influencing the economy through changing and reserve wit influence te money supply and available credit
options of monetary policy
Reserve requirement-% that set by the feds of the minimum of reserves a bank must have
discount rate-banks borrow money from the federal reserves
federal fund rate-banks loan out loans to each other
OMO (open market operation)- security/bonds
Expansionary ( easy money)
OMO- Buy bonds
Discount rate- decreases
federal fund rate- decreases
require reserve ratio- decreases
Contractionary (tight money)
OMO-Sell bonds
Discount Rate- increases
Fed fund rate- increases
Required reserve ratio-increases
Helpful formulas
-Excess reserves (ER)=actual reserves (AR)- Required reserves (RR)
-Required reserves= amount of deposit x required reserve ratio
-Maximum amount a single bank can loan=the change in excess reserves caused by a deposit -the money multiplier= 1/required reserve ratio
-total change in loans= amount a single bank can lend x money multiplier
-total change i the money supply= total change in loans + amount of fed action
-total change in the demand deposit= total change in loans+ any cash deposited
The fed requires banks to always have some money readily available to meet the customers need
The amount set by the fed is the required reserve ratio
Require reserve ratio-the percent of demand deposit that must not be loaned out
Usually the required reserve ration is 10%
Money multiplier
Money multiplier shows a change in demand deposit on loans and eventually the money supply
1/required reserve ratio
Ex if the reserve ratio is 20% then the multiplier is 5 ( 1/.20=5)
3 types of multiple deposit expansion
Type 1: calculate the initial change in excess reserves ( amount a single bank can loan from the initial deposit)
Type 2:calculate the change in loans in the banking system
Type 3: calculate the change in money supply
Example 1: Given a required reserve ratio of 20% assume the federal reserve purchases $100 million worth of US treasury securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this federal reserve purchase bonds.
amount of new demand deposit - required reserve= initial change in excess reserve
$100mill-(.2 X $100mill)
$100mill-$20 mill= $ 80mill in er
Example 2: given a required reserve of 20% assume the federal reserve purchases $100 million worth of US treasury securities on the open market from a primary security dealer. Determine the maximum total change in loans the banking system from this federal reserve purchases of bonds.
the inital change in excess reserves (money multiplier)=max change in loans
commodity money-a good that has another purpose. It can stand for money
Representative Money-what every you use as currency represents a specific quantity of a purchased money. Ex: Backed by gold or silver.. when the value of the metal changes so does the money. It wont be stable
Fiat money-not backed by metal. Backed up by the word of the government
-functions of money
Medium of exchange- Medium ( substance through. witch are passed) Through money things happen.
Store of value-put money away you expect it to be stable
Unit of account-we think price=worth. If something cost more we think we are getting more for our money. We assume prices implies worth.
Unit 4 part 3
Graphs
1 Axis
Vertical- price that is paid to get money- interest rate
Horizontal- Quantity money
2. Demand slopes down WHY?
when price is high quantity demanded is low
when price is low quantity demand is high
LAW OF DEMAND
when interest rate is low we have an incentive to borrow more
3. Supply of money is vertical WHY
does not vary based on the interest rate. (Set by the feds)
Manipulation of the graph
incentive for more money: increase the demand for money
Upward pressure on interest rate
Quantity is the same because supply is fixed (vertical)
2 ways to think about the money supply:
1. In terms of quantity
2. In terms of interest rates
Fed tries to stabilize interest rate, because if interest rate is unstable you can’t predict level of investment, consumer spending or manipulate aggregate demand
Unit 4 part 4
The fed: tools of Money policy
-Expansionary money ( easy money)
RR- Lowering puts more available money for loan
Discount rate ( when the bank borrows money from fed)- Lowered: encourage borrowing
Buy/sell bonds/securities- Buys bonds public gets the money. "BUY BONDS=BIG BUCKS"
-Contractionary money ( tight money)
RR-Higher: less money to loan
Discount rate: Higher: discourages borrowing
Sell Bonds: feds takes the money witch means less for the people
Unit 4 part 7
Lon-able funds- money that is available in the banking system for people to borrow
GRaph
SLF - comes from the amount of money in banks. Dependent of savings
Government deficit in loanable funds market can shown two ways: increase in demand or decrease in supply.
