MACRO STUDY GUIDE TEST 4 Final Exam CHAPTERS 14 15 16 Functions of Money 1 Medium of Exchange 2 Unit of Account and resources used to buy and sell goods and services monetary units to measure relative worth of goods services transfer of purchasing power from the present to the future C H A P T E R 1 4 M O N E Y B A N K N G I F I N A N C A L I I N S T I T U T I O N S a Easily compare prices of various goods b Define debt obligations c Determine taxes owed d Calculate GDP 3 Store of Value retains value over time M1 Currency coins paper money Checkable deposits o 50 checking account balances M2 includes M1 and near monies Near monies exchange but can be converted into M1 Savings deposits Small denominated 100 000 time deposits Money market mutual funds Faith in the government backs our money supply Federal Reserve System U S central bank Board of Governors of the Federal Reserve 12 Federal Reserve Banks highly liquid finances that don t function directly as a medium of o Control the lending activity money supply Privately owned publically operated Doesn t want high inflation because lenders banks lose Doesn t interest rates until FE reaches 6 5 full 6 Functions of the Fed 1 2 Setting reserve requirements and holding reserves Issuing currency account balances that banks must maintain as currency reserves create Federal Reserve Notes paper currency set the fractions of checking Central banks accept as deposits any portion of the mandated reserves not held as vault cash from the banks 3 Lending to financial institutions and serving as an emergency lender of last resort routine short term loans to banks charging them an interest rate discount rate occasionally auctions off loans to banks check deposits 4 Providing for check collection adjusts the reserves of the two banks involved in MACRO STUDY GUIDE TEST 4 Final Exam CHAPTERS 14 15 16 5 Acting as fiscal agent provides financial services for the Federal government Gov t collects huge sums through taxes spends large amounts sells and redeems bonds Uses Fed s facilities to carry out activities 6 Supervising banks periodic exams to assess banks profitability and make sure they perform in accordance to regulations high and rising levels of output employment and a relatively stable price level makes amount of money available consistent with 7 Controlling the money supply Influence interest rates Make unique policy decisions Banks creates money thanks to the 1 Fractional Reserve System a Lend out deposits b Only a portion 10 15 of checkable deposits are backed up by reserves in bank vaults i Excess money converted to loans increasing available cash c Goldsmiths IOU system paper money backed by gold 2 Checking account balances Included in definition of money part of the money supply a b Convert IOUs into checkable deposits c Money destroyed when lenders repay bank loans d Use excess reserves to buy public bonds create checkable deposit i Money vanishes when banks sell bonds to the public Money creation is limited o Bank can only lend amount to excess reserves actual required o Checks drawn by borrowers are likely deposited in other banks Loss of reserves and deposits to lending bank amount of lent Money Multiplier increase in the amount of cash in circulation generated by the banks ability to lend money out of their depositors funds Loan creates money loan becomes new deposit from which the borrow can withdraw cash to spend 1 R R required reserve ratio Spending Multiplier vs Money Multiplier 1 vs 1 MPS R Similar Concepts Saved not spent lent Fed out can wipe any C H A P T E R 1 5 M O N E Y C R E A T I O N MACRO STUDY GUIDE TEST 4 Final Exam CHAPTERS 14 15 16 changes made to the money supply by the banks simply by shifting MS money supply curve 1 day to change MS Cost of banks creating money Fed doesn t have total control over MS Can do it when they want profit driven Large MS recession MS is actually low Banks act opposite to what Fed wants Federal Funds Rate interest rate banks and other depository institutions charge one another on overnight loans made out of their excess reserves Monetary Policy change in MS that changes the FFR federal funds rate causing other interest rates to change as well as changes in interest sensitive spending which leads to a shift in the AD curve bringing an economy back to full employment Investment spending Consumer durable goods spending Interest Sensitive Spending MS FFR interest rates interest sensitive spending AD shift FE Interest rates affect spending therefore affecting RGDP Connects power of Fed and money market to spending AD curve and RGDP Important Interest Rates FFR interbank overnight lending rate of 1 million 0 Discount Rate rate at which the Fed lends to banks 75 Mortgage Rate rate on houses 30 years 4 45 Prime Rate rate that banks charge their most preferred customers 3 25 T Bill Rate rate that the treasury pays to lenders national debt 1 year 13 Too much money in circulation inflation Too little money in circulation stagnation Fed and MS Economy heading downward lower FFR Economy headed upward raise FFR Taylor Rule state of the economy Monetary Policy in Action tells the Fed what the optimal FFR should be given the current C H A P T E R 1 6 I N T E R E S T R A T E S M O N E T A R Y P O L I C Y MACRO STUDY GUIDE TEST 4 Final Exam CHAPTERS 14 15 16 1 Begin with AS AD model PL FE AS AD RGDP Economy in Recession Lower FFR 2 Use Taylor Rule to find target FFR FFR Pc FFRave Pc P Yt YFE YFE x100 Pc current inflation rate FFRave long run average FR 2 P target inflation rate Yt actual employment YFE full employment Pc P inflation gap Yt YFE YFE RGDP gap 3 Adjust MS increase to lower FFR Bring equilibrium rate to target rate Monet Market supply and demand of money M2 11 trillion o Determines equilibrium rate of interest MS vertical because Fed has control MD money in pockets not bonds o Reasons for keeping money out of bonds Transactions Speculation Emergencies o Downward sloping hold less money at higher interest rates MS MD shift right interest rates fall FFR MACRO STUDY GUIDE TEST 4 Final Exam CHAPTERS 14 15 16 MS1 FFR1 FFR2 Money Market Increase MS to lower FFR MD1 Money How the Fed changes MS 7 T Open market operations buying selling treasury bonds national debt Discount rate Quantitative easing buying selling financial assets mortgage backed Reserve requirement Term auction auctions off reserves Paying interest on reserves held at the Fed securities long term bonds shifts AD right 4 Use I Cd