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Functions of Money
-Medium of exchange (buy and sell goods) -Unit of account (goods valued in dollars) -Store of value (hold some wealth in money form)
Money Definition: M1
-Currency -Checkable deposits -Institutions offering checkable deposits -commercial banks -savings and loans associations -mutual savings bank -credit unions
Money Definition: M2
-M1 and near-monies -Savings deposits, including Money Market Deposit Accounts (MMDA) -Small-denominated time deposits (CD = Certificate of Deposit) less than $100,000 -Money Market Mutual Funds (MMMF) -Money Market securities
Money Market Deposit Accounts (MMDA)
A cross between a checking and a savings account. They earn a bit more than interest-bearing checking accounts, but restrict the number of deposits or withdrawals that can be made each month
Certificate of Deposit (CD)
A certificate issued by a bank to a person depositing money for a specified length of time, small-denominated time deposits (less than $100,000
Money Market Mutual Funds (MMMF)
An open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely (though not necessarily accurately) regarded as being as safe as bank deposits yet providing a higher yield. 
Money Market Securities
Very safe and liquid short term bonds issued by the Treasury Department 
Hedge Funds vs. MMMF
Larger investments -Can't get money back fast -Invest money into buying a company -Very illiquid and risky 
Why is Money Valuable?
-Acceptability -Legal Tender -Relative Security
Federal Reserve
Created in 1912 -Board of Governors: 7 of them, appointed by President, confirmed by Senate for a 14 year non reviewable term -Headquartered in DC -12 Federal Reserve banks
Federal Open Market Committee (FOMC)
12 appointed members: 7 governors, plus 5 presidents of district banks -meets 8 times a year -makes important monetary policy decisions
Big 4 US Banks
Bank of America (acquired Merrill Lynch*) -JP Morgan Chase (acquired Bear Sterns*) -Citi Group -Wells Fargo (acquired Wachovia Bank*) *after recession
Federal Reserve Functions
Issue currency -Set Reserve Requirements: Fed mandates every commercial bank to keep fraction of total deposits in reserve (10%) -Collect checks -Act as a fiscal agent for US government -Supervise banks -Control the money supply and influence interest rates -Dual mandate - price s…
Federal Reserve Independence
-Established by Congress as an independent agency -Protects Fed from political pressures -Fed's policies cannot be reversed -Fed is given freedom to pursue its own objectives and choose monetary policy tools to do so -Enables Fed to take actions to increase interest rates in order to …
Dodd-Frank Act / Wall Street Reform Act of 2010
Provisions that limit Fed problems -Make sure the Recession doesn't happen again -GAO Government Audit (Accountability) Office can audit Fed's lending programs -Proposal to audit Fed's monetary policy decisions, didn't work out -Passed to help prevent many of the practices that lead …
Financial Crisis of 2007-2009
Mortgage Default Crisis -Subprime mortgage loans -Mortgage-backed securities -Government programs that encouraged home ownership ("The American Dream") -Insurance companies insured securities -AIG insured all mortgage loans -When interest rates increased, real estate values fell,…
Securitization (or Securities, MBS)
The process of slicing up and bundling groups of loans into new securities , these securities (MBS) ended up everywhere: bad securities provided by mortgage lenders, declining real estate value 
Credit Rating Agencies
Moody's , S&P, and Fitch -Ratings from D to AAA -Rated AAA on lots of MBS because they got paid by companies that issued those securities
Troubled Asset Relief Programs (TARP)
Gave taxpayer $ to failing financial institutions -$700 bill -BUT Treasury ended up buying up stock (injected capital) -saved several institutions from failing/failure -Fed extensively lent money to financial institutions *Makes crisis possible in future b/c corporation knows it …
Major Categories of Financial Institutions
-Commercial banks -Insurance companies -Pension Funds -Thrifts -Mutual Fund companies -Securities firms
Mutual Funds
Sell shares to large numbers of small investors and invest funds in diversified portfolio of securities (stocks, bonds, commercial paper), not insured 
Security
Financial asset 
Financial Asset
Anything that promised a future steam of income that's traded on the financial market 
Asset
Something that promises future stream of income 
Stocks
Pay dividends, not guaranteed, varies with company profitability 
Bonds
Make fixed payments, guaranteed, does not vary 
Derivative
Promise to deliver certain asset at a specified price at some future date 
Investment Banks
Financial institutions that provide various services -wealth management -securities trading
Underwriting
Helping private start ups go public or helping already established corporations to sell new issues of stocks. 
