Macro Chapter 16 Notes
Macro Chapter 16 Notes EC 111
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This 0 page Class Notes was uploaded by Carter Cox on Wednesday March 23, 2016. The Class Notes belongs to EC 111 at University of Alabama - Tuscaloosa taught by Zirlott in Spring 2015. Since its upload, it has received 36 views. For similar materials see Principles of Macroeconomics in Economcs at University of Alabama - Tuscaloosa.
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Date Created: 03/23/16
Chapter 16 Econ Notes What is money and why is it important Without money trade would require barter o Barter is the exchange of one good or service for another Not US economy Very costly Most people would have to spend time searching for other to with This is a huge waste of resources This searching is unnecessary with money the set of assets that people regularly use to buy goods and services from other people 3 Functions of Money Medium of Exchange 0 Item buyers give to sellers when they want to purchase goods and services 0 Picking up and buying Unit of account 0 The yardstick people use to post prices and record debts dollars and cents 0 Prices are recorded Store of value save 0 Item people can use to transfer purchasing power from the present to the future 0 Investing and checking accounts are examples 2 Kinds of Money Commodity money 0 Takes the form of a commodity with intrinsic value 0 Gold coin diamonds cigarettes in POW camps are examples 0 Has uses other than just money Fiat Money 0 Money because the government says so 0 No intrinsic value 0 The US dollar is an example The Money Supply Money supply 0 The quantity of money available in the economy 0 Also known as money stock What assets should be considered part of the money supply 0 Currency Paper bills and coins in the hands of non bank public Not a good way to hold wealth You don t earn interest and it could get lost or stolen 0 Demand Deposits Balances in bank accounts that depositors can access on demand by writing a check Checking account is an example Measures of the US Money Supply M1 0 Currency demand deposits travelers checks and other checkable deposits M2 0 Everything in M1 plus savings deposits small time deposits CD under 100000 money market mutual funds write a check on it and a few minor categories M3 0 M1 and M2 plus a large time deposit over 100000 repurchase agreements repo and other categories The distinction between M1 and M2 will usually not matter when we talk about quot the money supplyquot in this course Central Banks and Monetary Policy Central Bank 0 Institution that oversees the banking system and regulates the money supply Monetary Policy 0 Setting of the money supply by policymakers in the central bank Federal Reserve FED o The central bank of the US The Federal Reserve Organization Created in 1913 from the Federal reserve act After a series of bank failures in 1907 quotPanic of 1907quot also called quotKnickerbocker Crisisquot The purpose of the FED is to ensure the health of the nations banking system FED Organization Continued Board of governors o 7 member with 14 year terms appointed by the president and con rmed by the senate o The chairman Directs the FED staff Presides over board meeting Testi es regularly about FED policy in front of congressional committees and nations Appointed by the president 4 year term Janet Yellen is the current chairwoman o The FED system Federal reserve board is in Washington DC 12 regional Federal Reserve Banks Closest one to TTown is in Atlanta 0 Major cities around the country 0 The presidents chosen by each banks board of directors Which state has two banks 0 Missouri The FED s Jobs Regulate banks and ensure the health of the banking system 0 Regional Federal Reserve Banks 0 Monitors each banks nancial condition 0 Facilitates bank transactions clearing checks 0 Acts as a banks bank Banks put their money into the FED o The FED lender of last resort FED can bailout 0 Control the money supply Quantity of money available in the economy Monetary policy their biggest job 0 By Federal Open Market Committee FOMC FOMC 7 members of the board of governors 5 of the twelve regional bank presidents o All twelve regional presidents attend each FOMC meeting but only ve vote 0 New York regional president always votes Meets about every 6 weeks in Washington DC 0 Discusses the condition of the economy 0 Consider changes in monetary policy The structure of the FED Board of governors o 7 members 12 regional FED banks 0 Located in the US FOMC 0 Includes the 7 board of governors and 5 presidents of the regional FED banks Bank Reserves Fractional reserve banking system 0 Banks keep a fraction of deposits as reserves and use the rest to make loans 0 This is what we have in the US FED establishes Reserve Requirements 0 Regulations on the minimum amount of reserves that banks must hold against deposits Banks can hold the reserves as vault or cash deposit at the FED Banks hold more than this minimum amount if they choose Reserve Ration 0 Fraction of deposits that banks hold as reserves 0 Total reserves as a percentage of total deposits Bank T account A simpli ed accounting statement that shows a banks assets and liabilities Liabilities includes deposits assets include loans and reserves Reserves deposits The money Multiplier The amount of money the banking system generates with each dollar of reserves Money multiplier equal 1 Reserve ration FED 3 tools of monetary control how FED controls money supply Open Market Operations OMO s o The purchase and sale of US government bonds by the FED 0 Buying and selling of government bonds 0 Increase money supply FED buys government bonds which are deposited in banks increasing reserves 0 Which banks use to make loans causing the money to expand 0 To reduce money supply FED sells government Bonds taking dollars out of circulation and the process works in reverse 0 OMO s are easy to conduct and are the FEDs monetary policy tool of choice Reserve Requirements RR 0 Affect how much money banks can create by making loans 0 To increase money supply FED reduces RR Banks make more loans from each dollar of reserves which increases money multiplier and money supply 0 To reduce money supply FED raises RR and the process works in reverse 0 Fed rarely uses RR to control money supply Frequent changes would disrupt banking Discount rate don t make loans to consumers 0 Interest rate on loans the FED makes to banks 0 When banks are running low on reserves they may borrow reserves from the FED 0 To increase money supply FED can lower discount rate which encourages banks to borrow more reserves from FED 0 Banks can then make more loans which increases the money supply 0 To reduce the money supply FED can raise discount rate Federal Funds Rate Banks with insufficient reserves can borrow from banks with excess reserves 0 Interest on the loans is the federal funds rate The FOMC use OMO s to target the FED funds rate Many interest rates are highly correlated so changes in the FED funds rate causes changes in other rates and have a big impact in the economy 0 Does not arbitrarily set the federal fund rate but can cause it to move Problems Controlling the Money Supply if households hold more of their money as currency banks have fewer reserves make fewer loans and the money supply falls if banks hold more reserves than required they make fewer loans and money supply falls 0 banks scared Banks runs and the money supply Run on banks people scared and go to bank to withdraw money Under fractional reserve banks don t have enough reserves to pay off all depositors hence banks may have to close Banks make fewer loans and hold more reserves to satisfy depositors These event increase the Reserve ratio If banks collapse you are insured with your money Financial Crisis of 2008 2009 banks capital 0 resources a banks owners have out into the institution 0 used to generate pro t Leverage 0 Use of borrowed money to supplement existing funds for purposes of investment Leverage ration 0 reserves Loans securities Capital Capital requirement 0 Gov regulation specifying a minimum amount of bank capital 0 Depends on the type of assets a bank holds 0 The safer the assets the lower the requirement Safe asset bonds Risky asset stocks Shortage of capital 0 After they had incurred losses on some of their assets Mortgage loans Securities 0 Reduce lending credit crunch Contributed to a severe downturn in economic activity US Treasury and the FED 0 Put many billions of dollars of public funds into the banking system To increase the amount of bank capital Called TARP o Temporarily made the US taxpayer a part owner of many banks 0 Goal to recapitalize the banking system Bank lending could return to a more normal level
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