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ECON111 Macroeconomic Chapter 16 Notes

by: Lauren Heller

ECON111 Macroeconomic Chapter 16 Notes Econ 111

Marketplace > University of Alabama - Tuscaloosa > Econ 111 > ECON111 Macroeconomic Chapter 16 Notes
Lauren Heller
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About this Document

These notes cover chapter 16 and were taken from the professor's lecture.
Kent 0. Zirlott
Class Notes
EC111, econ111, Macro, Macroeconomics, Econ, Economics, chapter 16 notes
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This 5 page Class Notes was uploaded by Lauren Heller on Monday March 7, 2016. The Class Notes belongs to Econ 111 at University of Alabama - Tuscaloosa taught by Kent 0. Zirlott in Fall 2016. Since its upload, it has received 24 views.


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Date Created: 03/07/16
Chapter 16  What’s money is and why it’s important  Without money trade would require barter  Barter- the exchange of one good or service for another  most people would have to spend time searching for others to trade with – a huge waste of resources  this searching is unnecessary with money  money- the set of assets people regularly use to buy goods and services from others  The 3 Functions of Money:  Medium of exchange- an item buyers give to sellers when they want to purchase goods and services  Unite of account- the yardstick people use to post prices and record debts  Store of value- an item people can use to transfer purchasing power from the present to the future  The 2 Kinds of money  Commodity money- takes the form of a commodity with intrinsic value  Ex. Gold coins, cigarettes in POW camps  Fiat money- money without intrinsic value, used as money because of government decree  ex. The U.S. dollar  The money supply- (money stock) the quantity of money available in the economy  What assets should be considered part of money supply?  Currency- the paper bills and coins in the hand of the (non-bank) public  Demand deposits- balances in bank accounts that depositors can access on demand by writing a check  Measures of the U.S. Money Supply  M1- currency, demand deposits, traveler’s checks, and other checkable deposits  M2- everything in M1 plus saving deposits, small time deposits, money market funds, and a few minor categories  M3- M1 and M2 plus large time deposits, repurchase agreements, and other categories  Currency- not a particularly good way to hold wealth  Can be lost or stolen  Doesn’t earn interest  Central Banks and Monetary Policy  Central bank- an institution that oversees the banking system and regulates the money supply  Monetary policy- the setting of the money supply by policy makers in the central bank  Federal Reserve (Fed)- the central bank of the U.S.  The Fed’s Organization  Created in 1913 from the Federal Reserve Act  After a series of bank failures in 1907  “Panic of 1907” also called the “Knickerbocker Crisis” – the failure of the Knickerbocker Trust Company  purpose: to ensure the health of the nation’s banking system  Fed Make of:  Board of governors  7 members, 14- year terms  appointed by president and confirmed by the Senate  the chairman  directs the Fed staf  presides over board meetings  testifies regularly about the Fed policy in front of the congressional committees  appointed by president (4-year term)  Janet Yellen (current chairwoman)  The Fed System:  Federal Reserve Board in Washington D.C.  12 regional Federal Reserve Bank  major cities around the country  the presidents- chosen by the bank’s board of directs  Tuscaloosa falls under Atlanta’s  Missouri is the only state with 2  The Fed’s Jobs:  Regulate banks and ensure he health of banking system  Regional Federal Reserve Banks  Monitors each bank’s financial condition  Facilitates bank transaction – clearing checks  Acts as banks bank  The Fed- lender of last resort  Control the money supply  Quantity of money available in the economy  Monetary policy  By Federal Open Market Committee (FOMC)  Money Supply  Quantity of money available in economy  Monetary Policy  Setting the money supply  Federal Open Market Committee (FOMC):  7 members of the board of governors  5 of the twelve regional bank presidents  all 12 regional regional presidents attend each FOMC meeting, but only 5 get to vote  NY regional president always votes  Meets about every 6 weeks in Washington D.C.  