Expenditure
C+I+G+net X
equilibrium
C+I
C
=b= marginal propensity to consume
a
45o means Y=C+I+G+net X
income
Expenditure
New equilibrium
New
C+I+G+net X
$10 billion Old equilibrium
More
Govt
Expenditure
C+I+G+net X
45o
HOW MUCH DOES
INCOME RISE?
income
Expenditure
$10 b.
More
Expenditure
45o
$10 b.
Means $9 b.
More income
More income
Means $9
b. more Expend
Means $10 b.
More income
Etc.
Etc.
New
C+I+G+net X
C+I+G+net X
INCOME RISES BY
$100 BILLION.
income
New equilibrium
New
C+I+G+net X
$10 billion Old equilibrium
More
Govt
Expenditure
C+I+G+net X
45o means Y=C+I+G+net X
C+I
C
Shifts of Aggregate Expenditures
Aggregate Expenditure Shifts UPWARD
(A)
EXP
Aggregate Expenditure Shifts Downward:
(B)
(C)
(D)
EXP
EXP
EXP
New equilibrium
FE
FE
New equilibrium
New equilibrium
New equilibrium
FE
45o
FE
45o
45o
Y
Y
FE= Full Employment
45o
Y
Y
The Equation of Exchange
MV=PQ
Where M = Money Supply (use M1)
V= Velocity of Money
P= Price Index
Q= Output=Expenditure=Income=RealGDP
(note: PQ=Nominal GDP
FEDERAL RESERVE BANK
BankA
A Reserves Bank
Bank
BankBB
Account
Account
Account
Account
Canceled check
Check
BANK A
Household
account
Canceled
check
BANK B
Business
account
Money
Deposited
Check
Check
Household
Business
Real goods and services
TYPES OF MONEY
1980 Percentages
Currency
2000 Percentages
115
5.76%
530
7.47%
plus travelers checks
3
0.15%
8
0.11%
plus Demand deposits
261
13.08%
313
4.41%
28
1.40%
239
3.37%
407
20.40%
1090
15.37%
64
3.21%
939
13.24%
plus savings deposits
400
20.05%
1872
26.40%
plus small time deposits**
729
36.54%
1046
14.75%
1600
80.20%
4947
69.75%
260
13.03%
827
11.66%
plus repurchase agreements
58
2.91%
360
5.08%
plus eurodollars
61
3.06%
191
2.69%
Money market funds- institutions only
16
0.80%
767
10.82%
1995
100.00%
7092
100.00%
plus Other checkable deposits*
Equals M1
plus Money market funds, retail
Equals M2
plus large time deposits***
Equals M3
*negotiable order of w ithdraw al (NOW) and automatic transfer service (ATS) accounts
as w ell as credit union share and thrift institution demand deposits
**less than $100,000 excluding retirement accounts
***$100,000 or more but excluding foreign
SETTING UP A NEW BANK AND TAKING DEPOSITS
ASSETS
LIABILITIES
2b. Reserves at Fed 100
2a. Transactions Account 100
1b. Building
1c. Equipment
1a. Equity
TOTAL ASSETS
60
40
200
100
TOTAL LIABILITIES 200
INVESTING NEW RESERVES
ASSETS
LIABILITIES
3a. Reserves at Fed 60
3b. Securities
40
3c Loans
50
1b. Building
1c. Equipment
60
40
TOTAL ASSETS
250
2a. Transactions Account 100
3d. Loan adds purchasing
power to Transactions
Accounts
50
NEWLY CREATED MONEY
1a. Equity
100
TOTAL LIABILITIES 250
THE BORROWER DRAWS DOWN THE LOAN
ASSETS
LIABILITIES
3a. Reserves at Fed 60
4b. Subtracted when
Fed transfers reserves
to another bank -50
3b. Securities
40
3c Loans
50
2a. Transactions Account 100
3d. added by loan
50
4a. Subtracted when
borrower spends
-50
1b. Building
1c. Equipment
1a. Equity
TOTAL ASSETS
60
40
200
100
TOTAL LIABILITIES 200
CHANGING THE RESERVE REQUIREMENT
ASSETS
LIABILITIES
Reserves at Fed 10
Securities
40
Loans
1a new loans
50
5
Building
Equipment
60
40
TOTAL ASSETS
205
Transactions Account 100
1b loan adds money
to transactions
accounts
5
Equity
100
TOTAL LIABILITIES 205
CHANGING THE RESERVE REQUIREMENT
ASSETS
LIABILITIES
Reserves at Fed 10
2a. Reserve drawn
down
-5
Securities
40
Loans
1a new loans
50
5
Building
Equipment
60
40
TOTAL ASSETS
200
Transactions Account 100
1b loan adds money
to transactions
accounts
5
2b. Borrower writes check
on account
-5
Equity
100
TOTAL LIABILITIES 200
OPEN MARKET OPERATIONS
ASSETS
1b.
3b.
1a.
2a.
LIABILITIES
Reserves at Fed 5
FED pays reserves +10
FED transfers
reserves to another
bank
-10
Securities
40
Bank sells
securities
-10
Loans
55
Bank makes loans 10
Building
Equipment
TOTAL ASSETS
60
40
200
Transactions Account 100
2b. Bank adds money
to transactions
account
10
3a. Borrower draws down
loan
-10
Equity
100
TOTAL LIABILITIES 200
DISCOUNTING
ASSETS
LIABILITIES
Reserves at Fed 5
1b. Reserves from Fed 15
3b. FED transfers
reserves to another
bank
-15
Securities
30
Loans
65
2a. Bank makes loans 15
Building
Equipment
TOTAL ASSETS
60
40
215
Transactions Account 100
2b. Bank adds money
to transactions
account
15
3a. Borrower draws down
loan
-15
1a. Discounts
15
Equity
100
TOTAL LIABILITIES 215
CHANGING THE RESERVE REQUIREMENT
FOR A MONOPOLY BANKING SYSTEM
ASSETS
LIABILITIES
Reserves at Fed 10
Securities
40
Loans
1a new loans
50
100
Building
Equipment
60
40
TOTAL ASSETS
300
Transactions Account 100
1b loan adds money
to transactions
accounts
100
Equity
100
TOTAL LIABILITIES 300