Econ 2133 1st Edition Lecture 14 Outline of Current Lecture Review of data regarding currency Functions of money 3 Fractional Reserve Banking How it works How and why the Money Multiplier Changes Demand Deposit Expansion Process Current Lecture Graph Data set from Dr Parker s book The Handbook of Major Economic Events in History Hungary s Monthly inflation Rate July 1946 4 19 time 10 to the 160 th power Daily inflation rate was 207 Took 15 hours for the price level to double Fiat currency was mass produced and made hyper inflation When printing money Zimbabwe in 2008 mid November 98 daily inflation rate Every 24 hours the price level would double Money Promotes economic efficiency No Money means bartering trading goods for goods would prevail Requires a double coincidence of wants Functions of money 1 Money has to be a medium something that facilitates communication and transactions of exchange money is a facilitator of transactions that replaces barter 2 Unit of Account one good one price where every good has one price Dollars and cents are the US unit of account every good has one combination of dollars and cents Car 45 600 Barrier N Goods Every good has N 1 prices barter economy would yield every good having so many prices in comparison to others WOULD BE SO CRAZY HECK NO Like 1 apple is worth 2 bananas 2 grapefruit 1 head of lettuce etc to account for every good in the system 3 Store of Value a method of transferring wealth into the future Disposable income Money s killer over time is inflation Fractional Reserve Banking banks keep a small of deposits as required reserves But they also then have excess reserves that they can keep or they can loan and invest them Money Multiplier is how many time 1 in MB gets blown up in M1 Ms MB x Money multiplier Change in Money supply change in money base times change in money multiplier Fed control monetary base how and why will learn in the next few classes before Exam 3 How and why does the money multiplier change These 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 1 2 3 4 Depends on a Feds b Banks c Borrowers d Public desire for I Currency II Depth of Financial Technology deeper and more widespread the tech is the less and less currency people have to have all the time on themselves Demand deposit expansion process Say I have 100 in currency If I take 100 and deposit it in my checking account the fun begins Because now banking system can get in on the party he has the weirdest way of explaining things Now still have 100 just not in currency in electronic book entry So bank takes 10 10 is the average required reserve in required reserves and now I have 90 in electronic reserves Bank can now even make a loan for 90 with the excess reserves Person who sold the good receives 90 and they deposit in their checking account Therefore I have 100 still though Round 2 bank B 9 in RR 81 in ER Loan is 81 so 81 in new checking accounts Now I have 100 Bank B has 90 81 271 Keeps continuing on and on until dwindles down to zero So why the money supply expands due to monetary base could even expand to as much as 10 because Money Multiplier M would be equal to 10 Meaning the Demand Deposit Expansion Process could blow up every 1 into 10 in just M1 Money Multiplier M 1 Required Reserve Percentage RR usually 10 on average and with this rate then Money Multiplier would be 10 If RR 25 M 4 RR and M are inversely related If RR 50 M 2 If RR 5 M 20 If M1 MB x M fed determines M 1 RR the Fed 2 Banks ER Behavior Deposited 100 and my bank kept all of it as reserves there wouldn t be a money multiplier 3 Borrowers dearth of them and banks not making as money loans then M not rising as much or being as effective 4 Depositors Public If they hold currency not checking accounts then M drops too Fed controls MB but DOES NOT CONTROL the Money Supply