Unit 4 Monetary Policy

Uses of Money 

1. Medium Exchange: using to barter our trade
2. Unit of Account: gives money economic worth
3. Store of Value: dollar does not fluctuate

Types of Money

1. Representative Money: paper money that is backed by a tangible product
2. Commodity Money: gold a silver coins, gets value from material that is is made of 
3. Flat Money: money because government said so 

Characteristics of money 

1. Durability: 
2. Portability: carry money everywhere
3. Divisibility: money can be broken down
4. Uniformity: money is identical
5. Scarcity:
6. Acceptability: 

M1 Money (more liquid) 

• Consist of currency circulation (paper and coins)
• Travelers checks
• Checkable deposits
• Demand deposits

M2 Money 

• Savings accounts
• Money market accounts
• Accounts held by banks outside of the United States
• Adding M1 money

• Assets=(Liabilities)+(Net Worth) 
• Reserve Ration=(Commercial Bank's Required Reserves)/(Commercial Bank's Checkable Deposit Liabilities)

Three Important Issues

1. Excess Reserves=(Actual Reserves)-(Required Reserves)
2. Control of lending liability
3. Asset or liability to which bank?

• Banks create money by lending excess reserves and destroy it by loan payment , purchasing bonds from the public also creates money
• Money Multiplier=(1)/(Required Reserve Ratio)
• Maximum Checkable Deposit Creation=(Excess Reserves)(Monetary Multiplier)

Reserve Equipment 

• The Fed requires banks to always have some money readily available to meet consumers' demand for cash
• The amount, set by the Fed, is the required reserve ratio
• The required reserve ratio is the percentage of demand deposits (checking account balance) that must not be loaned out
• Typically the required reserve ration equals 10%

The Money Multiplier

• Similar to the spending multiplier, the money multiplier shows us the impact of a change in demand deposits on loans and eventually the money supply
• To calculate the multiplier, divide 1 by the required reverse ratio
• Money Multiplier=(1)/(Reserve Ratio)

The Three Types of Multiplier of Multiple Deposit Expansion

Type 1

• Calculate the initial change in excess reserves
• The smount of a single bank can loan from the initial deposit

Type 2

• Calculate the change in loans in the banking system

Type 3

• Calculate the change in the money supply
• Sometimes type 2 and 3 will have the same result (no Fed involvement)

Monetary Policy (Federal Reserve Bank)

• Influencing the economy through changes in reserves which influences the money supply and available credit

4 Options of Monetary Policy

1. Reserve Requirement: percent that is set by the FED of the minimum reserve a bank must keep
2. Discount Rate: the rate of interest that the FED charges for overnight loans to banks
3. Federal Fund Rate: rate that FDIC members charge each other for loans 
4. OMO (Open Market Operation): either buy or sell securities (bonds)

• If the FED buys bonds they expand (expansionary) money supply
• If they sell bonds they decrease money supply (contractionary)

Prime Rate

• Interest rate that banks charge their most credit worthy borrowers

	Expansionary	Contractionary
OMO	Buy Bonds	Sell Bonds
Discount Rate	↓	↑
Federal Fund Rate	↓	↑
Required Reserve Ratio	↓	↑

• If initial deposit is not new money, the total change in money supply is only the new money created by the banking system
• Single Bank: amount of money single banks can create (loan out)=ER

AR-RR+ER

• Banking Sytem: can create money by a multiple of its initial ER

Deposit Multiplier= (1)/(RR)

System New Money= (Deposit Multiplier)(Initial ER)