Money, Monetary Policy and Economic Stability

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Unit 4

• Money, Monetary Policy and Economic Stability

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Money
Unit IV Lesson 1

• Before money, economies used a barter system
• Problem double coincidence of wants
• Basic properties of any commodity used as money
• Portability, uniformity, stability in value and
  acceptability

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Functions of Money
Unit IV Lesson 1

• Medium of Exchange function eliminates the need
  for the double coincidence of wants
• The Store-of-value function permits money to be
  held for use at a later time
• The Unit-of-Account, or Standard-of-Value
  function means there is an agreed-to measure for
  stating the prices of goods and services. This
  simplifies price comparisons.

4
Complete Activity 34 and review answers
Unit IV Lesson 1
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Definitions of Money in the U.S.
Unit IV Lesson 1

• M1
• Consists of currency, travelers checks, and
  checkable deposits
• M2
• Includes M1 plus savings deposits, small time
  deposits, money market deposit accounts (MMDAs),
  noninstitutional money market mutual funds
  (MMMFs) and other deposits
• M3
• Includes M2 plus large (100,000 or more) time
  deposits

6
Complete Activity 35 and review answers
Unit IV Lesson 1
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Equation of ExchangeMVPQ
Unit IV Lesson 2

• M M1, stock of money
• V Income (GDP) velocity of circulation or
  average number of times 1 is spent on final
  goods and services in a particular time period
• P average price level of final goods and
  services in GDP, also known as the GDP deflator
• Q real output, the quantity of goods and
  services in GDP

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Unit IV Lesson 2

• Evidence shows that income velocity (V) is highly
  predictable with its value remaining in a very
  narrow range over a multiyear period
• Thus, changes in the money supply (M) result in
  changes in Nominal GDP (PxQ)
• Depending on the state of the economy, the
  changes in the money supply can result in changes
  in prices, in output only or in some combination
  of both

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Complete Activity 36 and review answers
Unit IV Lesson 2
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Financial Intermediaries
Unit IV Lesson 3

• Bringing people who want to borrow funds together
  with people who want to lend funds
• Examples commercial banks, savings and loans
  associations, savings banks, credit unions
  money market mutual fund companies
• Functions
• liquidity creation, minimization of the cost of
  borrowing, minimization of the cost of monitoring
  borrowers and risk reduction through pooling

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Fractional ReserveSystem of Banking
Unit IV Lesson 3

• Banks any depository institution whose deposits
  are a part of M1.
• Banks must hold a specific percentage of deposits
  as reserves this percentage is called the
  required reserve ratio
• The deposit that is not part of required reserves
  is called excess reserves

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Unit IV Lesson 3

• Banks may loan excess reserves or buy government
  securities
• A bank makes a loan by creating a a checkable
  deposit for the borrower this results in an
  increase in the money supply

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Money Expansion Multiplier
Unit IV Lesson 3

• Exists because the reserves deposits lost by
  one bank are received by another bank
• It magnifies excess reserves into a larger
  creation of checkable-deposit money
• Deposit expansion multiplier ____1____
• reserve requirement
• Expansion of the money supply
• excess reserves x deposit expansion multiplier

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Unit IV Lesson 3

• Higher reserves lower money expansion
  multipliers and a decrease in the money supply
• Total increase in money supply may be less than
  predicted by the money expansion multiplier if
• Borrowers do not spend all the money they borrow
• Banks do not lend out all their excess reserves
• People hold part of their money as cash

15
Complete Activity 37 and review answers
Unit IV Lesson 3
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The Federal Reserve System
Unit IV Lesson 4

• Has the responsibility to control the money
  supply to promote the economic goals of full
  employment, price stability and stable economic
  growth
• Board of Governors
• Central authority, 7 member board, serve 14 year
  terms
• Chairman Alan Greenspan
• Federal Open Market Committee (FOMC)
• 7 members of the board and 5 of the presidents of
  the Federal Reserve Banks
• Sets the Feds monetary policy and directs the
  purchase and sale of govt securities

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Tools of the Fed
Unit IV Lesson 4

• Open-Market Operations
• The buying of bonds or securities from (increase
  money supply), or the selling of bonds to
  (decrease the money supply), commercial banks and
  the public
• Feds most important instrument for influencing
  the money supply

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Unit IV Lesson 4

• Reserve Ratio
• Raising the reserve ratio decrease in money
  supply
• Lowering the reserve ratio increases the money
  supply
• The Discount Rate
• Interest Rate charged on short-term loans from
  the Fed to commercial banks
• Lower discount rate increase in money supply
• Higher discount rate decrease in the money
  supply

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Complete Activity 38 and review answers
Unit IV Lesson 4
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The Money Market
Unit IV Lesson 5

• The Demand for Money
• Transactions demand the demand for money to
  make purchases of goods services
• Precautionary (liquidity)demand the demand for
  money to serve as protection against unexpected
  need
• Speculative demand the demand for money because
  it serves as a store of wealth
• How much of your wealth do you want to hold as
  money how much do you want to hold as
  interest-bearing assets?

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Explain and Illustrate Visual 4.1
Unit IV Lesson 5
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Explain and IllustrateVisual 4.2
Unit IV Lesson 5
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Explain and Illustrate Visual 4.3
Unit IV Lesson 5
24
Complete Activity 39 and review answers
Unit IV Lesson 5
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Explain and IllustrateVisual 4.4
Unit IV Lesson 5
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Understand?
Unit IV Lesson 5

• Fed purchases Treasury securities
• Money supply increases
• Interest rate decreases
• Investment increase ( interest-sensitive
  components of consumption spending increase)
• Aggregate Demand increases
• Output increases and the Price Level increases

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Unit IV Lesson 5

• Fed sells Treasury securities
• Money supply decreases
• Interest rate increases
• Investment decreases ( interest-sensitive
  components of consumption spending decrease)
• Aggregate Demand decreases
• Output decreases and the Price Level decreases

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Complete Activity 40 and review answers
Unit IV Lesson 5
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Interest Rates and Monetary Policy in the Short
Run the Long Run
Unit IV Lesson 6

• Nominal interest rate
• Rate that appears on the financial pages of
  newspapers ads for financial institutions
• Not adjusted for inflation
• Real interest rate
• Increase in purchasing power the lender wants to
  receive to forego consumption now for consumption
  in the future
• Adjusted for inflation
• Real interest rate Nominal interest rate
  inflation rate Fisher Equation

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Two Relationships between the real and nominal
interest rates
Unit IV Lesson 6

• Ex ante real interest rate (expected interest
  rate)
• equals the nominal interest rate minus the
  expected inflation rate
• Ex poste real interest rate (real interest rate
  actually received)
• Equals the nominal interest rate minus the actual
  rate of inflation

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Equation of exchangeMVPQ
Unit IV Lesson 6

• Looking at this equation, we see that changes in
  the money supply holding velocity real output
  constant lead to changes in the price level
• These changes in the price level change the
  nominal interest rate once they are anticipated

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Complete Activity 41 and review answers
Unit IV Lesson 6
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Complete Activity 42 and review answers
Unit IV Lesson 6
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REVIEW FOR UNIT IV EXAM