Discuss the condition of the economy  Consider changes in monetary policy  Bank Reserves  Fractional reserve banking system- banks keep a fraction of deposits as reserves and use the rest to make loans  The Fed establishes reserve requirements- regulations on the minimum amount of reserves that banks must hold against deposits  Banks can hold the reserves as vault cash or deposits at Fed  Banks may hold more than the minimum amount if they choose (excess reserves)  The reserve ratio, R = fraction of deposits that banks hold as reserves  Bank T- account  T-account- a simplified accounting statement that show’s a banks assets and liabilities  Banks’ liabilities include deposits, assets include loans and reserves  Banks and Money Supply  100% reserve system- banks hold 100% of deposits as reserves, make no loans  Money supply = currency + deposits  In a 100% reserve banking system, banks do not afect size of money supply  Fractional reserve banking system creates money, but not wealth  When banks make loans, they create money  Money multiplier- the amount of money the banking system generates with each dollar of reserves  the money multiplier = 1/R  maximum possible increase in deposits is (1/R) X deposit  since money supply also includes currency subtract original deposit  minimum amount the money supply could increase 0 because bank makes no loan doesn’t create money  The Fed’s 3 Tools of Monetary Control  1. Open market operations (OMOs)- the purchase and sale of U.S. government bonds by the Fed.  To increase money supply, the Fed buys government bonds, paying with new dollars  which are deposited in banks, increasing reserves  which banks use to make loans, causing the money supply to expand  to reduce money supply, Fed sells government bonds, taking dollars out of circulation, and the process works in reserve  OMOs are easy to conduct, and are the Feds monetary policy number one tool of choice  2. Reserve Requirement (RR) – afects how much money banks can create by making loans  to increase more supply, Fed reduces RR, banks make more loans from each dollar of reserves, which decreases the reserve ratio and increases the money multiplier and the money supply  to reduce money supply, Fed raises RR, banks make fewer loans and the process works in reverse, the reserve ration increases and the money multiplier and the money supply decrease  Fed rarely uses reserve requirements to control money supply, frequent changes would disrupt banking  3. Discount Rate- the interest rate on loans the Fed makes to banks  when banks are running low on reserves, they may borrow reserves from the Fed  to increase money supply, fed can lower discount rate, which encourages banks to borrow more reserves from Fed  banks can then make more loans, which increases the money supply  to reduce money supply, Fed can raise discount rate  use in times of crisis  The Federal Funds Rates- the interest rate on loans a bank charges another banks  On any given day, banks with insufficient reserves can borrow from banks with excess reserves  The FOMC uses OMOs to target the federal funds rate  Many interest rates are highly correlated, so changes in fed funds rate causes changes in other rates and have a big impact in the economy  Monetary Policy and the Fed Funds Rate  To raise fed funds, Fed sells government bonds (OMO), this removes reserves from the banking system, reduces supply of federal funds, causing rate to rise  Problems Controlling the Money Supply  If households hold more of their money as currency, banks have fewer reserves, making loans, and the money supply falls  If banks hold more reserves than required, they make fewer loans, the money multiplier decreases, and the money supply falls  Yet, Fed can compensate for household and bank behavior to retain fairly precise control over the money supply  Bank Runs and the Money Supply  A bank run- when people suspect their banks are in trouble, they may “run” to the bank to withdraw their funds, holding more currency and less deposits  Under factional-reserve banking, banks don’t have enough reserves to pay of ALL depositors, hence banks may have to close  Banks may make fewer loans and hold more reserves to satisfy depositors  These events increase R, reserves the process of money creation, causes money supply to fall  Background info of the Financial Crisis of 2008-2009 (The Great Recession)  Bank capital  Resources a bank’s owners have put into the institution  Used to generate profit  Leverage  Use of borrowed money to supplement existing funds for purpose of investment  Leverage ratio  Ratio of assets to bank capital  (Reserves + Loans + Securities) / Capital  Capital requirements  Government regulation specifying a minimum amount of bank capital  Depends on the type of assets a bank holds  The safer the assets… the lower the requirement  Financial Crisis of 2008-2009 (The Great Recession)  Shortage of capital  After they had incurred losses on some of their assets  Mortgage loans  Securities backed by mortgage loans  “Subprime Mortgage Crisis”  Reducing lending (credit crunch)  Contributed to a severe downturn in economic activity  U.S. Treasury and the Fed  Put many billions of dollars of public funds into the banking system  To increase the amount of the bank capital  Called TARP  It temporarily made the U.S. taxpayer a part owner of many banks  Goal: to recapitalize the banking system  Bank lending could return to a more normal level  Occurred by late 2009


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