Econ 1202 1st Edition Lecture 19 Outline of Lecture 19 (Money and Banking (continued))I. Macroeconomic “M and M’s”II. How is Money Measured in the U.S?III. Show Me the MoneyIV. Generally SpeakingV. Other “Bits” of MoneyVI. The Banking System: Commercial Banks, The Fed, and UsVII. Commercial Banks: The “Webster and Liberty Banks” of the U.S. WorldVIII. “Deep in the Rust Belt, Regional Banks Fill Industrial Niche”IX. Federal Reserve SystemX. Organization of the Federal Reserve SystemXI. Board of GovernorsXII. Regional Banks (The Commercial Bank’s Bank)XIII. Federal Open Market Committee (FOMC)XIV. What is the Fed’s Job?XV. What is U.S. Monetary Policy?XVI. Tools of Monetary PolicyXVII. Open Market OperationsXVIII. Discount Rate policy: A Tale of Two RatesXIX. Reserve Requirements: First Some BackgroundsXX. Reserve Requirements: A More Theoretical, Less Practical ToolXXI. Where are the Reserves Kept?Outline of Lecture 20 (Money and Banking (continued)/Monetary and Fiscal Policy)I. How is Money Created?II. Multiple Expansion of Money SupplyIII. Simple Money or Deposit MultiplierIV. What is Happening and its Significance?V. One Tool of Monetary PolicyVI. Prices and MoneyVII. Price RevolutionVIII. Quantity Theory of MoneyIX. From an Identity to a “Monetary Workhorse”X. Reformation of QTMXI. Monetary PolicyXII. Tools of Monetary PolicyXIII. Monetary Policy TargetsXIV. Critical PointXV. Second Critical PointXVI. Money MarketMoney and Banking (continued)I. How is Money Created?a. The Fed buys a U.S. government bond that you own for $1000b. You take the check that the Fed gave you and deposit it into your bank accountc. Your bank sends the check to the Fed for payment and then the Fed credits your bank’s reserve accountd. The bank then keeps $100 for the reserves and lends out the restII. Multiple Expansion of the Money Supplya. Notice that each new loan by a bank occurs through the creation of a newor additional demand deposit liability (M1)b. Each new loan is 10% less, which corresponds to the 10% in the RR that each bank is required to keepIII. Simple Money or Deposit Multipliera. Simple money or deposit multiplier=m=1/RRb. Change in money supply=change in bank reserves*1/RRi. Basically: Change in M1=1/RR*Change in Reservesc. Money multiplier in “real” worldi. Excess Reservesii. Currencyiii. Timeiv. Other ParticipantsIV. What is Happening and its Significance?a. First:i. The money supply is expanding as banks are trying to “push put” their excess reservesii. Banks want to lend their excess reservesiii. Banks make little to no interest on their reserves, so banks want tolend the excess reserves 1. Remember: this is a banks business modelloans are liabilities to borrowers, but assets to lendersiv. This is why banks are wiling to lend on a very short basis (over night) their reserves to other banksb. Second:i. Through the Fed’s open market operations, the Fed is able control the banking systems reserves and thus the nation’s money supplyii. Buying bonds increases the overall banking reserves and thus the nation’s money supplyiii. Selling bonds decreases the overall banking reserves and thus the nation’s money supplyc. Third:i. Why do individuals borrow?ii. What is the increased borrowing saying about spending and AD?V. One Tool of Monetary Policya. Open Market Operations-the buying and selling of U.S. government securities (bonds)b. What is the significance of the Fes buying bonds?i. Increased reservesincreased lending/borrowingincreases spending (C and I)increases ADVI. Prices and Moneya. Systemic, long-term inflation caused by “too much money”b. Can individuals have “too much money”?i. No1. What about a nation?a. YesVII. Price Revolutiona. Europe (1503-1650)i. 35 million pounds of goldii. 407,000 pounds of silveriii. Entered into Spain (and then Europe)VIII. Quantity Theory of Moneya. Direct connection in the long run between the supply of money and inflationb. Steps:i. GDP Deflator=NGDP/Real GDPii. NGDP=GDP Deflator (Price Index)*Real GDPiii. NGDP=P*Yiv. GDP must also equal the amount of money that exists times the number of times it is spent of M*Vv. M*V=P*X (QTM)1. One, if not, the most important ideas in monetary economicsc. Meaning of M, V, P, and Y?i. M=M2ii. P=CPIiii. Y=Real GDPiv. V=Velocity of money1. Velocity of Money-rate at which money changes hands2. V=(P*Y)/MIX. From an Identity to a “Monetary Workhorse”a. Quantity Equation: M*V=P*Yi. Quantity of money (M)ii. Velocity of money (V)iii. Dollar value of the economy’s output of goods and services (P*Y)b. It shows an increase in quantity of moneyi. Must be reflected in:1. Price levels must rise2. Quantity of output must rise3. Velocity of money must fallc. However,i. If V is constant (or we assume it to be constant) andii. Y is determined by the real side or factors in an economy theniii. Increases or decreases in the quantity of money must be reflectedin increases or decreases in the overall price level (inflation or deflation)X. Reformulation of QTMa. Percentage of change in M+percentage of change in V=Percentage of change in P+percentage of change in Yb. Assume percentage of change in velocity=0 then,c. Percentage of change in P= percentage of change in M-percentage of change in Yd. Big Idea: in the long run, inflation is caused by excess growth in a nation’s money supply (relative to GDP growth)Monetary and Fiscal PolicyXI. Monetary Policya. Monetary Policy-purposeful control of nation’s money supply and interestrates to achieve the following macroeconomic goals:i. Price stabilityii. Full employmentiii. Economic growthiv. Financial market stabilityXII. Tools of Monetary Policya. The Fed has 3 monetary policy tools at its disposal:i. Open market operationsii. Discount policyiii. Reserve requirementsXIII. Monetary Policy Targetsa. The Fed uses these tools (open market operations and discount rates) to try to influence the unemployment and inflation ratesb. It does this by directly influencing its monetary policy targets:i. The money supplyii. Short-term interest rate (currently this is the primary monetary policy target of the Fed)iii. Recently the Fed has articulated other targets such as inflation targetsXIV. Critical Pointa. The Fed’s control of the short-term interest rates is through its control of the money supplyi. The Fed’s control of the money supply (and open market operations) goes “hand-in-hand” with the Fed’s targeting of short