3/1/12
Upcoming Events:
 SECOND MIDTERM: Tuesday, March 13. Chapters 2, 4-12. (Emphasis on 7-9, 11, 12)
 Current Online Discussions:
Liounis v. Lympus: Should you put your savings in the Stock Market?
Orteza vs. Keplinger: Is Immigration Good for the Economy? (ends Sunday)
Assignment:
 Read Chapter 12.
Announcements:
 Office hours TTh 2:00-4:30, W1:30-2:30. Or by appointment.
Key Points from Last Class:
 Risk may be mitigated through diversification. For example, insurance companies’s ability to
diversify risk allows them to make a profit by taking on risk for pay.
 Diversification can't remove all risk; the risk remaining after you are fully diversified is called
aggregate risk (or systematic risk), and it arises from the overall movements of the market.
 On average, returns in the stock market go to stockholders who take on aggregate risk, not to
those who take on the idiosyncratic risk of particular stocks.
 To avoid a death spiral due to ADVERSE SELECTION, health insurance companies must deny
coverage due to pre-existing conditions, unless health insurance is mandatory.
 MORAL HAZARD is the tendency of insured people to take on risks they wouldn’t without insurance.
 FUNDAMENTAL ANALYSIS is a method of determining whether a stock's price will rise or fall in the
future based on the profitability and growth prospects for the company (PV of future profits).
 TECHNICAL ANALYSIS is a method of determining whether a stock's price will rise or fall in the
future based on historical patterns of its price. ("The trend is your friend!")
 The EFFICIENT MARKETS HYPOTHESIS says that the market price takes into account all relevant
information, so you can't determine whether a stock's price will rise or fall in the future using
either fundamental or technical analysis. It’s a controversial hypothesis, though the average
person buying stocks should always keep it in mind.
 Money facilitates efficient trade.
It is a medium of exchange, a unit of account, and a store of value.
 Money can be a commodity (with intrinsic value), or fiat.
 Liquidity is the ability of an asset to be converted into a medium of exchange.
Current Class Outline:
XI. The Monetary System
A. The Meaning of Money
B. The Federal Reserve System
C. Banks and the Money Supply
American Eagle Coins, US Silver Dollar, Gold Eagle, Platinum Eagle, High-Relief Eagle
Liberty Dollar Wikipedia Entry

“Remember when gas was only 25-cents a gallon? You could take a dollar down to the gas station and buy four
gallons for a buck! . . . Guess what? That same amount of silver still buys four gallons of gas!”
– Bernard von NotHaus (currently facing a 15-year federal sentence)

Actually, it's 10 gallons of gas now: Price of Silver; Price of Gasoline
Yap - Analysis
Current Money Supply & Monetary Data
Historical Money Supply & Other Economic Data
Interest Rate Data
http://www.federalreserve.gov/bios/
Twelve Regional Banks
Purposes and Functions of the Fed
Interest on Reserves: A New Fed Tool
Monetary Components (Numbers are rounded)
Demand Deposits:
Currency in Circ:
Travelers’ Checks:
M1:
Savings Deposits:
Small Time Deposits:
Money Market Funds:
M2:
$1116B
$1018B
$
4B
$2138B
$6212B
$ 740B
$ 673B
$9763B
Monetary Base = Currency in Circulation + Currency in Banks + Banks' Deposits at Fed
= Total Currency + Banks' Deposits at the Fed
= $2641 B
Since January 2008:
M1 has grown 61%, or 17% per year
M2 has grown 30%, or 9% per year.
The monetary base has grown 218%, or 47% per year.
Excess reserves have grown to $1.5 trillion from about $2 Billion (75,000%, or 808% per year).
Assume that the Required Reserve Ratio is .10 or (10%):
1. Mr. Jones takes $1000 cash from his pocket and deposits it in
Stop’n’Rob National Bank: 100% Reserves
Assets
Liabilities
Reserves +$1000
Deposits +$1000
1) After Mr. Jones' deposit, what are the bank’s Total Reserves?
a) $1000
b) $900
c) $100
d) Can't be determined from the information given.
2) After Mr. Jones' deposit, what are the bank’s Required Reserves?
a) $1000
b) $900
c) $100
d) $0
3) After Mr. Jones' deposit, what are the bank’s Excess Reserves?
a) $1000
b) $900
c) $100
d) $0
4) How much does Mr. Jones' action of depositing $1000 currency into his checking account directly change M1?
a) -$1000
b) +$1000
c) $100
d) $0.
2. The Bank loans as much as it can to Ms. Smith, who takes cash
Stop’n’Rob National Bank: 10% Reserves
Assets
Liabilities
Reserves $100
Deposits $1000
Loans
$900
5) After Ms. Smith leaves the bank with her cash, what are the bank’s Required Reserves?
a) $1000
b) $900
c) $100
d) $0.
6) After Ms. Smith leaves the bank with her cash, what are the bank’s Excess Reserves?
a) $1000
b) $900
c) $100
d) $0
7) How much does Ms Smith's loan directly change M1?
a) -$1000
b) +$1000
c) +$900
d) $0.
