ECON 2133 1st Edition Exam 3 Study Guide Lectures 10 17 Monetary Policy The fed using policy tools to affect bank reserves Monetary base Monetary supply M interest rates and other financial variable to counter cyclically reduce amplitude and periodicity of economic fluctuations Thereby stabilizing the business cycle Fiscal policy government spending and taxation Monetary policy works through financial markets Transmission mechanism Net Worth Assets what you own like stocks property etc liabilities what you owe like debts whatever you borrow etc Examples of Monetary Policy August 9th 2007 Bank Nationale Paris BNP suspended mortgage backed securities BNP refused to cash out investments not sure how much they would be worth September 15th 2009 US Treasury lends to Gadhafi in Libya US issued IOU s and had federal budget deficit needed money somehow Relationship between Treasure and the Fed When treasury borrows money fed lends it to them 800 Billion now tripled to 2 4 Trillion Fed owns 2 Trillion of houses due to housing market crash Who does surgery on surgeons where does your bank bank Mo monetary base currency and bank reserves Dollar bills are liabilities of the fed FIAT currencies currency has value because government says so Commodity standard until 1993 Could take 23 67 to get 1 ounce of gold because gold was the commodity the dollar was backed by In order to have more dollar bills had to get more gold Depths of Great Depression was prolonged because of gold standard Demand Deposit Multiplier Commodity vs Fiat money Fiat is what we currently have nothing backs up value of our currency Give the fed a dollar get back another dollar for what it s actually worth Acceptability in exchange for goods and services give fiat money its worth Inflation crashes monetary systems remember hyperinflation monetary system examples 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 Commodity has something of worth backing up its value that it can be traded for Chinese were on silver standard We were on gold standard until March 1933 for one oz of gold for 26 62 Roosevelt stopped this though In order to make more money have to make or get more commodity gold for instance Fractional Reserve Banking What we live in banks are only forced to keep a small percentage of your deposits as reserves RR so reserves are a fraction of deposits thus the name fractional reserves Total Reserves Required Reserves only around 10 Excess Reserves amount banks choose to keep With excess reserves banks can make loans and investments which increases the total money supply So total reserves also vault cash deposits at the Fed have to by law hence why we say banks are in asset transformation business take your assets like deposits and turn them into longer running assets with higher interest rates for themselves 5 on your credit card but lending rate for credit cards at 24 4 way interaction of different entities to determine money supply Money Supply MS Money Base MB x Money Multiplier MM so changes in MS changes in MB x changed in MM Govt Fed has control of changes in MB through open market operations where they buy mortgaged back and treasury backed securities Can do this at will MM is determined by Fed chooses RR banks decide what type of excess reserves they want to hold and if they don t make those loans of investments then MS won t increase as Fed quintupled their balance sheet borrowers because it takes borrowers in order to have loan demand dearth of borrowers weakens deposit expansion process depositors make the choice between cash and checking accounts more cash than checking the MM goes down because banks need those excess reserves to fuel that deposit expansionary process hence then the MS can t change Fed cannot control the MS just the MB not the MM Monetary Base vs M1 Money Supply vs M2 Money Supply M1 MB x Money Multiplier So changes in M1 changes in MB x changes in Money Multiplier In Great Recession money multiplier tanked and therefore monetary supply fell by 33 Ben Bernanke increased monetary base in response during recession to stop money supply from falling into an abyss Currently money supply is up but not off long run trend MB Federal Reserve controls this completely Can move it up or down by any amount any time they want to Money Multiplier 4 way interaction to create the MM value 1 Federal Reserve 2 Banks for profit institutions Take in deposits and then transform them into long term assets Asset transformation process Take in short term liquid liabilities then purchase or lend long term assets and that s how they make their money Checkable deposits Must keep 10 of deposits as required reserves Choose to keep excess in reserves can keep them or loan invest them in order to increase their profits Banks MUST have excess reserves to make loans and investments Total Reserves required reserves excess reserves Total Reserves vault cash deposits federal bank 3 Depositors how they choose to keep their money in currency or in banks 4 Borrowers MB function is the foundation of all the subsequent supplies of money M2 M1 savings accounts small time deposits less than 100K savings account with contractual time limit on it as little as 7 days retail money market mutual funds households avg joe investors not big time or corporate savings account that can be liquidated into cash quickly sort of like money just for investments Dr Parker may swap retail money market fund highly liquidable and very safe but not lots of interest to equities bought stocks in petroleum company OXY that pays 4 dividend that is a large capitalization company not losing money anytime soon so reduced money in M2 and bought 25 year old equity M1 currency checkable deposits Travelers Checks small amount MB Currency Bank Reserves Bank reserves Required Reserves Excess Reserves Bank reserves vault cash deposits at Fed banks Demand deposit expansion process Demand deposit expansion process 1 Say I have 100 in currency 2 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