Wall Street
Financial institutions provide necessary funding to all kinds for long run and day-to-day operations. 
Glass Steagall Act of 1933
Separated commercial banking from investment and insurance 
Systemically Important Financial Institutions (SIFI)
-Too big to fail, failure means affect on entire economy *Living Will: what needs to be done to protect it, it won't fail
Fractional Reserve System
Banks create money through lending, banks are subject to panics (or bank runs), US has it, means that only a small fraction of our deposited money stays in the bank, majority is loaned out (like the goldsmiths) 
Goldsmiths
First banks, stored people's gold and them a receipt to use else where as proof that they have the gold to buy things 
Balance sheets
Assets = Liabilities + Net Worth (A=what you own) (L=what you owe) (N.W=what bank owns vs. what bank owes) *both sides should ultimately be balanced, if not positive, bank will bankrupt
Necessary Transactions
1. Create a bank with owner's own money (capital) 2. Accept deposits (liabilities) 3. Make loans 4. Profit
Fed's Regulation
Requires we keep 10% of deposits in Reserve that can't be touched Revenue $9000 - Expense $1000 = Profit $8000
Liquidity Risk
-If deposit withdrawals happen on large scale, banks don't have the money ( not enough in Reserve account), causes financial crisis -To prevent this, tend to keep more than 10% to avoid these risks 
Multiple Deposit Creation
What happens when an initial deposit creates more deposits in banking system (see 4/12 notes for an example) 
Money Multiplier
= 1/required reserve ratio or 1/R = the amount of new deposits created by a single dollar of excess reserves 
Interest Rate
Price paid for the use of money -Determined by money supply and money demanded -Cost of borrowing -Reward for lender -Equilibrium Interest Rate: changes with shifts in $ supply and $ demand -Fed can influence $ supply through tools of monetary policy
Demand for Money
Asset Demand, Da -money on store value -varies inversely with interest rate Total Money Demanded, Dm
Tools for Monetary Policy
Open Market operations conducted at NY Fed -Two Operations: 1. Open Market Purchase: Fed buys securities by giving reserves to banks 2. Open Market Sale: Fed sells securities to banks
Reserve Ratio
Changes the money multiplier -Lowering the reserve ratio, increases money multiplier, increases money supply -Increasing reserve ratio, lowers money multiplier, decreases money supply R=10% M.M. = 1/0.1 = 10 
The Discount Rate
-Fed acts as lender of last resort -Increasing discount rate, discourages banks from borrowing so money supply shrinks 
Expansionary Monetary Policy (Easy Money) Cause and Effect Chain
-Economy faces a recession -Fed buys securities -Lowers reserve rate -Lowers discount rate -Excess reserves increase -Rise of money supply -Interest rate falls -Investment spending increases -Real GDP rises 
Restrictive Monetary Policy (Tight Money) Cause and Effect Chain
-Periods of rising inflation -Fed sells securities -Increases reserve ratio -Lowers discount rate -Excess reserves decreases -Money supply falls -Investment spending lowers -Real GDP lowers
Advantages of Monetary Policy over Fiscal Policy
Speed and flexibility -Isolation from political pressures -Monetary Policy is more subtle than Fiscal Policy: (conducted by Congress and Pres.)
