10/31/2012
Upcoming Events:
 SECOND MIDTERM: Monday, November 5 (THIS COMING MONDAY).
Chapters 2, 4-12, readings; emphasis on 8, 9, 11, 12.
BRING: Scantron 30423, #2 pencil. Optional: One 3x5 card with notes, Simple calculator.
Assignment:
 Read Mankiw Brief Principles of Macroeconomics Chapter 12, “Money Growth and Inflation.”
 One Aplia problem set (on Chapter 12) due this week.
Announcements:
 Prof. Stratford Douglas, 416 B&E, 304-293-7863, smdouglas@mix.wvu.edu.
My office hours are MW following this class. Normally I will stay until 5:00 or later you like.
Let me know if you’re coming. For an appointment at another time, email me.
 The TA for this class is Imran Arif. Imran.Arif@mail.wvu.edu.
Imran’s Office Hours are MW 11:20–1:20 & Friday 12:00-1:00 in the BLRC (349 B&E).
Key Points from Last Time:
 Monetary Base = (Currency in Circulation) + (Currency in Bank Vaults) + (Banks' Balances at the
Fed).
 RESERVES = (Cash in Bank Vaults) + (Bank Balances at Fed)
 RESERVE RATIO = R = Reserves/Deposits.
 REQUIRED RESERVES = (Required Reserve Ratio) x (Checking Deposits).
 EXCESS RESERVES = Reserves  (Required Reserves).
 Banks create money by making loans from their excess reserves.
 The “Money Multiplier” gives the maximum amount of new money that can be created from an
additional dollar of excess reserves. It equals 1/R, so
Change in the Money Supply (1/R) x (Change in Excess Reserves).
 The amount of new money created from an additional dollar of excess reserves will be less than
the money multiplier if (1) the public does not deposit all the loan proceeds back into the banking
system, or (2) if banks decide to hold excess reserves rather than loaning them out.
 The Fed has historically used three tools to control the money supply. It can REDUCE the money
supply by 1) Selling bonds, 2) Raising the required reserve ratio, or 3) Lending reserves to banks
through the Discount Window at the "Discount Rate". (More recently, it’s lent through TALF.)
 Currently, the Fed is paying interest on the reserve accounts (IOR) that banks hold at the Fed.
This interest rate is a fourth monetary policy tool. An increase in IOR encourages banks to hold
excess reserves rather than lending them out, reducing the money supply.
 In normal times, banks do not hold much in excess reserves. These are not normal times.
 Banks lend to each other overnight at the FEDERAL FUNDS RATE, which they determine privately.
Fed policy targets this rate in the short run, and affects longer term rates more indirectly.
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 Hyperinflation (Wikipedia)
More on Zimbabwe
Weimar Republic of Germany`
Hyperinflation Episodes in History
Hyperinflation (Cato Institute)
Inflation is always and
everywhere a monetary
phenomenon.”
- Milton Friedman
Monetary Components (Numbers are rounded, monthly, seasonally adjusted)
Demand Deposits:
Currency in Circulation:
Travelers’ Checks:
M1:
Savings Deposits:
Small Time Deposits:
Money Market Funds:
M2:
$1307B
$1069B
$
4B
$2380B
$6457B
$ 668B
$ 622B
$10,127B
Monetary Base = Currency in Circulation + Currency in Banks + Banks' Deposits at Fed
= Total Currency + Banks' Deposits at the Fed
= $2616 B
Since January 2008:
M1 has grown 70%, or 14% per year.
M2 has grown 40%, or 29% per year.
The monetary base has grown 216%, or 33% per year.
Excess reserves have grown to $1.4 Trillion from $1.65 Billion (85,300%, or 414% per year).
Today's iClicker Questions
These questions will raise your grade if you answer correctly,
and may lower your grade if you don’t answer at all.
Wrong answers neither hurt nor help.
You may go ahead and answer the first question below right now.
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.”
Assume a required reserve ratio R = .05 (that is, 5%).
1) 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 in itself creates ____ in new reserves, ____ in excess reserves, and with subsequent
bank lending could result in the eventual creation of up to _____ in additional money (M1) through
the money multiplier process.
a) $1 billion; $1 billion; $20 billion.
b) $1 billion; $950 million, $20 billion.
c) $950 million; $950 million; $19 billion
d) $1 billion; $950 million, $1 billion
2)
3) Which of the following actions by the Fed will all tend to increase the money supply?
a) buy bonds, lower discount rate, increase required reserve ratio, decrease interest on reserves.
b) buy bonds, lower discount rate, decrease required reserve ratio, decrease interest on reserves.
c) sell bonds, lower discount rate, decrease required reserve ratio, decrease interest on reserves.
d) buy bonds, raise discount rate, decrease required reserve ratio, decrease interest on reserves.
4) 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.
MS
1
MS
2
0.5
0.33
MD
10,000
15,000
5) MS is the Money Supply, MD is Money Demand. The usual quantities are measured on the axes.
If the money supply is currently MS1, the the equilibrium price level is
a) 0.5 and the equilibrium value of money is 2.
b) 2 and the equilibrium value of money is 0.5.
c) 0.5 and the equilibrium value of money can not be determined from the graph.
d) 2.0 and the equilibrium value of money can not be determined from the graph.
MS
1
MS
2
0.5
0.33
MD
10,000
15,000
6) Which of the following could explain a shift of the MS curve from MS1 to MS2?
a) An increase in the interest on reserves (IOR) paid by the Fed.
b) An increase in the value of money
c) A decrease in the required reserve ratio.
d) None of the above is correct.
MS
1
MS
2
0.5
0.33
MD
10,000
15,000
7) MS is the Money Supply, MD is Money Demand. If the money supply moves from MS1 to MS2,
perhaps because of the Fed purchasing bonds on the open market, the price level will
a) increase to 3 and the value of money will fall.
b) fall to 0.33 and the value of money will fall also
c) increase to 3 and the value of money will rise also.
d) fall to 0.33 and the value of money will rise.
Answers:
1) A
2) D
3) B
4) C
5) B
6) C
7) A