AP Macro Unit 4

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13 Terms

Monetary Policy

Central bank actions to control money supply and interest rates (to fight UNemployment & Inflation)

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Money Multiplier

mm = 1/Reserve Ratio
Multiply: to find MAXIMUM change in Money Supply (MS)
Divide: to find MINIMUM change in Money Supply (MS)

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Expansionary vs Contractionary Monetary Policy

Expansionary: INCREASES MS —> DECREASE interest rates —> INCREASES PL (price levels)
- BUY bonds in O.M.O (open market operations), DECREASE discount rate & reserve requirement
Contractionary: DECREASES MS —> INCREASE interest rates —> DECREASES PL (price levels)
- SELL bonds in OMO, INCREASE discount rate & reserve requirement

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Limited Reserves

banks are REQUIRED to have a reserve requirement (RR%) and/or excess reserves (ER)

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What are bonds?

Temporary loan to a firm/government to earn i% (interest rates) OVERTIME (money will GROW/SLOW)

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Relationship between bonds and i%

INVERSE!! As interest rates RISE, bond prices FALL and vice versa

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M0 - M3

M0 (monetary base/money base): CASH & deposits @FED (federal reserve/central bank)
M1: M0 + savings acct
M2: M1 + SMALL deposits ($ < 100K)
M3: M2 + LARGE deposits (100K +)
MOST liquid to LESS liquid

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Fractional Reserve Banking

KEEP fraction of $, REST is loaned with i%
Bank to bank loan each other EXCESS RESERVES
RR (required reserve): percentage of money deposited in acct
- “NEW” $: bonds, NOT cash; MS will change by 100%
- “OLD” $: CASH; MS will change by MAXIMUM $ - original
Liabilities: OWED $
Assets: OWNS $

$<ul><li>KEEP fraction of $, REST is loaned with i%</li><li>Bank to bank loan each other EXCESS RESERVES</li><li>RR (required reserve): percentage of money deposited in acct<ul><li>“NEW” $: bonds, NOT cash; MS will change by 100%</li><li>“OLD” $: CASH; MS will change by MAXIMUM $ - original</li></ul></li><li>Liabilities: OWED $</li><li>Assets: OWNS $</li></ul>$

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Loanable Funds Market

THEORY
LFS (Loanable Funds Supply) shifts when:
- ↑/↓ household savings
- ↑/↓ business profit
- ↑/↓ Govt surplus
- ↑/↓ foreign invest
LFD (Loanable Funds Demand) shifts when:
- ↑/↓ household consumption
- ↑/↓ business spending
- ↑/↓ Govt spending
- ↑/↓ foreign demand
Affects BOTH r% (real interest rates) & $ of loans

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#1 Example of LFM (Loanable Funds Market)

Govt crowding out

<ul><li><p>Govt crowding out</p></li></ul><p></p>

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Real = …

nominal i% - expected inflation = real (adjusted for inflation)

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↑/↓ Capital Formation/Shock

↑/↓ Long-run growth = ↑/↓ investment

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Ample Reserves

keep reserves @ FED/earn i%; RR = 0% {post 2008 econ. crisis)
Shift Demand?
- ↑/↓ IOR (interest on reserves): interest rates that FED pays banks to KEEP reserves
- ↑ IOR = ↓ Demand (EXPANSIONARY)
- ↓ IOR = ↑ Demand (Contractionary)

<ul><li><p>keep reserves @ FED/earn i%; RR = 0% {post 2008 econ. crisis)</p></li><li><p>Shift Demand?</p><ul><li><p><span>↑/↓ IOR (interest on reserves): interest rates that FED pays banks to KEEP reserves</span></p></li><li><p><span>↑ IOR = </span>↓ Demand (EXPANSIONARY)</p></li><li><p>↓ IOR = ↑ Demand (Contractionary)</p></li></ul></li></ul><p></p>

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