macro unit 4 review

M0/monetary base

bank reserves (not money) & currency in circulation (money)

M1

M0 + checkable deposits, saving deposits

M2

M1 + small time deposits, money market

three functions of money

• medium of exchange

• unit of account (measure relative)

• store value

unexpected inflation: borrowers and lenders

borrowers: helped/gained bc they pay lower interest rate

lenders: hurt/lost bc they paid a lower interest rate (earned less back)

three tools for monetary policy in limited reserves

1. reserve requirements

2. discount rate

3. open market operations (OMOs)

purpose: to make minor changes in money supply curve/target policy rate by affecting interest rates

three tools for monetary policy in ample reserves (basically administered rates)

1. interest on reserve balances (IORB)

2. overnight reverse repurchase agreement (ON RRP) rate to set short-term interest rates

3. quantitative easing

• changes in reserve supply do not significantly affect interest rates

expansionary montary policy for limited reserves

decrease discount rate

decrease reserve requirement

increase investment spending/interest sensitive consumption

increase AD

increase MS

decrease nominal interest rate

• buying bonds help bc it increases MS

contractionary monetary policy for limited reserves

increase discount rate

increase reserve requirement

decrease investment spending/interest-sensitive consumption

decrease AD

decrease MS

increase nominal interest rate

• selling bonds help bc it decreases MS

expansionary monetary policy in ample reserves

decrease interest on reserves

decrease policy rate

• shifts demand curve down

contractionary monetary policy in ample reserves

increase interest on reserves

increase policy rate

• shifts demand curve up

what causes shifts in money demand

changes in price level, changes in real GDP, changes in banking tech, changes in banking regulation

increase in price level

increase in money demand for money, MD shifts right

decrease in price level

decrease in money demand for money, MD shifts left

increase in real GDP

increase in money demand, MD shifts right

decrease in real GDP

decrease in money demand, MD shifts left

changes in tech such as digital payment systems/advances in information tech

reduce demand for money (left shift) bc it makes it easier for the public to makepurchases w/o holding significant amounts of cash

interest forgo by holding funds in checking account instead of an interest bearing asset

opportunity of holding funds in checking account increases (no longer earning interest)

decreasing MS and/or increasing MD

increase in nominal interest rate

increasing MS and/or decreasing MD

decrease in nominal interest rate

loanable funds model

the real interest rate matches the quantity of loanable funds supplied by savers with the quantity of loanable funds demanded for investment spending

policy rate/federal funds rate in US

the central bank’s target range for ran overnight interbank lending rate; the interest rate that banks charge other banks for overnight loans determined in the federal funds market

federal funds market

a financial market that allows banks that need or want additional liquidity to borrow from banks that want to lend their excess reserves

limited reserves

describes an economy in which reserves are scarce and therefore relatively small changes in the supply in the reserves shifts the MS curve and changes interest rate

ample reserves

describes an economy in which banks hold high levels of excess reservesand therefore changes in supply of reserves does not change the interest rate significantly

federal open market committee

meets every 6 weeks and issues a policy statement after each meeting that summarizes its outlook for the economy and its monetary policy decision

increase in reserve requirement

more borrowing and increasing demand for reserves, increase in EQ policy rate

decrease in reserve requirement

less borrowing and decreasing demand for reserves = decrease EQ policy rate

required reserve ratio decreases

banks supplying more loans and increasing MS via money multiplier

• lower interest rates

• increase investment/interest-sensitive consumption

• increase AD and GDP

required reserve ratio increases

banks are forced to reduce lending and decreasing MS via money multiplier

• higher interest rates

• decrease investment/interest-sensitive consumption

• increases AD and GDP

discount rate

the interest rate the central bank charges on loans to banks (how much is charged to banks for loaning from central bank); SET BY FEDERAL RESERVE

• number is usually just above federal funds rate and move with other interest short term rates

discount rate increases

banks borrow less from central bank and supply of bank loans decrease

• decreasing MS

• increasing interest rate

discount rate decreases

banks borrow more as a result of cost to borrowing falling

• increasing MS

• reducing interest rate

open market operations (OMOs)

a purchase or sale of government debt (e..g bond) by a central bank

• central bank buy or sell bonds

• ex: Fed purchasing US treasury bills (us gov bonds); asset for Fed but liability of government

central bank buys bonds

• increase MS via money multiplier: shift right

• EQ interest rate decreases

central bank selling bonds/ OMO sale

• decreases MS shift left via money multiplier

• EQ interest rate increases

zero bound rate of zero

for a central bank, a point when the short-term interest rate has been lowered to zero and requires fed to use nontraditional policy tools; a con tousing expansionary monetary policy 

quantitative easing (QE)

an expansionary monetary policy that involves central banks purchasing longe-term government bonds and other private financial assets; large scale purchase of assets by central bank to stimulate economy/combat deflation by providing liquidity

• involves expanding central bank balance sheet to include various financial assets (e.g. long term gov bonds, private corporate bonds, mortgage-backed securities)

interest on reserve balances (IORB)

the amount the central bank pays in interest or banks for their balances held in reserves

increase in IOR

banks hold more cash as excess reserve (instead of making loans) 

• shift lower horizontal section of demand curve upward (AMPLE RESREVES)

decrease in IOR

banks make more loans because they earn less by keeping cash in reserves

• shifts lower horizontal section downward of demand curve (AMPLE RESREVES)

increase in reserves

shift supply curve (IN AMPLE RESREVES) to the right

decrease in reserves

shifts supply curve (SR; AMPLE RESERVES) to the left

monetary policy lags

the result from the time it takes to recognize a problem in the economy to the time it takes for am onetary policy action to make effect; usually shorter than fiscal monetary lags

budget surplus

the difference between tax revenue and government spending when government spending on goods, Services, and transfer payments exceeds tax revenue

budget deficit

the difference between tax revenue and government spending when government spending on goods, services, and transfer payments exceeds tax revenue (tax deficient)

rate of return

(revenue from project - cost fof project) / cost of project x 100

• a business will want to loan when the rate of return on a project is greater than equal to interest rate