Unit four part 8
Bank creates money by making loans
the feds control rr
Multiplier: 1/RR
EX: RR: 20%. The bank make a loan of $ 500. How much money total will be created?
1/.2=5 X Loan=$2500
Bob gets $500 -> Bank
Loan to Joe, $400 -> Bank
Loan to Suzie $320 -> Bank
Add ALL potential loans ($2500) *
Unit four part 9
Change in supply of money is equivalent to change in price.
Fisher Effect - interest and price level are connected. As interest goes up, price level also goes up.
Ex: 1% increase in interest = 1% increase in price level.
Fiscal Policy -Fiscal Policy: changes in expenditures or tax revenues of the federal government 2 tools of fiscal Policy: 1) Taxes-government can increase or decrease 2) Spending-government can increase or decrease spending
Deficits, Surplus, and Debt -Balanced Budget
Revenues = Expenditures
-Budget Deficit
Revenues < Expenditures
-Budget Surplus
Revenues > Expenditures
-Government Debt
Sum of all DEFICITS-Sum of all SURPLUSES
-Government mustbarrow money when it runs a budget deficit Barrows from: -Individuals -Corporations -Financial Institutions -Foreign entities or foreign governments Fiscal Policy Two Options -Discretionary Fiscal Policy (action)
Expansionaryfiscal policy-Think DEFICIT
Contractionary fiscal policy- Think SURPLUS
-Non-discretionary Fiscal Policy (NO action) Discretionary v. Automatic Fiscal Policies -Discretionary
Increasing or decreasing Government Spending / taxes in order to return the economy to full employment
-Automatic
transfer payments,unemployment, marginal tax rates
Contractionary v. Expansionary Fiscal Policy -Contractionary fiscal policy:policy designed toDECREASEaggregate demand (AD)
Strategy for controlling inflation
Inflation countered with contractionary fiscal policy
-Decrease government spending -Increase taxes -Expansionary fiscal policy: policy designed to increase aggregate demand (AD)
Strategy for increasing GDP, combating a recession, and reducing unemployment
Recession is countered with expansionary policy
-Increase government spending -Decrease taxes
Automatic or Built-In Stabilizers -Anything that increases the government's budget deficit during a recession and increases its budget surplusduring inflationwithout requiring explicit action by policy makers -Progressive Tax System
Average tax rate (tax revenue / GDP) RISES with GDP
Disposable Income (DI)- amount of money after taxes/net incomes.
DI= gross income -taxes.
2 Choices :Spending/ConsumptionandSaving.
Consumption - household spending.
The ability to consume is constrained by:
-the amount of DI.
-the propensity to save.
Do household consume if DI = 0?
-autonomous consumption
-dis-saving
APC = (C / DI) = DI that is spent.
Saving - household not spending.
The ability to save is constrained by:
-the amount of DI.
-the propensity to consume.
Do household consume if DI = 0? No
APS= (S / DI) = DI that is not spent.
APS & APC
APS + APC = 1
1 - APS = APC
1 - APC = APS
APC > 1 .: Dissaving
APS .: Dissaving
MPC&MPS
Marginal propensity to consume.
-change in C / change in DI
-% of every extra dollars earned that is spent.
Marginal propensity to save.
-change in in S / change in in DI
-% of every extra dollar earned that is saved.
MPC + MPS = 1
1- MPC = MPS
1- MPS = MPC
Determinants of Consumption and Saving
wealth
expectations
household debts
taxes
Spending multiplier effect- an initial change in spending (C, Ig, G, Xn) causes a larger change in AD.
Multiplier: change in AD/change in spending.
Multiplier: change in AD/change in C, Xn, G, Ig.
Why does this happen? . expenditures and income glow continuously which sets off a spending increase in the economy Calculating the spending multiplier
Multiplier: 1 / 1-MPC
Multiplier: 1 / MPS
.multipliers are (+) when there is an increase in spending & (-) when there is a decrease Calculating the tax multiplier
-MPC / 1 - MPC
-MPC / MPS
if there is a tax cut then the multiplier is +, because now there is more money in the circular flow.
3 Ranges of As
1.horizontal or Keynesian-includes only levels of real output that are less than full employment. Implies that the economy is in a recession
2. Vertical/classical-the economy reaches its full capacity output.
3.intermediate-expansion of real out and price level. Actual GDP can exceed full employmeny
