Prin Macroeconomics ECON 2105
Popular in Course
Popular in Economcs
This 2 page Class Notes was uploaded by Ms. Nathanael Collins on Monday October 12, 2015. The Class Notes belongs to ECON 2105 at Gordon College taught by Prathibha Joshi in Fall. Since its upload, it has received 15 views. For similar materials see /class/222104/econ-2105-gordon-college in Economcs at Gordon College.
Reviews for Prin Macroeconomics
Report this Material
What is Karma?
Karma is the currency of StudySoup.
Date Created: 10/12/15
Money is used as a medium of exchange for goods and services as a unit of account for expressing price and as a store of value People will only accept money in exchange for goods and services and for the work they perform if they can be reasonably certain that the medium of exchangeimoneyiwill retain its value until they are ready to spend it In runaway in ations of the thousands or tens of thousands of percent a year people revert to barter Again drastic in ation greatly reduces money s use as a measure of value for it is impossible to adjust instantaneously all prices strictly in line with their relative values Thus opportunities are afforded to speculators to pro t at the expense of the less sophisticated who eventually will learn to distrust money s usefulness as a measure of value Finally and most obviously money s usefulness as a store of value is destroyed in a drastic in ation The rule of 70 is instructive here By dividing the absolute in ation rate into 70 one can estimate how long it takes one s dollar savings to lose half their purchasing power At 7 percent in ation the dollar will be worth half as much in ten years Commercial banks and thrift institutions offer checkable deposits Currency held by banks is not counted in either M1 or M2 M l currency in circulation checkable deposits The largest component of M l is currency 54 percent and it is the only part that is legal tender If the face value of a coin were not greater than its intrinsic metallic value people would remove coins from circulation and sell them for their metallic content M2 M 1 noncheckable savings deposits money market deposit accounts small time deposits money market mutual fund balances A balance sheet is a statement of assets and claims or liabilities and net worth It must balance because every asset is claimed by someone so that assets the lefthand side liabilities net worth the righthand side The major assets of a bank are cash including cash reserves held by the Fed its property the loans it has made and the securities it holds over and above general loans Its liabilities are the deposits of its customers The difference between the assets and liabilities is the bank s net worth which is shown on the liabilities side thus ensuring that the balance sheet balances Reserves provide the Fed a means of controlling the money supply It is through increasing and decreasing excess reserves that the Fed is able to achieve a money supply of the size it thinks best for the economy Reserves are assets of commercial banks because these funds are cash belonging to them they are a claim the commercial banks have against the Federal Reserve Bank Reserves deposited at the Fed are a liability to the Fed because they are funds it owes they are claims that commercial banks have against it Excess reserves are the amount by which actual reserves exceed required reserves Excess reserves Excess reserves actual reserves required reserves Commercial banks can safely lend excess reserves thereby increasing the money supply 1610 When a bank grants a loan it can expect that the borrower will not leave the proceeds of the loan sitting idle in his or her account Most people borrow to spend Therefore the lending bank can expect that checks will be written against the loan and that the bank will shortly lose reserves to other banks as the checks are presented for payment to the full extent of the loan In short when a bank grants loans to the full extent of its excess reserves it can shortly expect to lose these excess reserves to other banks From this it can be seen why a bank cannot safely lend more than its excess reserves If it did it would soon nd that its cash reserves were below its legal reserve requirement From the above it can be seen why the commercial banking system can safely lend a multiple of its excess reserves Whereas one bank loses reserves to other banks the system does not With a legal cash reserve requirement of say 20 percent Bank B on receiving as a new deposit the 100 loaned by Bank A the excess reserves of Bank A may safely lend 80 80 percent of 100 Bank C on receiving as a new deposit the 80 loan of Bank B loans 80 percent of that namely 64 Note that the 100 initial excess reserves of the banking system have already resulted in the money supply increasing by 244 100 80 64 The money supply will continue to increase at a diminishing rate Bank D will increase the money supply by 5120 in loaning this amount until the total increase in the money supply is 500 The algebra underlying the monetary multiplier is that of an in nite geometric progression Designating the xed fraction of the previous number as b 08 in our case and k as the sum of the progression we have k 1bb2b3 bn Solvingthis fora very large n we getk 117b In our example the multiplier k is 11 08 12 5 And 5 is the reciprocal of the reserve ratio of 20 percent of 02 The multiplier is inversely related to the reserve ratio The basic objective of monetary policy is to assist the economy in achieving a fullemployment nonin ationary level of total output The major strengths of monetary policy are its speed and exibility compared to scal policy the Board of Governors is somewhat removed from political pressure and its successful record in preventing in ation and keeping prices stable The Fed is given some credit for prosperity in the 1990s and early 2000s Monetary policy is formed by the 7 members of the Board of Governors Fiscal policy requires the consent of both houses in Congress plus the President One of the implications is that monetary policy has a much shorter administrative lag than scal policy A change in the nation s money supply achieved by changing reserves in the banking system will cause an opposite change in the interest rate A reduction in the money supply will make funds increasingly scarce and drive up their price interest rate The interest rate and investment spending are also inversely related A rising interest rate will make some investments capital spending projects unpro table so spending on those will decline Investment spending is part of aggregate demand so they will move together as will real GDP A decline in spending AD will reduce in ationary pressure and will reduce prices if they are downwardly exible