Int Macro Econ the money system
Int Macro Econ the money system Economics 5570
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This 3 page Class Notes was uploaded by Ashish Kondoju on Saturday March 12, 2016. The Class Notes belongs to Economics 5570 at Wayne State University taught by Shuan Jung in Spring 2016. Since its upload, it has received 29 views. For similar materials see Intermediate Macroeconomics in Economcs at Wayne State University.
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Date Created: 03/12/16
The Money System Money: Types 1. Fiat money has no intrinsic value example: the paper currency we use 2. Commodity money has intrinsic value examples: gold coins, cigarettes in P.O.W. camps The money supply is the quantity of money available in the economy. Monetary policy is the control over the money supply. Monetary policy is conducted by a country’s central bank. The U.S.’s central bank is called the Federal Reserve (“the Fed”). To control the money supply, the Fed uses open market operations, the purchase and sale of government bonds. The money supply equals currency plus demand (checking account) deposits: M = C + D Since the money supply includes demand deposits, the banking system plays an important role. Reserves (R ): the portion of deposits that banks have not lent. A bank’s liabilities include deposits; assets include reserves and outstanding loans. 100-percent-reserve banking: a system in which banks hold all deposits as reserves. Fractional-reserve banking: a system in which banks hold a fraction of their deposits as reserves. Banks’ role in the monetary system To understand the role of banks, we will consider three scenarios: 1. No banks 2. 100-percent-reserve banking (banks hold all deposits as reserves) 3. Fractional-reserve banking (banks hold a fraction of deposits as reserves, use the rest to make loans) In each scenario, we assume C = $1,000. With no banks, D = 0 and M = C = $1,000. SCENARIO 2: 100-percent-reserve banking Initially C = $1000, D = $0, M = $1,000. Now suppose households deposit the $1,000 at “Firstbank.” After the deposit: C = $0, D = $1,000, M = $1,000 LESSON: 100%-reserve banking has no impact on size of money supply. SCENARIO 3: Fractional-reserve banking Suppose the borrower deposits the $800 in Secondbank. Initially, Secondbank’s balance sheet is: Secondbank will loan 80% of this deposit. Finding the total amount of money: Original deposit = $1000 + Firstbank lending = $ 800 + Secondbank lending = $ 640 + Thirdbank lending = $ 512 + other lending… Total money supply = (1/rr ) × $1,000 where rr = ratio of reserves to deposits In our example, rr = 0.2, so M = $5,000