Unit 4

Color Coordination

Money
Federal Reserve Bank
Balance sheet
Fiscal Policy
Loanable funds


1. Uses of money
-As a medium of exchange, trading
-Unit of account, establishes economic worth (P » worth (quality))
-Store of value, money holds value over a period of time

2. Types of money
-Commodity money, goods: chicken, beans, shoes. 
     It gets its value from the type of material from which it is made.
-Representative money: IOU, paper money that is backed by something tangible
- fiat money: it is money because the government says so
*America uses fiat money

3. Characteristics of money
- Durability
- portability
- divisibility
- uniformity
- scarcity
- acceptability

4. Money supply
- M1 money; consists of currency in circulation. 
     »Currency is coins and paper money. 
     »Checkable deposits (demand deposits) or checks.
     » traveler's checks
- M2 money; consists of M1 money plus 
     »savings accounts
     »money market accounts
     »deposits held by banks outside the US

»»Fractional reserve banking: it is the process by banks of holding a small portion of their deposits in reserve and loaning out the excess
1. Banks keep cash on hand (required reserves) to meet depositor's need
2. Banks must keep reserved deposits in their vaults or at the federal reserve bank
3. Total reserves, total funds held by a bank,
    *TR = (required reserves) RR + ER (excess reserves, reserves beyond those that are required )
4. Banks can legally lend only to the extent of their excess reserves
5. Reserve ratio = required reserves divided by total reserves.  *RR / TR
     ***typical required reserve ratio = 10%, set by the Fed

»»Significance of a fractional reserve system
1. 
2. Required reserves do not prevent bank pennants because banks must keep their required reserves (fdisd)
3. Reserve requirements gives the Fed control over how much money banks can create


»»Functions of the Fed (federal reserve bank)
1. To control the money supply through monetary policy (circulation of currency and adjusting the interest rate)
2. Issue paper money
3. Serve as a clearing house for checks
4. Regulate banking activities
5. Serve as a bank for banks

»»»Balance sheet:
A statement of assets and claims summarizing the financial position of a firm or a bank at some point in time
 *A balance sheet must balance at all times
»»Assets vs liabilities
»Assets:
     -What you own
     -Reserves:
          - required reserves (RR) - % required by Fed to keep on hand to meet demand
          - excess reserves (ER) - % reserve over and above the amount needed to satisfy the minimum reserve ratio set by Fed
     -Loans and firms, consumers, and other banks (earns interest)
     -Loans to government = treasury securities
     -Bank property - (if bank fails, you could liquidate the building / property)

»Liabilities + owner's equity or network:
     -What you owe
     -Claims of non owners
     -Demand deposits ($ put into bank)
     -Times deposits (CDs)
     -Loan firms: federal reserve and other banks
     -Shareholders equity - (to set up a bank, you must invest your own money in it to have a stake in the banks success or failure)

100% reserve banking have no impact on size of money supply

In a fractional-reserve bank system, banks create money

»»  the required reserve ratio
-The % of demand deposits that must be sure as vault cash or kept on reserve as federal funds in the bank's account with the federal reserve.
-The required reserve ratio determines the money multiplier (1/reserve ratio )
     -decreasing the reserve ratio increased the rate of money creation in the banking system and is expansionary
     -increasing the reserve ratio decreases the rate of money creation in the banking system and is Contractionary
-Changing the required reserve ratio is the least used tool of monetary policy and is usually held constant at 10%

»»The monetary (money) multiplier
-The money multiplier shows us the impact of s change in demand deposits on land and eventually the money supply
-The money multiplier indicates the total number of dollars created in the banking system by each 1$ addition to the monetary base (bank reserves & currency in circulation)
-To calculate the money multiplier, divide 1 by the required reserve ratio
     Money multiplier = 1/reserve ratio
          EX: if the reserve ratio is 25%, then the multiplier = 4

»»The four types of multiple deposit expansion question
-Type 1: calculate the initial change in excess reserves
     Aka the amount a single bank can loan from the initial deposit
-Type 2: calculate the change in loans in the banking system
-Type 3: calculate the change in the money supply
*sometimes type 2 and type 3 will have the same result (ie no federal involvement)
-Type 4: calculate the change in demand deposits 


»»Fiscal policy
-Controlled by congress
     1. Tax or
     2. Spend
»»Monetary policy
-Controlled by Fed reserve bank
     1. OMO (open market operation - feds can buy or sell bonds/securities) a referred monetary tool because it's flexible
     2. Reserve requirement
     3. Discount rate; it is the interest rate charged by the Fed for over night loans to commercial banks *it doesn't change money supply directly
     4. Federal fund rate; it is the interest rate charged by one commercial bank for overnight loans to another commercial bank

»»»The Fed has several tools to manage the money supply by manipulating the excess reserves held by banks, a practice known as monetary policy
»»The federal tools of $ policy
» expansionary (easy $) - wants to increase money supply
- monetary policy options;
    -open market operation (OMO): buy back bonds from the public
     -Required reserves: decrease reserve ratio
     - discount rate: decrease discount rate
     - Federal funds rate: decrease federal fund rate
»» Contractionary (tight $) - wants to retract money supply
     -OMO: sell bonds to the public
     -RR: increase reserve ratio
     - discount rate: increase discount rate
     -Federal funds rate: increase federal fund rate

»» money creation process
- $ multiplier = 1/RR
- multiple deposit expansion
- Banks create money by making loans
EX: RR = 20%, loan = $500, Q: total money created
1/.2 = 5 x loan, 500 = 2500 money created « potential loans
**assumption: no excess reserves

»»Loanable funds market
- the market whee savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)
- the demand for loanable funds, or borrowing comes from households, firms, government and foreign sector. The demand for loanable funds is in fact the supply of bonds
- the supply of loanable funds, or saving comes from households, firms, government and foreign sector. The supply of loanable funds is also the demand for bonds.

»Changes in the demand for loanable funds
-demand for loanable funds= borrowing (I.e. supplying bonds)
- more borrowing = more demand for loanable funds »
-less borrowing= less demand for loanable funds «
EX: -government deficit spending= more borrowing= more demand for loanable funds therefore DLF » and r%^
- less investment demand= less borrowing= less demand for loadable funds therefore DLF « and r% v

»Changes in supply for loanable funds
-supply of loanable funds= saving (I.e. demand for bonds)
- more saving = more supply in loanable funds »
- less saving= less supply in loanable funds «
EX: -government budget surplus = more saving= more supply of loanable funds therefore SLF » and r%  v
-decrease in consumer's MPS = less saving= less supply of loanable funds therefore SLF « and r%^

Review:
-Required reserves = amount of deposit X required reserve ratio
-Excess reserves = total reserves - required reserve
-Maximum amount in a single bank can loan= the change in excess reserves caused by a deposit
-The money multiplier = 1/required reserve ratio
-Total change in loans = amount single bank can lend X money multiplier
-Total change in the money supply= total change in loans + $ amount of Fed action
-Total change in demand deposit = total change in loans + any cash deposited