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Chapter 11 Notes Monetary System

by: Henry Notetaker

Chapter 11 Notes Monetary System ECON 2133

Marketplace > East Carolina University > Economcs > ECON 2133 > Chapter 11 Notes Monetary System
Henry Notetaker
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About this Document

This chapter covers money and the monetary system of our economy.
Nehad Elsawaf
Class Notes
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This 4 page Class Notes was uploaded by Henry Notetaker on Thursday April 21, 2016. The Class Notes belongs to ECON 2133 at East Carolina University taught by Nehad Elsawaf in Spring 2016. Since its upload, it has received 28 views. For similar materials see Macroeconomics in Economcs at East Carolina University.


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Date Created: 04/21/16
Chapter 11 The Monetary System In this chapter we discuss money and its needs/usage in our economy. Enjoy. I) What Money Is and Why It’s Important a) Without money, trade would require a barter (the exchange of one good or service for another) b) Every transaction would require a double coincidence of wants (the unlikely occurrence that two people each have a good the other wants) c) Most people would have to spend time searching for others to trade with. i) Huge waste of time and resources d) This searching is unnecessary with money (the set of assets that people regularly use to buy G&S from one another) II) The 3 Functions of Money a) Medium of Exchange: An item buyers give to sellers when they want to purchase G&S. b) Unit of Account: The yardstick people use to post prices and record debts. c) Store of Value: An item people can use to transfer purchasing power from the present to the future. III) The 2 Kinds of Money a) Commodity Money: Takes the form of a commodity with intrinsic value i) i.e. Gold Coins, cigs in POW camps b) Fiat Money: Money without intrinsic value, used as money because of government decree. i) i.e. The U.S. Dollar IV)The Money Supply a) The Money Supply (stock): The quantity of money available in the economy. V) Measures of the US Money Supply a) M1: Currency, demand deposits, traveler’s checks, and other checkable deposits. i) M1= $1.4 Trillion (June 2008) b) M2: Everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few minor categories. i) M2= $7.7 Trillion (June 2008) VI)Central Banks & Monetary Policy a) Central Bank: An institution that oversees the banking system and regulates the money supply. b) Monetary Policy: The setting of the money supply by policymakers in the central bank. c) Federal Reserve (FED): The central bank of the United States. VII) Structure of the FED a) The Federal Reserve System consists of: i) Board of Governors: 7 members, in Washington D.C. ii) 12 Regional FED Banks: located around the U.S. iii) Federal Open Market Committee (FOMC): Includes the Bd of Governors and presidents of some of the Regional FED banks. (1)FMOC decides monetary policy. iv) Jenet Yellen: Chair of the FOMC Feb. 2014-present VIII) Bank Reserves a) Fractional Reserve Banking System: The bank keeps a fraction of deposits as reserves and use the rest to make loans. b) Reserve Requirements: Established by the FED as regulations on the minimum amount of reserves that banks must hold against deposits. c) Banks may hold more than this minimum amount if they choose. d) Reserve Ratio, R= Fraction of deposits that banks hold as reserves and total reserves as a percentage of total deposits. IX)Bank T-account a) T-account: A simplified accounting statement that shows a banks assets and liabilities. b) Example: First National Bank i) Assests: (1)Reserves: $10 (2)Loans: $90 ii) Liabilities: (1)Deposits: $100 (a)Banks’ liabilities include deposits; assets include loans and reserves. (b)Notice R= $10/$100 = 10% X) The Money Multiplier a) Money Multiplier: The amount of money the banking system generates with each dollar of reserves. b) The money multiplier= 1/R c) From example above, i) R= 10% ii) MM = 1/R = 10 (1)$100 of reserves creates $1000 of money XI)The FED’s 3 Tools of Monetary Control a) Open-Market Operations (OMOs): The purchase and sale of U.S. government bods by the FED. i) To increase money supply, FED buys gov’t bonds ii) To reduce money supply, FED sells gov’t bonds iii) OMOs are easy to conduct, and are the FED’s monetary policy tool of choice. b) Reserve Requirements (RR): Affects how much money banks can create by making loans. i) To increase money supply, FED reduces RR ii) To decrease money supply, FED raises RR iii) FED rarely uses reserve requirements to control money supply. c) Discount Rate: The interest rate on loans the FED makes to banks i) When banks are running low on reserves, they may borrow reserves from the FED. ii) To increase money supply, FED can lower discount rate. iii) To decrease money supply, FED can raise discount rate. iv) NOTE: FED is a “lender of last resort” XII) The Federal Funds Rate a) On any given day, any bank with insufficient reserves my borrow from the banks with excess reserves. b) Federal Funds Rate: The interest rate on loans c) The FOMC uses OMOs to target the FED funds rate. d) Changes in the rate have large impacts in the economy. XIII) Monetary Policy and the FEDs Fund Rate a) To raise FED funds rate, FED sells gov’t bonds (OMOs) b) This removes reserves from the banking system, reduces supply of federal funds, causes Federal Funds Rate to raise. XIV) Problems Controlling the Money Supply a) If households hold more of their money as currency, banks have fewer reserves, maker fewer loans, and money supply falls. b) If banks hold more reserves than required, they make fewer loans, and money supply falls. c) Yet, FED can compensate for households and bank behavior to retain fairly precise control over the money supply. XV) Bank Runs and the Money Supply a) “Run on Banks”: When people suspect their banks are in trouble, they may “run” to the bank to withdraw their funds, holding more currency and less deposits. b) Under fractional-reserve banking, banks don’t have enough reserves to pay off ALL depositors, hence banks may have to close. c) Also, banks may have fewer loans and hold more reserves to satisfy depositors. d) These events increase R, reserve the process of money creation, which causes money supply to fall.


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