8.0 Money

Econ 102 University of Michigan Oleg Z. Lecture 8 Flashcards

The three money functions and their definitions

1. Medium of Exchange (use money rather than barter)

2. Unit of Account (money describe value of assets)

3. Store of Value (money stores value across time)

Benefits of Commodity Money

Money has intrinsic value, will always has worth (example, gold will always have value)

Negatives of Commodity Money

• Intrinsic value exceeds monetary value, people stop using as money

• Not convenient to use

• Supply is hard to control

M1 Money Supply Definition

Cash, checking accounts, liquid assets

M2 Money Supply Definition

M1 + Saving accounts and similar things

M3 Money Supply Definition

M2 + Financial Assets

Monetary Base

Only accounts for money in circulation and bank reserves

The two main monetary policy instruments

1. Direct lending to banks

2. Open market operations

Describe how open market operations work

Fed buys securities in secondary market, when Fed buys security (example; bond), it adds money though system and vice versa

Monetary base formula

= cash on hand + bank reserves

M2 formula

= cash on hand + bank deposits

Money multiplier formula

M/B = (currency ratio + 1) / (currency ratio + reserve ratio)

Describe how money is created

Money is created when someone deposits money and banks then loans that to someone. That person buys goods with the loaned money which go into bank accounts, allowing two deposits and only one loan

Explain the two sides to a balance sheet and the aspects of them

1. Assets side

Holds reserves (which is deposits multiplied by reserve ratio) and money to be loaned out

2. Liabilities

Money deposited by users

How money supply and monetary base changes (using balance sheets)

Money supply changes based on the total amount of deposits on balance sheets, while monetary base is sum of reserves and loans. If money is loaned, supply increases but base stays same

Money supply formula

= starting amount * money multiplier

Explain the two ways that the money multiplier is reduced

1. People hold more money as cash (cr increases)

2. Banks hold more reserves (rr increases)

Name the 2 times when the multiplier changed drastically

1. Great Depression, money fell because multiplier fell (rr increased and cr increased)

2. 2008 Recession, multiplier fell (cr increased)

Name the 2 ways that the Fed can influence the money multiplier

1. Required reserve ratio (minimum amount a bank is required to hold as share of deposits)

2. Interest rate of excess reserves (helps banks hold excesses reserves by giving interest on them)

Describe the federal funds rate

Rate the Fed sets, markets can borrow from each other at this rate when short in cash, so Fed targets it towards banks. As rate goes above target, Fed buys bonds to make interest rates go down and vice versa

Does Fed determine money supply?

Yes and no, Fed has an effect but no full control. They cannot control lending but can influence money creation