Federal Funds Rate
Rate banks charge each other on overnight loans -Easy for the Fed to target -To lower: Fed increases bank reserves by conducting open market purchases -To raise: Fed decreases bank reserves by conducting open market sales
Quantitative Easing (Q.E) or Asset Purchase Program
In Response to Recession: -Fed bought trillions worth of securities from the banks -Critics claim Fed contributed to the crisis by keeping the Federal Funds rate too low for too long
Lags
Recognition and operational -Price level is reported monthly and GDP is reported quarterly -Takes 3-6 months for interest rates to affect investment spending & economic activity 
Liquidity Trap
Pumping reserves may not solve problems if banks aren't willing to lend and households/businesses aren't willing to borrow
Aggregate Demand
Real GDP desired at each price level -Inverse relationship -Households -Firms -Foreigners -Spend less at a higher price level
Changes in Aggregate Demand
Change in consumer spending (C) -Change in investment spending (I) -Change in government spending (G) -Change export spending (NX) 
Consumer Spending
Consumer wealth: stock market and real estate market -Household borrowing or saving -Consumer expectations about future income or inflation -Personal taxes -Determined by fiscal policy
Investment Spending
Real interest rates (cost of borrowing): monetary policy -Expected returns (of current investment): fiscal policy -investment spending is more volatile than consumer spending
Government Spending
Gov spending increases when aggregate demand increases (as long as interest rates and tax rates do not change) ex: more transportation projects -Gov spending decreases when aggregate demand decreases ex: less military spending
Foreign Spending
National Income abroad -Exchange rates -Dollar Depreciation: Foreigners spend more on US goods and services (N.E increases) -Dollar Appreciation: Foreigners buy and spend less on US goods and services (N.E decreases)
Tourism
Foreign nationals visiting US is our export: -Weaker dollar promotes country to foreign tourists -Weaker dollar discourages US tourists from visiting other countries
Aggregate Supply
Total real output produced at each price level -Relationship depends on time horizon (short run vs long run) -Short Run: A.S. is upward sloping, positive relationship b/w aggregate price level and quantity produced. Sticky prices, input prices are inflexible, fixed in short run -Long …
Changes in Aggregate Supply
Changes in input prices -Changes in productivity -Changes in legal-institutional environment
Input Prices
Domestic Resources prices Labor Capital Land in natural resources -Prices of imported resources Imported oil Exchange rates Dollar appreciation implies cheaper imported resources and increased capabilities to produce things here
Legal-Institutional Environment
Taxes of subsidies -Extent of gov regulation, corruption and "red tape"
Stagflation/Cost Push Inflation
Inflation rises and contraction/ recession of real GDP Ex: OPEC oil crisis, price of oil went up really high
Demand Pull Inflation
Inflation rises and expansion of real GDP Ex: stock market is good, real estate boom, global economic expansion
Recession
Deflation lowers and recession of real GDP Ex: stock market crash, real-estate market crash, banking crisis
Responding to Recession
Gov will try to stimulate A.D. -Congress would pursue expansionary fiscal policy (lowering taxes and giving rebates) and Fed would employ expansionary monetary policy (lower interest rate and increase money supply)
Targeting Inflation
Fed pursues tight money, lowered A.D. to fight inflation but causes GDP to lower and increase unemployment (severe inflation)
Targeting Unemployment
Fed pursues easy money, lower interest rate, raises GDP, lowered unemployment rate but causes severe deflation
Supply Side Economics
Less regulation -Lower taxes and give tax breaks for firms -"Reaganomics"
US Trade Facts
US trade deficit in goods (import>export): $738 billion -US trade surplus in services (export>import): $178 billion -US has a trade deficit/negative net exports
Foreign Investments
Main reason it is possible for US to get stuff from foreigners (despite deficit) is by two ways: Foreign Direct Investment or Foreign Public Investment
Foreign Direct Investment (FDI)
