ECN 150: Week 12 Notes
ECN 150: Week 12 Notes ECN 150
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This 4 page Class Notes was uploaded by Alexis Ibarra on Wednesday April 20, 2016. The Class Notes belongs to ECN 150 at La Salle University taught by Francis Thomas Mallon in Summer 2015. Since its upload, it has received 8 views. For similar materials see Macroeconomics in Economcs at La Salle University.
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Date Created: 04/20/16
WEEK 12 NOTES 4/11/16 Expansionary Monetary Policy If the Federal open market committee wanted to increase the market money supply: Curve shifts outward to the right Reasons they would increase the money supply: A high unemployment rate Too slow a rate of growth in GDP By increasing the money supply, they would be hoping to decrease the interest rates. (This would stimulate higher levels of spending: cause people to buy houses, cars, etc. And cause businesses to expand more and hire more people) How do they increase the money supply? Buy government securities Lower discount rate Lower legal reserve requirements Contractionary Monetary Policy If the Federal open market committee wanted to decrease the market money supply: Curve shifts inward to the left Reasons they would decrease the money supply: Inflation in government is too great, unacceptable Stable level of employment Acceptable rate of GDP growth By decreasing the money supply, they would be hoping to increase the interest rates. (This would decrease the levels of spending: cause people to not buy new houses, cars, etc. And cause businesses to contract, reducing inflation) How do they decrease the money supply? Sell government securities Raise the discount rate Raise the legal reserve requirements Opponents of Federal Reserve policy actions would agree with the mechanics of the above policies, HOWEVER, they would argue that the change in interest rates would have the projected effect on spending. Just because interest rates decrease, will spending really increase? Not necessarily! Demand for Money: Why is it that we as a society demand to have money as a part of our economic system? 2 Reasons: To carry out transactions To hold as an asset Transaction Demand for Money: The amount of money required by society to facilitate purchasing and/or spending of the transactions within the society Asset Demand for Money: The amount of money required by society to satisfy the desire to hold money (currency, coin, demand deposits) as a physical asset. Example: Me Example of Transaction Demand: I make $1,000 a week. I have to spend money on rent, utilities, food, taxes, clothes, entertainment, etc. This stuff accumulates $800. Will my use of the $800 be influenced by the rate of return on government securities? NO. Rate of 2% jumped to 9%, does this deny me from paying my rent? NO. Rate of return doesn’t influence our money needed for transactions so transaction demand will be a vertical line Example of Asset Demand: I make $1,000 a week. I need $800 to facilitate my spending. This extra $200 is sitting in my pocket, so it is an asset to me. How will the rate of return influence my willingness to hold this $200 as an asset? Interest rate of return jumps to 25%, what happens to my willingness to hold the money rather than buy a security? I will want to buy the security instead of holding on to the $200!! (When the rate of the return is high, my asset demand for money is low) At high rates of return, there is little or no asset demand for money (people will buy security bonds) At low rates of return, there is more demand for money (people won’t buy security bonds) *What do you give up when you turn in your $200 for the security? The ability to spend that money (AKA: liquidity) Also, you give effort/hassle to go and exchange for the bond. Demand for money curve: Add the transaction curve + asset curve 4/13/16 Bonds Bonds have face values and market values Face value: Value that bond is going to have at maturity You buy a bond for &740 that is issued at a face value of $1,000 on April 13, 2016. Its maturity date is 10 years from now. 10 years from now, it will be worth $1,000. Market value: Price that the bond would sell at in the market today What you pay when you buy the bond that day The amount of interest earned on government bonds is the difference between the market value and the face value ($1,000 $750= $250 in interest returned) To increase the money supply: Government can entice people to sell their bonds back by increasing the market price for them, thus increasing the money supply, lowering the interest rates. To decrease the money supply: Government can make people hold onto their bonds by lowering the market price for the bonds, decreasing the money supply, increasing the interest rates. Banks Commercial banks: They are businesses. Commercial banks function and seek to profit by accepting deposits, and making loans. In doing so, they create money. The Federal Reserve identifies a legal reserve requirement: The minimum amount of money that the commercial banks need to have. Banks need to keep a minimum amount of accepted amount of money in the banks Banks have a high emotional visibility in the community. Ex: If a shoe store goes out of business it’s not a big deal. If a bank goes out of business, that would cause concern to the community regarding the stability of the economy. How do they create money? Example: You find a treasure chest with $1,000,000 in it. You put it in the bank: BANK A Liability Demand Deposit:$1,000,000 Legal Reserve (10%) $100,000 Excess Reserve $900,000 So the bank could lend out the $900,000, increasing the money supply. $900,000 of new money was created!! The $900,000 that was lent out, might wind up being deposited in another bank. BANK B Liability Demand Deposit:$900,000 Legal Reserve (10%) $90,000 Excess Reserve $810,000 1 1 Monetary multiplier: LPR = .10=10 The amount of money ($1,000,000) × multiplier (10) = $10,000,000 created
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