I. Roles of Money
A. Medium of exchange – an asset that individuals use to trade for goods and
services
B. Store of Value - a way of holding purchasing power over time
C. Unit of account – measure individuals use to set prices and make economic
calculations
http://www.brainpop.com/socialstudies/economics/money/
II. Definition of Money
A. M1
1. currency
2. checkable deposits
3. traveler’s checks
B. M2
1. M1
2. Near Monies – financial assets that are highly liquid but not directly usable
a. Savings deposits
b. Money market funds
c. Small time deposits – CDs
C. M3
1. M1 and M2
2. large time deposits
VI. Bank T accounts
A. Financial spreadsheet that displays an institution’s financial
B. Assets
1. economic resources, things of value
2. on the left side of the T-account
C. Liabilities
1. debts
2. on the right side of the T-account
position
Work through this example:
Suppose Narvaizville has a single bank that has:
• $20,000 of deposits
• $4000 of reserves
• $16,000 of loans
• Narvaizville’s central bank has 10% reserve requirement.
Construct a T-account depicting this situation. Make sure you:
• differentiate between required and excess reserves
• Have assets equal to liabilities.
Assets
Required Reserves $2,000
Excess Reserves $2,000
Loans $16,000
Liabilities
Deposits $20,000
Work through this example:
Remember the reserve requirement is 10%
What is the multiplier ?
1/rr = 1/.1 = 10
Assets
Required Reserves $2,000
Excess Reserves $2,000
Loans $16,000
Liabilities
Deposits $20,000
Work through this example:
Suppose the bank in Narvaizville lends all its excess reserves (the amount you calculated in
the previous problem) until it reaches the point where its excess reserves equal zero.
How much additional money will the bank lend out?
$2,000
How much money will this additional lending add to the money supply?
$2,000 x 10 (multiplier) = $20,000
Work through this example:
How much money will this additional lending add to the money supply?
$2000 x 10 (multiplier) = $20,000
Assume that all of the money that is created will be deposited in the bank and
that the bank will loan out all excess reserves. Create a t-account that shows this.
Assets
Required Reserves $4,000
Excess Reserves $0
Loans $36,000
Liabilities
Deposits $40,000
Monetary Policy Tools
1. Reserve Requirement
a. Banks that need reserve can borrow
1. from one another – pay federal funds rate
2. from the FED at the discount window
2. Discount Rate
a. Interest rate the Fed charges on loans
b. Normally set above federal funds rate to discourage borrowing from the FED
3. Open Market Operations
a. Fed buys and sells U.S. Treasury Bills (Bonds)
b. Buying increases the money supply
c. Selling decreases the money supply
https://www.youtube.com/wa
tch?v=6OpzAD9Okds
FOMC meeting
Money Demand Curve
1. horizontal axis – quantity of money
2. vertical axis – NOMINAL (not real) interest rate
3. graphic representation of opportunity cost
a. Higher interest rate – less cash demanded
b. Lower interest rate – more cash demanded
4. changes in interest rate causes a movement along the curve
a.
b.
c.
d.
Change in aggregate Price level
Changes in Real GDP (spending)
Changes in Technology
Changes in institutions
Money Supply
a. Vertical line whose location is controlled by the FED
b. Since FED controls Money supply curve they control
interest rate
Interest Rate and Equilibrium
1. Increase money supply moves curve right.
a. Lowers interest rate
b. Caused by FED action
1. buy bonds
2. lower reserve requirement
3. lower discount rate
Interest Rate
MS
MS1
MD
Quantity of
money
Interest Rate and Equilibrium
1. decrease money supply moves curve left.
a. Raises interest rate
b. Caused by FED action
1. sell bonds
2. raise reserve requirements
3. raise discount rate
Interest Rate
MS 1
MS
https://www.youtube.c
om/watch?v=_dNIDo8U
FSc
MD
Quantity of money
Demand
for
Money
Draw a graph that represents BOTH
the demand and supply of money.
On the same graph
Show what happens when the
FOMC engages in an open market
purchase of Treasure bills.
• What happened to the equilibrium
quantity of money? Increase
• What happened to the equilibrium
interest rate? .Decrease
On the same graph
Show what happens when the
FOMC engages in an open market
sale of Treasure Bills.
• What happened to the equilibrium
quantity of money? Decrease
• What happened to the equilibrium
interest rate? Increase
Loanable Funds Equilibrium
1. interest rate at which quantity of loanable funds supplied
equals quantity of loanable funds demanded
Loanable
Funds
Draw a properly labeled
loanable funds graph
Interest rate
Draw a properly labeled
loanable funds graph
S
E
D
Quantity of loanable funds
In each of the situations given:
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
Interest rate
•
•
•
S
E
D
Quantity of loanable funds
In each of the situations given:
•
•
•
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
There is an increase in
capital inflows into the
country.
In each of the situations given:
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
R
Q lf
Interest rate
•
•
•
S
S1
E
D
Quantity of loanable funds
In each of the situations given:
•
•
•
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
The government reduces
the government deficit
In each of the situations given:
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
R
Q lf
Interest rate
•
•
•
S
E
D2
D
Quantity of loanable funds
In each of the situations given:
•
•
•
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
There is an increase in
private savings
In each of the situations given:
Sketch the change in the graph that will occur
What happens to equilibrium interest rate?
What happens to equilibrium quantity of loanable funds
R
Q lf
Interest rate
•
•
•
S
E
D2
D
Quantity of loanable funds