test4-slides

Uses of Money

• Anything that serves all of the following purposes can be thought of as money:

• Medium of exchange — accepted as payment for goods and services (and debts).

• Store of value — can be held for future purchases.

Basic Money Supply

• The basic money supply is referred to by the abbreviation M1.

• M1 is currency held by the public, plus balances in transactions accounts&.so-called checkable deposits

• Currency and coins account for less than half of the basic money supply.

• Most money consists of balances in transactions accounts.

Money Supply: M1, M2

Currency + checkable deposits + Traveler’s checks =

M1

Creation and Destruction of Money

• Banks create money by making loans

– This money is new money in the form of additional checkable deposits

Deposit Creation

• A bank effectively creates money when it makes a loan or when it invests

• Transactions-account balances are counted as part of the money supply.

• Transactions-account balances are the largest part of the money supply.

Reserve Requirement

The reserve ratio is the ratio of a bank’s reserves to its total deposits.

Reserve ratio = required reserves / deposits

Required Reserves

• Required Reserves are the minimum amount of liquid assets a bank is required to hold by government regulation

• Required reserves are equal to the required reserve ratio times transactions deposits.

Required Reserves = Reserve Ratio * Deposits

EX. If bank deposits equal 10 million dollars and the the reserve ratio is 10%, then&

Excess Reserves

• Excess Reserves are bank reserves (liquid assets) in excess of required reserves.

• The ability of banks to make loans depends on its excess reserves, since excess reserves are the loanable reserves of a bank.

Excess Reserves = Total Reserves – Required Reserves

EX. If a bank’s total reserves are 2 million dollars and its required reserves are 1 million dollars, then&&&..

Excess Reserves = 2,000,000 $ - 1,000,000 $ = 1,000,000 $

The Deposit Multiplier

(and the Credit Multiplier)

• The deposit multiplier is the number of deposit dollars that the banking system can create from $1 of reserves.

d = 1 / reserve ratio

Deposits = d * Reserves

• It can also be called the credit multiplier when it serves to estimate the number of credit dollars that the banking system can create from $1 of excess reserves.

d = 1 / reserve ratio

Limits of Deposit Creation

• If the required reserve ratio = .25, then the deposit multiplier = 4

• If excess reserves are 25 $, then potential new deposit creation = 100$

• Each bank may lend an amount equal to excess reserves and no more.

Money Supply

The money supply is controlled by the Federal Reserve through: _{Open-market operations}

_{Changing the reserve requirements Changing the discount rate}

Because it is fixed by the Federal Reserve, the quantity of money supplied does not depend on the interest rate. The fixed money supply is represented by a vertical supply curve.

Money Demand

Money demand is determined by several factors.

Equilibrium in the Money Market

Quantity of

Money

Interest

Rate

0

Money

demand

Quantity fixed

by the Fed

Money

supply

r

M

r

M

Changes in the Money Supply

_{The Fed can shift the aggregate demand curve when it changes monetary policy.}

_{An increase in the money supply shifts the money supply curve to the right.}

_{Without a change in the money demand curve, the interest rate falls.}

Y

AD₂ 3. …which increases the quantity of

goods and services demanded at a given price level. 1. When the Fed increases the money supply…

MS

Expansionary Monetary Policy

Y

P

Quantity

of Output

0

Price

Level

demand, AD₁

The Money Market

Quantity

of Money

0

r

Interest

Rate

The Aggregate-Demand Curve

r

Changes in the Money Supply

_{When the Fed increases the money supply, it lowers the interest rate and increases the} quantity of goods and services demanded at any given price level, shifting aggregate-demand to the right.

Summary

_{Policymakers can influence aggregate demand with monetary policy.}

_{An increase in the money supply will ultimately lead to the aggregate-demand} increasing&&&&..a decrease in the money supply will ultimately lead to the aggregate-demand decreasing

_{Because monetary and fiscal policy can influence aggregate demand, the}