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Chapter 11 notes

by: Sophie Turner

Chapter 11 notes ECON 105 001

Sophie Turner

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Here is the notes from chapter 11 which covers the monetary system!
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This 5 page Class Notes was uploaded by Sophie Turner on Wednesday October 28, 2015. The Class Notes belongs to ECON 105 001 at University of New Mexico taught by in Summer 2015. Since its upload, it has received 46 views. For similar materials see Macroeconomics in Economcs at University of New Mexico.

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Date Created: 10/28/15
MONEY 3 functions of Money 0 Medium of exchange an item buyers give to sellers when they want to purchase GampS Unit 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 present to the future 0 2 kinds of money Commodity money takes the form of a commodity with intrinsic value EX gold coins Fiat Money Money without intrinsic value used as money because of government decree EX US dollar 0 The money stock 0 The money stock is the quantity of money available in the economy 0 Currency the paper bills and coins in the hands of the nonBank public 0 Demand Deposits balances in the bank accounts that depositors can access on demand by writing a check 0 A lot of currency is abroad and with illegal activities ie drug dealers M1 0 Demand deposits Travelers check 0 Other checkable deposit 0 Currency M2 saving deposits 0 Small time deposits 0 Money market mutual funds 0 A few minor categories 0 Everything in M1 Central banks and monetary policy 0 Central bank an institution that oversees the banking system and regulates the money supply 0 Monetary Policy the setting of the money by policy makers in the central bank 0 Federal reserve the central bank of the US Created in 1913 0 After a series of bank failures in 1907 Fed has 2 jobs 0 To regulate the banks and ensure the health of a nations banking system c To control the quantity of money in the economy money supply 0 Structure of the fed 0 Board of Governors 7 members in DC o 12 regional fed banks 0 Located around the us Federal open market committee FOMC 7 members of board of governors 5 of the 12 regional bank presidents All 12 are there only 5 get to vote Meets every 6 weeks in DC 0 Discuss the condition of the economy Consider changes in monetary policy Bank Reserves 0 Reserves deposits that banks have received but have not loaned out o The reserve ration R fraction of deposits that banks hold as reserves total reserves as a percentage of total deposits 0 Reserve requirements 0 Regulations on the minimum amount of reserves that banks must hold against deposits 0 Banks may hold more than this minimum if they choose Bank T account T account is a simpli ed accounting statement that shoes a banks assets and liabilities EX Assets Liabilities Reserves 10 Deposits 100 Loans 90 0 Banks Liabilities include deposits assets include loans and reserves 0 In this example notice that R1010010 Banks and the Money Supply Example Suppose 100 of currency is in circulation To determine banks39 impact on money supple we calculate the money supply in 3 different cases 0 No banking system 100 reserve banking system 0 Banks hold 100 of deposits as reserves make no loans 0 Fractional reserve banking system 0 CASE 1 No Banking system public holds the 100 as currency Money supply 100 Case 2 100 reserve banking system publicdeposits the 100 at the First national Bank FNB FNB holds 100 of deposits as reserves Money supply currencydeposits0100100 CASE 3 Fractional Reserve banking system Suppose R10 FNB loans all but 10 of the deposit Depositors have 100 in deposits barrowers have 90 in currency CD MS 90100190 How did the money supply grow 0 When banks make loans they create money the barrower gets 90 in currency an asset counted as money supply 0 90 in new debt a liability that does not have an offsetting effect on the money supply A FRACTIONAL RESERVE BANKING SYSTEM CREATES MONEY BUT NOT WEALTH Barrower depostis the 90 at the second national bank Initially SNB39s Taccount looks like this ElE NlEl HHTlD l aL Assets Lieliillii39ties Reserves Elepssits E E30 s 33 31 If R10 for SNB it will oan all but 10 of the deposit SNB39s barrower deposits the 81 at Third National Bank Initially TNB39s Taccount looks like this Lssns 39ll39llIIR H Tll N L lial Assets Lisliillii39ties Essewes 31 Elepssits E El Lssns 290 If R10 for TNB it will oan all but 10 of the deposit The process continues and money is created with each new loan 0 Original deposit 10000 FNB lending 9000 SNB lending 8100 7290 TNB lending Tota money suppy100000 o The Money Multiplier The amount of money the banking system generates with each dollar of reserves The money multiplier 1R In our example R10 money multiplier 1R 10 100 of reserves creates 1000 of money 0 EXAMPLE while cleaning your apartment you look under the sofa cushion and ns a 50 bill You deposit the bill in your checking account The Fed39s reserve requirement is 20 of deposits A What is the money multiplier 1R125 B What is the Maximum amount that the money supply could increase 5x50250 but the money supply also includes currency which falls by 50 Hence the Max increase in money supply is 200 Fed39s tools of monetary Control Earlier we learned Money suppymoney multiplier x bank reserves The fed can change the money supply by changing bank reserves or changing the money multiplier How the Fed in uences Reserves Open Market Operations OMO39s The purchase and sale of US government bonds by the Fed If the Fed buys a government bond from a bank it pays by depositing new reserves in that bank39s reserve account A Increase the money supply 0 To decrease bank reserves and the money supply the Fed sells Government bonds Fed lending to banks 0 Traditional method adjusting the discount rate the interest rate on loans the fed makes to banks to in uence the amount of reserves banks barrow New Method Term Auction Facility The Fed chooses the quantity of reserves it will loan then banks bid against each other for these loans Feds set reserve requirements 0 Reducing reserve requirements woiuld lower the reserve ration and increase the money multiplier gt increase money supply Feds pay interest on reserves 0 Raising this interest rate would increase the reserve ration and lower the money multiplier gtdecrease the money supply Problems controlling the money supply The Fed39s control the money supply 0 Not precise The Fed does not control 0 The amount of money that households choose to hold as deposits in banks 0 The amount that bankers choose to lend o Bank runs Depositors suspect that a bank may go bankrupt quotrunquot to the bank to withdraw their deposits 0 Problem for banks under fractionalreserve banking Cannot satisfy withdraw requests from all depositors Great depression early 193039s 0 Wave of bank runs and bank closings Households and bankers more cautious House holds A Withdrew their deposits from banks Bankers responded to falling reserves A Reducing bank loans B Increased their reserve rations C Smaller money multiplier D Decrease in money supply 0 Bank runs today 0 Not a major problem for US banking system c The federal Government Guarantees the safety of deposits at most banks A Federal Deposit insurance Corporation FDIC The federal Funds rate 0 On any given day banks with insufficient reserves can barrow from banks with excess reserves 0 The interest rate on these loans is the FEDERAL FUNDS RATE The FOMC uses OMO39s to target the fed funds rate 0 Changes in the fed funds rate cause changes in other rates and have a big impact on the economy Summary of Ch 11 0 Money serves 3 functions 0 Medium of exchange 0 Unit of account 0 Store of value c There are two types of money Commodity money has intrinsic value FiatNo intrinsic value c The US uses at money which includes currency and various types of bank deposits


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