3. Ms Smith buys a $900 TV set from Rex, who deposits the money in his account at Stop’n’Rob:
Stop’n’Rob National Bank
Assets
Liabilities
Reserves
Deposits
Loans
8) After Rex's deposit, what are the bank’s Total Reserves?
a) $1000
b) $900
c) $100
9) After Rex's deposit, what are the bank’s Required Reserves?
a) $900
b) $190
c) $100
10) After Rex's deposit, what are the bank’s Excess Reserves?
a) $900
b) $810
c) $710
d) $0
11) How much does Rex's action of depositing $900 into his checking account directly change M1?
a) -$900
b) +$900
c) $1900
d) $0.
12) How much M1 has been created so far since Mr. Jones made his original deposit?
a) $1000
b) $900
c) $1900
d) $0.
1. The Bank loans as much as it can to Mr. Black, who takes cash
Stop’n’Rob National Bank
Assets
Liabilities
Reserves
Deposits
Loans
13) After Mr. Black leaves the bank with his $810 cash, what are the bank’s Required Reserves?
a) $1000
b) $190
c) $100
d) $0.
14) After Mr. Black leaves the bank with his cash, what are the bank’s Excess Reserves?
a) $1000
b) $190
c) $810
d) $0.
15) How much does Mr Black's loan directly change M1?
a) -$810
b) +$810
c) +$190
d) $0.
16) How much M1 has been created so far since Mr. Jones made his original deposit?
a) $1000
b) $1710
c) $1900
d) $0.
Then Mr. Black spends his money; the recipient deposits it in the bank, then the bank loans out its excess reserves,
creating more money, and the cycle repeats.
17) Suppose you have saved $10,000 and want to put your savings into the stock market. By buying into a welldiversified mutual fund, or otherwise spreading your savings among many different companies' stocks (instead
of putting all $10,000 into a single company's stock) you can
a) Reduce your overall risk, but not eliminate your systematic risk.
b) Eliminate systematic risk, but not your exposure to risk from the ups and downs of any particular company.
c) Eliminate all risk you face from fluctuating stock prices.
d) Eliminate none of the risk you face from fluctuating stock prices.
18) “Total Currency” = “Currency in Circulation” + “Currency Held by Banks.”
Consider also the following definitions:
Monetary Base = “Total Currency” + “Account balances at the Fed” and
Reserves = “Currency Held by Banks” + “Account balances at the Fed”
It is true therefore, by definition, that the Monetary Base equals
a) M1 + Reserves.
b) M2 + Reserves.
c) Currency in Circulation + Excess Reserves.
d) Currency in Circulation + Reserves.
Recall that M1 is defined as follows:
M1 = Currency in Circulation + Demand Deposits + Travellers Checks.
Monetary Base = “Total Currency” + “Account balances at the Fed” and
Reserves = “Currency Held by Banks” + “Account balances at the Fed”
Total Currency = “Currency in Circulation” + “Currency Held by Banks.”
19) Given the above definitions, what is the relationship between the money supply, (as measured by M1) and the
monetary base?
a) the money supply (M1) and the monetary base are the same thing.
b) the money supply (M1) is part of the monetary base
c) the monetary base and the money supply have a common element, but are not the same thing.
d) the monetary base is part of M1.
M1 = Currency in Circulation + Demand Deposits + Travellers Checks.
Monetary Base = “Total Currency” + “Account balances at the Fed” and
Reserves = “Currency Held by Banks” + “Account balances at the Fed”
Total Currency = “Currency in Circulation” + “Currency Held by Banks.”
20) Suppose the Fed buys $1 billion in bonds from a bank, which it pays the bank for by increasing the balance in
the bank’s account at the Fed by $1 billion.
This action by itself increases
a) the money supply (M1) and the monetary base.
b) the monetary base, but not the money supply (M1).
c) the money supply (M1), but not the monetary base.
d) neither the money supply (M1) nor the monetary base.
M1 = Currency in Circulation + Demand Deposits + Travellers Checks.
Monetary Base = “Total Currency” + “Account balances at the Fed” and
Reserves = “Currency Held by Banks” + “Account balances at the Fed”
Total Currency = “Currency in Circulation” + “Currency Held by Banks.”
21) Thus the Fed, through its open market operations, has direct control over
a) both the money supply (M1) and the monetary base.
b) the monetary base, but not the money supply (M1).
c) the money supply (M1), but not the monetary base.
d) neither the money supply (M1) nor the monetary base.
22) If the Fed directly controls the monetary base, but not M1 or M2, why do economists often say that the Fed
controls the money supply (M)?
a) The monetary base and the money supply are nearly the same thing.
b) The monetary base is a better measure of M than either M1 or M2 are.
c) The Fed controls the monetary base, from which banks make loans, and banks’ loans create money, so the
Fed has considerable control over M.
d) Economists generally have no clue what they are talking about.
Current Class Outline:
XII. Money Growth and Inflation
A. Money Supply and Demand
B. The Classical Theory of Inflation
C. The Costs of Inflation
Zimbabwe (Wikipedia)
More on Zimbabwe
Weimar Republic of Germany`
Hyperinflation Episodes in History
Hyperinflation (Cato Institute)
Wizard of OZ
“Inflation is always and everywhere a monetary phenomenon.”
- Milton Friedman