selling domestic assets to foreigners ex: InBev purchasing Anheuser-Busch 
Foreign Portfolio Investment
Borrowing money from foreign institutions ex: Japanese pension fund buying Facebook stock
Public (or National) US Borrowing
US government selling debt securities (bonds) to foreigners 
Private US Borrowing
Microsoft selling bonds to Chinese bank or taking out loan from a French bank 
Principal US Exports
Chemicals -Food/Agricultural products -Consumer durables -Semiconductors (computer insides) -Aircraft (civil and military) *US provides 8.5% of world's exports (China is largest)
Principal US Imports
-Oil -Cars -Metal -Households appliances -Computers *Trading is more important for smaller countries than for larger countries
Exchange Rates
-Foreign exchange market determines the foreign exchange rates -Big participants are banks that trade deposits denominated in different currencies on behalf of multinational corporations
Exchange Equation
Changing amount of money between two different currencies: ex: $1,000,000 USD $800,000 euro $1 mil / $1 mil = $800,000/$1 mil $1 USD = $0.8 euro per USD
Dollar Appreciation
The dollar gains value *appreciation makes goods/services more expensive to foreigners, hurts US companies exporting goods/services, tourism in US less attractive *appreciation makes foreign goods/services cheaper to US consumers, encourages US imports, cheaper for US tourists to study …
Dollar Depreciation
The dollar loses value 
Who Demands Dollars?
Foreigners -to by US goods/services, must use $ to purchase, so they demand the US $ -buying US assets (i.e. stocks) -tourism Speculators -buy $ to profit if $ is predicted to appreciate
Who Supplies Dollars?
US Residents -in order to buy foreign goods/services, use the $ in exchange for foreign currency -buying foreign assets (i.e. stocks) Speculators -buy foreign money to profit if $ predicted to depreciate
Determinants of Flexible Exchange Rates
Changes in tastes -Relative income changes -Relative inflation rate changes -Relative interest rates -Relative expected returns on assets -Speculation
Speculators
Expect future dollar appreciation, will buy dollar to sell for profit later, which drives up demand and dollar appreciates -Expect future dollar depreciation, will sell dollar, drives up supply and dollar depreciates
Fixed Exchange Rate
-Some currencies have fixed exchange rates, governments and/or central banks intervene to maintain fixed value of currency. -Or a country links/pegs their currency to another country's -Makes trade easier, less volatile, more certain 
Trade Barriers and Export Subsidy
ariffs: special tax on imported goods -Import quotas: limits # of what can be imported -Nontariff Barrier (NTB): makes harder for foreigners to sell in the US -Export Subsidy: US can export more/control amount US exports
Economic Impacts of Tariffs
Decline in consumption -Increase in domestic production -Decline in imports -Tariff revenue -Foreign producers lose revenue and sales -Spillover effects to other domestic industries
Net Costs of Tariffs
Price of imported products goes up -Consumer shifts purchases to higher priced domestic goods -Domestically produced goods become more expensive as import competition declines
Three Arguments for Trade Protection
1. Increased domestic employment 2. Cheap foreign labor 3. Protection against dumping: practice where some foreign firms sell products below actual cost
Infant Industry Argument
A way of protecting infant companies that are just starting up by raising tariff price on the products of larger, global companies 
Trade Adjustment Assistance Act
Helps those who lose their jobs because of foreign/international trade 
Offshoring of Jobs
Shifting work previously done by American workers to foreign workers abroad 
World Trade Organization (WTO)
153 member nations, starting in 2011 -Oversees trade agreements and rules on disputes -equal, nondiscriminatory trade between member nations -Reduction in tariffs -Eliminates trade quotas -Critics say it allows nations to circumvent certain environmental and worker protection laws
European Union (EU)
-Created in 1958 as a Common Market -Abolished tariffs and import quotas between member nations -Common tariff with countries outside of EU -Created euro zone (same currency: euro), though not all EU members use euro

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