Macroeconomics- Everything You Need to Know

Banks and Lending

  • Money Lending Process

    • When a bank lends money, the borrower uses it and deposits it into another bank.

    • The second bank only keeps a portion as reserves and loans out the rest.

    • This creates a continuous cycle of lending and depositing.

  • Money Multiplier

    • Calculated as 1 over the reserve requirement.

    • Similar to spending multiplier (1 over marginal propensity to save).

    • The total change in the money supply = initial change in supply x multiplier.

Money Market Graph

  • Represents supply and demand for money.

  • Axes:

    • X-axis: Quantity of money

    • Y-axis: Interest rates

  • Demand for Money:

    • Downward sloping due to two factors:

      • Transaction demand: need for money to buy goods and services.

      • Asset demand: preference for holding money as an asset over bonds or stocks.

  • Supply of Money:

    • Vertical line, set by the Federal Reserve (Fed).

    • Intersection sets nominal interest rate.

Fed and Money Supply Control

  • The Fed can shift the money supply:

    • Increasing Supply:

      • Rightward shift, lowering interest rates.

      • Encourages borrowing, increasing investment and consumer spending.

      • Known as expansionary monetary policy.

    • Decreasing Supply:

      • Leftward shift, increasing interest rates.

      • Discourages borrowing, decreasing investment and consumer spending.

      • Known as contractionary monetary policy.

Tools to Shift Money Supply

  • Shifters:

    • Reserve Requirement: Adjusts how much banks must hold in reserve.

    • Discount Rate: Interest banks pay to borrow from the Fed.

    • Open Market Operations: Buying or selling bonds by the Fed.

  • Monetary Policy Rules:

    • Understand how each tool impacts the money supply.

Federal Funds Rate vs Discount Rate

  • Discount Rate: Charged by the Fed to banks.

  • Federal Funds Rate: Rate at which banks lend to each other.

  • Transaction Options for Banks:

    • Banks can approach the Fed, another bank, or create agreements with borrowers to manage liquidity.

Loanable Funds Market

  • Demand for Loans:

    • Driven by borrowers (individuals, businesses).

  • Supply of Loans:

    • Provided by savers and lenders.

  • Shifting Curves:

    • Increased government borrowing raises loan demand, leading to higher interest rates.

  • Crowding Out Concept:

    • Increased government demand for loans raises interest rates, discouraging private sector investment.

International Trade and Foreign Exchange

  • Balance of Payments:

    • Records all transactions between countries.

    • Consists of two accounts:

      • Current Account: Trade balance, investment income, and net transfers.

      • Financial Account: Financial assets inflow and outflow.

    • Surplus in one account offsets deficit in the other, maintaining balance.

Currency Value Concepts

  • Appreciation: Currency increases in value compared to others.

  • Depreciation: Currency decreases in value.

  • Net Exports Relationship:

    • Appreciation reduces exports (higher prices); depreciation increases exports (lower prices).

Foreign Exchange Market Dynamics

  • Graphing Currency Value:

    • Demand for dollars (by foreigners) and supply by Americans affect exchange rates.

    • Example: Increase in European tourists raises demand for dollars, causing appreciation.

  • Shifters in Foreign Exchange:

    • Tastes and Preferences: Influence demand for foreign currency.

    • Income Levels: Wealthier countries demand more imports.

    • Inflation: High domestic prices lead to reduced local purchasing and increased foreign purchases.

    • Interest Rates: Higher rates attract foreign investments, increasing currency value.

Floating vs Fixed Exchange Rates

  • Floating Exchange Rates: Determined by market forces of supply and demand.

  • Fixed Exchange Rates: Government pegs their currency to another currency's value.

Overall Difficulty Assessment

  • Unit Four: Rated 8/10 difficulty due to complexities in graphs and calculations involving monetary policy.

  • Unit Five: Rated 6/10 difficulty; crucial for understanding exchange rates, with fewer graphs but high importance.

Conclusion

  • Emphasize the importance of mastering these concepts for performance in exams, particularly in monetary policy and foreign exchange dynamics.