/16
The Monetary System Money – the set of assets in the economy that people regularly use to buy goods and services from others  Money has 3 functions in the economy. Money is a…. 1) Medium of Exchange – an item that buyers give sellers when purchasing a good or service 2) Unit of Account – the yardstick people use to post prices and record debts 3) Store of Value – an item used to transfer purchasing power from the present to the future o Ex: people can transfer purchasing power from present to future by holding stock/bonds o “Wealth” describes the total all stores of value, includes money & nonmonetary assets Types of Money: Commodity Money – money that takes the form of a commodity with intrinsic value o Intrinsic value is the value of an item/asset would have even if not used as money (Ex: Gold) o When an economy uses gold as money (or gold-backed paper) it operates under gold standard Fiat Money – money without intrinsic value that is used as money because of government decree/rule  U.S. government has decreed its dollars to be valid money (why you can’t use monopoly $$ irl) Money Stock – the quantity of money circulating in the economy. To measure money stock include:  Currency – the paper bills & coins held by the public; most widely accepted medium of exchange  Demand Deposits – balances in bank accounts that depositors can access on demand simply by writing a check or swiping a debit card at a stores How can money keep being made but doesn’t create inflation? 1) Currency is held abroad in foreign countries 2) Currency is held and exchanged by drug dealers, tax evaders, and other criminals Liquidly – the ability of an asset to be easily converted into a medium of exchange (money = most liquid) Central Bank – institution overseeing bank system & regulates quantity of money in the economy (Fed) Federal Reserve (Fed) The Federal Reserve is the central bank of the United States, responsible for regulating the bank system  Created in 1913 to ensure the health of the nation’s banking system after a series of bank failures  Run by a board of 7 governors who each serve 14-terms (they are confirmed by Senate)  The chairman of the Federal Reserve is appointed by the president each 4-year term The Fed has 2 Related Jobs: 1) Regulate banks & ensure the health of the banking system (clearing checks = monitoring errors) o Acts as a ‘banks bank’ (it can borrow itself) it is a lender of last resort for banks in $ trouble 2) Control the Money Supply (quantity of money that is made available in the economy) o Policymakers decisions regarding money supply are part of Monetary Policy made by FOMC** o Monetary Policy – the setting of the money supply by policymakers in the central bank Federal Open Market Committee (FOMC) – 7 board of governors members & 5 of the 12 national regional bank presidents (all 12 regional presidents attend but only 5 get to vote~ rotate vote, except NY)  If FOMC increases money supply, Fed creates $ and uses it to buy gov. bonds from the public….  The public now owns this $… Thus if Fed purchases bonds in an Open-Market money supply  Reserves – deposits’ banks have received but haven’t loaned out (100% reserve banking = all $ in reser)e  Each bank deposit Reduces Currency & Raises Demand Deposits by exactly the same amount ( ū)  If Banks hold all deposits in reserve, banks do not influence the supply of money Fractional-Reserve Banking – system where banks hold only a fraction of deposits as reserves (USA)  The fraction of total deposits that a bank holds as reserves is called the Reserve Ratio  Reserve Ratio is influences by: Gov. regulations & Bank policy o Fed sets a minimum amount of reserves banks must hold  Reserve Requirement o Banks may hold reserves above min called Excess Reserves  ¡¡¡ When banks hold only a fraction of deposits in reserve, the banking system creates money !!!! o As banks create money (asset) also creates a liability for those who borrowed the created $ o Economy = more liquid bc there’s more mediums of exchange, but economy is not wealthier Money Multiplier – amount of money the banking system generates with each dollar of reserves  The money multiplier is the Reciprocal of the Reserve Ratio (1 ÷ Reserve Ratio)  Higher Reserve Ratio = Less of each deposit banks loan out = Smaller Money Multiplier o (in the special case of 100% reserve banking, the reserve ratio = 1, money multiplier = 1) Bank Capital – resources that a bank’s owners have put into the institution.  Banks use capital to make loans and holds and to buy financial securities (stocks/bonds) Capital Requirement – Gov. regulation specifying a min amount of bank capital. Goal is to ensure banks will be able to pay off their depositors (w/o having to resort to gov- provided deposit insurance funds) Leverage – using borrowed money to supplement existing funds for purposes of investment (key for banks) Leverage Ratio – ratio of the bank’s total assets : bank capital  Ratio of 20  for every $20 of assets,$19 financed with borrowed money (take deposits/ issue debt) Insolvent – when bank assets fall below liabilities & unable to pay off its debt holders & depositors in full Credit Crunch– phenomenon where capital shortage makes banks to reduce lending = economic decline  To fix this, U.S. Treasury & Federal Reserve put $$$ into the bank system to increase bank capital Fed has a variety of tools in its monetary toolbox. 2 groups of tools:  Those that influence the quantity of reserves  Those that influence the reserve ration and thereby the money multiplier How the Fed influences the quantity of reserves: 1) Fed alters quantity of reserves in economy either by buying or selling bonds in open- market operations or by making loans to banks (or a combo)  To increase money supply, Fed makes bond traders at NY Fed buy bonds from public in market o Each $1 added increases money supply; bank deposits increases over $1 bc creates money  Fed can increase the quantity of reserves in the economy by lending reserves to banks o Banks borrow from Fed’s Discount Window & pay Discount Rate (an interest rate on that loan) o High Discount Rate discourages banks from borrowing reserves = reduces quantity of reserves o Term Auction Facility – Fed set up quantity of funds to lend to banks & those eligible bid to borrow 2) Federal changes the money supply by: regulating the quantities of reserves the bank must hold or through the interest rate that the Fed pays banks on their reserves Problems for the Fed from Monetary Control: (Both arise from fractional-reserve banking) 1) Fed does not control the amount of money that households choose to hold as deposits in banks o More money households deposit, the more reserves banks have and that can be created 2) Fed doesn’t control the amount bankers choose to lend ~ depends on part on behavior of depositors Federal Funds Rate – short-term interest rate that banks charge one another for loans o Banks can lend money to each other (temporarily). The price of the loan = federal funds rate All else = Decrease in federal funds rate target = increase in money supply = reduction in money supply


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