Macroeconomics Final Exam Study Guide Chapter 14 will NOT be on the exam Chapter 15 Money Creation 1 Fractional Reserve System 1 Keeps the financial system stable 2 Prevents from bank panics or bank runs 3 Creates money by lending more than original reserve 2 Reserve Ratio 1 The percentage of checkable deposits in which the bank must keep as reserves 2 lf there is a 20 reserve ratto A The banks keeps 20 of checkable deposits B The bank can lend out 80 ofthe checkable deposits as loans Calculation of Reserve Ratio R seavc Rdtro Co Ncftu b k s feLq r gd fgscrve LD r rnaft A brak 5 q c1k4 q r rp i a L L J 3 Money Multiplier Effect 1 Calculation of monetary multiplier effect 2 lf reserve ratio decreases the multiplier effect will increase 3 lf reserve ratio increases the multiplier effect will decrease I Example Showing the above concept in a real situation below A Peter deposits 100 into Bank of America Bank of America has a reserve ratio of 2oo o 6o fl 1lo SrecK 0 f8t2 f b x2c 7jtlo soaSo tL t to L rL l 1rIfrI C v t t b 2 llb tL hr rsr ir r a 2 o e sr r r l t a 9 l ff zo x2 r t s rr Lt 1 e rrl R 5 v Sto z 62 1 The required reserve is the money banks are required to keep in case of any withdrawals 2 Multiplier effect takes place because banks lend money to other banks who keep their required reserves 2O l and lend to other banks Chapter 16 Interest Rates and Monetary Policy 1 Money Market and Interest Rate 5 t l F al a t 5 rtir Noncl Nbrkl Q u c rq 0crur lpel 1 Downward sloping Demand Curve a Opportunity cost of holding money varies directly with the interst rate b lf interest rates were at 1oo you would put all of your money in bonds and sell them to obtain maximum returns c lf interest rates are low this is not worth the hassle 2 Perfectly Inelastic Supply Curve a Fed has complete control over the supply of money 3 6 Methods to change the money supply 7 open Market operotion Federal Reserve buys or sells government bonds from the commercial bank to the public a Most important tool Fed has because it is the one that is used most often b Buys T Bills with reserves to increase the money supply 2 Chonge the required reseNe rotio a To increase the money supply decrease the reserve ratio b lf you decrease the reserve ratio the multiplier will increase 3 Change the discount rote a The rate the Fed charges the banks to borrow from the Federal Reserve Bank b To increase the money supply decrease the discount rate 4 Te rm ouction Focility a Commercial banks compete with each other commercial banks for the money that the Federal Reserve is lending 5 Federol Reserve Bank poys interest on commerciol bonk s required reserve a To increase the money supply the Federal Reserve should decrease interest rates on commercial banks b This plan back fired 6 Quontitotive Erosing a Federal Reserve Bank can buy or sell long term bonds to effect long term interest rates b To increase the money supply the Federal Reserve Bank must buy long term bonds 4 Monetary Policy Rule Taylor Rule I Definition The guideline for the Fed follows when determining the supply of money and the federal funds rate 2 Grophic Explonotionsi a Recession LL qc I q d J 0 n r A 6ra h F irr6 t gqll Y Noncl f l orkcl r1 Xn oh en fl rnf o 5 7ea iy Fn t OvQ h Q oalr 1 oi fl r a 9e Y Firrrt f t qItr 1 rY Nor cy Norktl In r r crl Rn O 0 f 3 Equotion Explonotionl FFR n r FFR nyn IlY Yre Yre 100 FF Current Federal Funds Rate what we are solving for rrt Current Inflation Rate FFR Long Run Average Federal Funds Rate Always 2 r Target inflation rate that the Fed would like Yi GDP at current time YFE Full employment GDP a Recession Current Federal Funds Rate is too low Due to a low inflation rate and low current GDp To solve Fed increases money supply decreases interest rates increases investments shifts aggregate demand curve to the right arriving back at full employment b Inflation Current Federal Funds Rate is too high Due to a high inflation rate and high current GDp To solve Fed decreases money supply increases interest rates decreases investments shifts aggregate demand curve to the left arriving back at full employment 5 Monetary Policy Problems a Lag Times Recoqnition Las The time it takes the congress and the fed to realize the state of the economy Recession or Inflation Administrative Lap How long it takes for the policy to be implemented after the problem has been recognized Operational Las How long it takes before it is put into effect b tiquidityTrap i You can lead a horse to water but you cannot make it drink People do not spend even though interest rates are low Everyone is worried because we are still in a recession so they do not spend Low interest rates gives banks less of an incentive to lend money Especially at a risky time such as in a recession ii Steepness Investment Demand Curves Steeo Investment demand curves A decrease in the interest rate does not substantially increase investment spending More likely in a recession Flat Investment demand curves A decrease in the interest rate will substantially increase investment spending More likely in inflationary times 5 ccf nvcfr rn drnnJc r 11 C rr rtr r eh crl t irl roq f s 41irr4t tf lig ll rq rF P twdn iF Sgxtng C rag ia r vatrtrJt 9icrr 9 Practice Questions for Chapter l6 l The asset demand for money is downsloping because A the opportunity cost ofholding money increases as the interest rate nses B it is more attractive to hold money at high interest rates than at low interest rates C bond prices rise as interest rates rise D the opportunity cost ofholding money declines as the interest rate rises 2 If in the market for money the quantity ofmoney demanded exceeds the monev supply the interest rate will A fall causing households and businesses to hold less money B rise causing households and businesses to hold less money C rise causing households and businesses to hold more money D fall causing households and businesses to hold more money 3 The purchase ofgovernment securities from the public by the Fed will cause A commercial bank reserves to decrease B the money supply to increase C demand deposits to decrease D the interest rate to increase 4 Projecting that it might temporarily fall short of legally required reserves in the coming days the Bank of Beano decides to borrow money from its regional Federal Reserve Bank The interest rate on …