Unit 4 - Single Banks/Banking System

When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON MONEY SUPPLY.

It only changes:

• The composition of money
• Excess Reserves
• Required Reserves

Single Bank: only loan money from Excess Reserves (ER)

Banking System: (ER * MULTIPLIER)

Total Money Supply

Unit 4 - Expansionary/Contractionary (3-21-16)

3 Tools of Monetary Policy

1) Reserve Requirement: Only a small percent of your bank deposit is in the safe, the rest of your money has been loaned out. This is "Fractional Reserve Banking". The FED sets the amount that banks must hold.

• When the FED increases the money supply it increases the amount of money held in bank deposits.

2) Discount Rate: Interest rate that the FED charges commercial banks
Example: If Bank of America needs $10 million, they borrow it from the U.S. Treasury (which the FED controls), but they must pay it back with interest.

• To INCREASE money supply, the FED should DECREASE the discount rate (expansionary)
• To DECREASE money supply, the FED should INCREASE the discount rate (contractionary) 

3) Open Market Operations: The FED buys/sells government bonds (securities). This is the most important and widely used monetary policy.

• To INCREASE money supply, the FED should BUY securities.
• To DECREASE money supply, the FED should SELL securities.

Federal Fund Rate: where FDIC member banks make overnight loans to other banks
Prime Rate: interest rate that banks charge to their most credit worthy customers

Unit 4 - FED/Multiple Deposit Expansion (3-10-16)

Federal Reserve Bank (FED)

Functions of FED:

• issues paper money
• sets reserve requirements and holds reserves of the bank
• lends money to banks and charges them interest
• they're a check clearing service for banks
• acts as a personal bank for the government
• supervises member banks
• control money supply

Multiple Deposit Expansion

Reserve Requirement: 

• the % of Demand Deposits that must not be loaned out
• usually 10%, no more
• amount set by the FED
• FED requires banks to always have money available for consumer demand for cash

Three Types of Multiple Deposit Expansion Question

1. Calculate initial change in excess reserves (amount a single bank can loan from initial deposit)
2. Calculate the change in loans in banking system
3. Calculate change in money supply 

Unit 4 - Assets & Liabilities (3-9-16)

Financial Sector

1) Financial Assets - stocks or bonds that provide expected future benefits, it benefits the owner only if the issuer of the asset meet certain obligations

2) Financial Liabilities - it is incurred by the issuer of a financial asset to stand behind the issues asset

3) Interest Rate - price paid for the use of a financial asset

4) Stocks - financial assets that convey ownership in a corporation

5) Bonds - promise to pay a certain amount of money plus interest in the future


What Banks Do

• a bank is a financial intermediary
• uses liquid assets (bank deposits) to finance the investments of borrowers
• process known as "fractional reserve banking" = a system in which depository institutions hold liquid assets less than the amount of deposits

Can take the form of
1) Currency in bank vaults
2) Bank reserves - deposits held at federal reserve

T-Account (Balance Sheet): statements of assets and liabilities

Assets: (Amount Owned)

• items to which a bank holds legal claim
• uses of funds by financial intermediaries
• capital stock
• owners equity

Liabilities: (Amount Owed)

• legal claims against a bank 

Unit 4 - Money Demand/Supply/Shifters (3-9-16)

• Demand for money has an inverse relationship between nominal interest rates and quantity of money demanded

1. What happens to quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest assets instead of borrow liabilities 

2. What happens to quantity demanded when interest rates decrease?

• Quantity demanded increases, there is no incentive to convert cash into interest earning assets.

Money Demand Shifters:

1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment

Money Supply:

• If FED increases money supply, a temporary surplus of money will occur at 5% interest. This surplus will cause interest rate to fall to 2%

How does this affect AD?
Increase money supply --> Decrease interest rate --> Increase investment --> Increase AD

Decrease money supply --> Increase interest rate --> Decrease investment --> Decrease AD

Unit 4 - Time Value of Money (3-9-16)

Is a dollar today worth more than a dollar tomorrow?

• Yes, because opportunity cost and inflation, this is the reason for charging and paying interest.

v = future value of $
p = present value of $
r = real interest rate (nominal - inflation rate)
n = years
k = number of times interest is credited per year

Simple Interest Formula: V = (1 + r)^n * p

Compound Interest Formula: V = (1 + r/k)^nk * p

Example

Assume inflation is expected to be 3% and nominal interest rate on simple interest savings is 1%. Calculate value of $ after  1 year. 

Step 1: Calculate real interest rate. (r% = i% - n%) = (1 - 3 = -2%) OR (-.02)

Step 2: Use simple interest formula to calculate future value of $1
V = (1 + r)^n *p
V = .98 * 1
V = $0.98

Unit 4 - Money (3-4-16)

Money

Uses of money:

• Median of Exchange - to trade
• Unit of Account - establishes economic worth in exchange process
• Store of Value - money holds value for period of time

Types of money:

• Commodity - get its value from type of material from which it was made
• Representative - paper money backed up by something tangible, giving it value
• Fiat - money because government says so. 

Characteristics of money:

• Portable
• Durable
• Scarce
• Divisible
• Acceptable
• Uniform

Money Supply:

• M1 money - (1) cash & coins, (2) check-able deposits/demand deposits, (3) travelers checks)
• M2 money - consists of M1 money, savings accounts, market accounts, and deposits held by banks outside the U.S., not as liquid to convert
• M3 money - consists of M2 money and certificates of deposits held by private institutions

Monetary Policy Video Problem III

https://youtu.be/73Kj2huWnOM