ECON 201 1st Edition Lecture 22Outline of Last Lecture I. Bank Reservesa. Definition of required reservesb. Definition of actual reservesc. Definition of excess reservesII. T-Account and Examplesa. Definition of t-accountIII. Money Multipliera. Definition of money multiplierIV. Extended Bank Balance Sheeta. Definition of bank capital b. Definition of leveragec. Definition of leverage ratioOutline of Current Lecture I. Understanding Appreciation and DepreciationII. Leveragea. Definition of capital requirementb. Definition of credit crunchIII. Analyzing a Real-World Economic ProblemIV. Consumer Price Indexa. Definition of consumer price indexb. Definition of inflation rateV. Example Problem: CPI and Inflation RateCurrent LectureI. Understanding Appreciation and DepreciationWe are using a T-Account statement from previous lecture notes to understand appreciation and depreciation, as shown below.Balance SheetAssets LiabilitiesReserves: $200 Deposits: $800Loans: $700 Debts: $150Securities: $100 Capital: $50These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.This bank’s total assets are worth $1,000. Suppose that the assets appreciate by 5% from $1,000to $5,000. This increases the bank’s capital from $50 to $100, doubling the owner’s equity. Now, suppose a bank’s assets decrease by 5%, so that the bank capital falls from $50 to $0. If this bank’s assets decrease by more than 5%, the bank capital will be negative and the bank is insolvent. II. LeverageLeverage amplifies profits and losses. A capital requirement is a government regulation that specifies a minimum amount of capital intended to ensure banks will be able to pay off depositors and debts. In 2008-2009, there was a financial crisis because banks suffered losses on mortgage loans and mortgage-backed securities due to widespread defaults. As a result of this, many banks became insolvent. To understand the impact of the crisis, from approximately 2000-2007 (a seven-year span) there were approximately 27 bank failures; in the 2008-2009 year alone, there were 166. Even so, this still does not come close to the amount of bank failure that occurred during the Great Depression, when 9,000 banks failed and the money supply was very compressed. When this happens it is called a credit crunch – banks have too little capital and reduce lending, which dries up the borrowing/investing funds. As a result of this financial crisis, the Fed and Treasury injected lots of money into the economy. III. Analyzing a Real-World Economic ProblemThe following article discusses efforts taken by the government to prevent credit crunches. “America's biggest banks would lose $490 billion -- most of that due to bad loans -- over the next nine quarters in a worst-case scenario devised by the Federal Reserve. Thankfully, the Fed does not expect that scary scenario to happen. But in an effort to prevent a repeat of the 2008 financial crisis, the Fed is putting the big banks through stress tests. As jarring as the latest stress test results sound, the Fed said Thursday that banks deserve a lot of credit for boosting their capital levels and improving their financial health since the last crisis. The Fed tested 31 big banks (including U.S. subsidiaries of large foreign banks) for several severe hypothetical economic scenarios. In the Fed's most adverse case, which calls for an unemployment rate reaching 10%, home prices falling 25% and stock prices plunging 60%, the average tier 1 common capital ratio for these banks (one of the Fed's metrics of bank health) would be 8.2% -- significantly above the 5.5% level that they had in early 2009. ‘The largest U.S.-based bank holding companies continue to build their capital levels and to strengthen their ability to lend to households and businesses during a period marked by severe recession and financial market volatility,’ the Fed said in a statement. Unsurprisingly, the lion's share of the loan losses would likely fall to the nation's four largest consumer banks: Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM) and Wells Fargo (WFC). But all 31 banks did well on the stress test, which calls for banks to have a minimum capital ratio of 5% in the event that the bottom completely fell out of the job, housing and stockmarkets. Regional bank Zions (ZION), which was the only bank to fall below thisthreshold test last year, topped it this time around ... albeit barely. It had a capital ratio of 5.1%. The bank with the highest capital ratio was the U.S. trust subsidiary of Germany's Deutsche Bank (DB). However, a Fed official noted in a conference call that the Fed only stress tested a small portion of Deutsche's overall U.S. operations. Next hurdle: This is the first of two rounds of stress tests. Next week, the Fed will indicate whether or not it approves of plans by the big banks to raise dividends and buy back stock.”-CNN, March 5, 2015This article demonstrates how the federal government has increased their capital requirements to prevent a financial crisis like the one in 2008-2009 from happening again. The average level was 5.5% and now is closer to 8.2%. This is a much better financial position than banks were in six years ago; the public needs these banks to work. So what the federal government is doing is trying to ensure that the banks are on a solid foundation so that they can continue to work in a time of economic stress. During periods of greater economic uncertainty, the non-bank public tends to hold relatively more in currency and relatively less in deposits. This action decreases the expansion of deposits from lending and decreases the money supply; collectively, this decreases spending, consumption, and GDP. This is why it is so important for the government toperform these “stress tests” to gauge the financial position of the banks and prevent a crisis. IV. Consumer Price IndexThe consumer price index (CPI) is a primary measure of inflation use in the United States calculated by the Bureau of Labor Statistics (BLS). It measures the consumer’s cost of living, known as a basic Cost of Living Allowances and Adjustments (COLA). To calculate the CPI, follow the next five steps.1. Fix the “basket”. This is typically given in a problem and is simply the “shopping basket” of goods and services used by consumers.2. Find the prices. These too are also given along with