ECON 2133 1st EditionExam # 3 Study Guide Lectures: 10 - 17Monetary Policy- The fed using policy tools to affect bank reserves- Monetary base, Monetary supply (Mᶳ), 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 somehowRelationship 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 byIn order to have more dollar bills, had to get more goldDepths of Great Depression was prolonged because of gold standardDemand Deposit MultiplierCommodity 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 supplyMoney 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 SupplyM1 = 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 Reserve2. 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 reservesTotal Reserves = vault cash + deposits @ federal bank3. Depositors (how they choose to keep their money, in currency or in banks)4. BorrowersMB 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 soreduced 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 ReservesBank reserves = vault cash + deposits at Fed banksDemand 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