Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Money that is available (money supply) affects Output1. GDP = C + Ig + G + Xn2. Increased spending increases output3. Increased money supply increases spending=**MVPQVelocityPriceQ Output- the actual amount of money in circulation- the number of time each $ is spent in a year (considered to be stable)- the actual output of goods and services- the level of pricesMoneyMVPQ=**MVPQMoneyVelocityPriceQ =output•If V and P are constant, then an increase in M will lead to a proportional increase in Q GDP increases.•but if V and Q are constant(at full employment), then an increase in M will lead to a proportional increase in P =Inflation.•P Q Total Sales (GDP)=*1. Printing Money2. Making Loansa. Key Ingredients: •Deposits – Household savings•Required Reserves – money held at the bank or at the FRS (around 10%)•Excess Reserves – loan able funds = Deposits – Required ReservesA depository institution can make loans up to the value of its excess reservesA depository institution can make loans up to the value of its excess reserves•The U.S. banking system is a fractional reserve system where banks maintain only a fraction of their assets as reserves to meet the requirements of depositors.•Under a fractional reserve system, an increase in reserves will permit banks to extend additional loans and thereby expand the money supply (by creating additional checking deposits). Fractional Reserve BankingMain Street Bank Situation:Demand deposits = $50,000Reserve requirement = 10 %Actual reserves at bank = $10,000Excess Reserves:Demand deposits = $50,000Reserve requirement= 10 %Actual reserves = $10,000- Required reserves = $5,000= Excess reserves = $5,000Excess Reserves ($5,000) can be loanedBy making a loan, the bank has created money. The original deposits are still in Main Street Bank, but now there is an additional $5,000 out floating around.The Bank of the James which has a reserve ratio of 10 percent on its deposits, has calculated the following numbers as of the end of business today: total deposits = $13,500,000; reserve account = $3,750,000; and vault cash = $2,250,000. Determine the following for this bank:Actual reserves = __________________Required reserves = _________________Excess reserves = __________________3,750,000 + 2,250,000 = 6,000,00013,500,000 x .10 = 1,350,0006,000,000 -1,350,000 = 4,650,000How much in new loans can Madison Heights National Bank make if its deposits are $45,000,000, vault cash is $5,500,000, and reserve account balance is $7,750,000? MHNB’s reserve requirement is 8%.New loans = _____________________5,500,000 + 7,750,000 = 13,250,00045,000,000 x .08 = 3,600,00013,250,000 -3,600,000 = 9,650,0009,650,000What is the amount that must be borrowed by the Smith Mountain Lake Marine Bank to cover its anticipated reserve shortfall if it has a reserve requirement of 12 percent, deposits of $27,500,000, vault cash of $2,500,000, a reserve account of $3,250,000, and it has just made a new loan of $2,500,000 that has not yet cleared?New borrowing = ___________________ 2,500,000 + 3,250,000 = 5,750,00027,500,000 x .12 = 3,300,0005,750,000 -3,300,000 = 2,450,000-50,000If the Excess Reserves are loanedThe borrowed money is spent and deposited at another bank.The second bank’s reserves are now up $5,000- it must keep 10% or $500- it can then loan out $4,500 ($5,000 – $500)This process can be repeated at each step. 10% of the money is lost at each stepThe more that is required to be held in reserve, the less money can be createdThe lower the reserve requirement, the greater the amount of money that can be createdBankNew cash deposits:Actual Reserves NewRequired ReservesPotential demand deposits created byextending new loansInitial deposit (bank A) Second stage (bank B) Third stage (bank C) Fourth stage (bank D) Fifth stage (bank E) Sixth stage (bank F) Seventh stage (bank G) $1,000.00 $200.00 160.00 102.40 81.92 65.54 52.43 800.00 $800.00 512.00 128.00 640.00 640.00 512.00 409.60 409.60 327.68 327.68 262.14 262.14 209.71 Total $5,000.00 $1,000.00 $4,000.00All others (other banks) 1,048.58 209.71 838.87 Creating Money from New Reserves•When banks are required to maintain 20% reserves against demand deposits, the creation of $1,000 of new reserves will potentially increase the supply of money by $5,000.From the table a deposit of $1000, with a 20% reserve requirement led to a $4000 expansion of the money supplyIs there a pattern here? It just takes 3 easy steps3. Subtract out the the initial change $5000 - 1000 = $40001. Find the reciprocal of the required reserve1/20% = 1/1/5= 52. Multiply the initial change by the multiplier$1000 * 5 = $50001. Deposit of $10,0002. Required reserve 10%3. Increase in the money supply?How about if the reserve requirement was 20%?1. ________2. ________3. ________1. ________2. ________3. ________1. Deposit of $16,0002. Required reserve 25%3. Increase in the money supply?How about if the reserve requirement was 20%?How about if the reserve requirement was 10%?1. ________2. ________3. ________1. ________2. ________3. ________1. ________2. ________3. ________1. Loan making changes the money supply2. Increases in loans leads to increased spending which increases the money supply.3. BUT, decreases in loan making, or even paying back a loan decreases the money supply.1. More or less voluntary transaction2. The interest rate is important3. Supply in the money for loansa. Households decide to save or spendb. Banks decide how to use the savings3. Demand for the loansa. Households how much to borrowb. Businesses compare interest rate to expected profit•Households and Banks supply the money based on interest rates•There is a direct relationship between interest rate and amount of $InterestRate Quantityof loansSDQ .05 DeterminingtheInterest Rate•Household and business demand for money is based on the interest•There is an inverse relationship between interest and amount of $•Expectation of poor economic conditions could shift the curve left•This would decrease the equilibrium interest rateDeterminingtheInterest RateInterestRate Quantityof