Monetary policy

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UNIT 4 - MONETARY POLICY


  • Uses of Money
    • Medium of exchange
    • Unit of account
    • Store of value
  • Store of Value
    • Is this really a dollar?
    • Is this actually worth a dollar?
    • If you have money in an account and money in storage, are they the same value?
      • No, because banks draw interest
  • Types of Money
    • Commodity money
      • Gold, silver
      • significant economic value
    • Representative money
      • IOUs
    • Fiat money
  • Characteristics of money
    • Durability
      • Cutting a dollar in half, going to the bank to exchange it
    • Portability
    • Divisibility
    • Uniformity
    • Scarcity
    • Acceptability 

  • Money Supply
    • M1 Money
      • Cash
      • Coins
      • Currency
      • Traveler's checks (cheques)
      • Demand or checkable deposits
        • Checkable deposits are the largest component of M1
    • M2 Money
      • M1 + savings accounts
    • M3 Money
      • M2 + money market accounts + CD's
      • MMA = An account that grows interest
      • CD = certificate of deposit: people deposit money to bank, interest grows, bank gives money back to you + interest
    • Liquidity (M2 & M3)
      • Easy to convert to cash
  • Liquidity
    • Easy to convert to cash
    • M2 and M3 is very liquid 
    • M1 is not included due to CD's
  • Balance Sheet
    • T-account or T-chart
    • Summarizes the financial position of a bank at a certain time

    •  Assets
       Liabilities
      1. Required Reserves (RR) Percent of DD that must be held in the vault
      1. Demand/Checking Deposits (DD/CC)Cash deposits from the public, liability because they belong to the depositors and can be withdrawn by depositors 
      2. Excess Reserves (ER)Source of new loans
      2. Net Worth/ Owner's EquityValue of stock that is held by public ownership of bank shares
      3. Bank PropertyBuildings and fixtures

      4. Securities or BondsBonds that are previously purchased by the bank or new bonds sold to the bank by the Federal Reserve. Can be purchased from the bank, turned into cash, and immediately available as excess reserves

      5. Loans

    • Usually, Liabilities v. Assets except for banks

  • Fractional Reserve Banking System
    • The banks have to keep a fraction of the total money supply that is held in reserve as currency
    • The bank cannot loan out all the money in the vault
    • Must keep a fraction of the deposits they get in
  • Money Market
    • Market where the Fed and the users of money interact thus determining the nominal interest rate
  • Money Demand(MD)
    • Money demand comes from households, firms, the government, and the foreign sector
    • Downward sloping bc at high interest rates people are less inclined to hold money and more inclined to hold stocks and bonds
    • Two Types of Money Demand
      • Transaction Demand: Demand for money as a medium of exchange
      • Asset Demand: Demand for money as a store of value, dependent upon the interest rate
  • Money Supply (MS)
    • Determined only by the Federal Reserve Bank bc the Fed has the monopoly over money supply 
      • This is why MS has a vertical curve
    • Also vertical because it is independent of the interest rate

    • Expansionary Monetary Policy
      Contractionary Monetary Policy
      1.     MS will shift to the right
      2.     ir decreases
      3.     Discount rate decreases
      4.     Reserve ratio decreases
      5.     Buy bonds (more money)
      6.     MS increases
      1.     MS will shift to the left
      2.     ir increases
      3.     Discount rate increases
      4.     Reserve ratio increases
      5.     Sell bonds (less money)
      6.     MS decreases
    • Loanable Funds
      • Market where buyers and savers meet to exchange funds at the real interest rate
      • Both the demand and supply for loanable funds comes from households, firms, the government, and the foreign sector

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