macro 4.3-3.5

• Money is any asset that can easily be used to purchase goods and services

• The money supply is the total value of financial assets in the economy that are considered money.

• A medium of exchange is an asset that individuals acquire for the purpose of trading for goods and services rather than for their own consumption.

• A store of value is a means of holding purchasing power over time.

• A unit of account is measure used to set prices and make economic calculations

• Commodity money is a good used as a medium of exchange that has intrinsic value in other uses

• commodity -backed money is a medium of exchange with no intrinsic value, but whose ultimate value is guaranteed by a promise that it can be converted into valuable goods.

• Flat money is a medium of exchange whose value derives entirely from its official status as a means of payment

• A monetary aggregate is an overall measure of the money supply

• The monetary base (also known as M0 or MB) is the total amount of currency (cash) in circulation or kept on reserve by commercial banks

• The M1 monetary aggregate includes currency in circulation, checkable bank deposits, and other liquid deposits

• The M2 monetary aggregate includes M1 plus less liquid “near monies” (financial assets that can be readily converted into cash).

• A central bank is a government institution that issues currency, oversees and regulates the banking system, controls the monetary base, and implements monetary policy.

• An open market operation (OMO) is a purchase or sale of government debt (bond) by the Fed.

• In a fractional reserve banking system, only a fraction of bank deposits are backed by cash on hand and available for withdrawal

• Bank reserves are the currency that bands hold in their vaults plus their deposits at the central bank

• The reserve ratio is the fraction of bank deposits that a bank holds as reserves.

• The required Reserve ratio is the smallest fraction of deposits that the Central Bank requires banks to hold 

• Reserve requirements are rules set by the central bank that determine the required reserve ratio for banks

• Required reserves are the reserves that banks must hold, as mandated by the central bank.

• Excess reserves are a bank's reserves over and above its required reserves

• The money multiplier is the ratio of the money supply to the monetary base. It indicates the total number of dollars created in the banking system by each $1 addition to the monetary base

Money market – supply and demand for equilibrium price of money, borrowers and lenders agree to short-term loans

M1 is used as definition of money supply (currency in circulation and liquid deposits) M2 = broader

Demand → hold money because convenience (fast) but opportunity cost because no interest earned

• opportunity cost cost depends on interest rates (directly related)

We assume only on interest rate (short run i) however

• Long term interest rates reflect average market expectations

• Short term rates affect the money demand (short term is normally under a year)

The money demand curve shows the relationship between the quantity of money demanded and the nominal interest rate

 → decreasing and concave up (y axis i / nominal interest rate and x axis quantity of money)

Shifts!!!

• Changes in agg PL → higher prices increase demand for money (right), lower prices = left, *proportional to the price level (movement from M1 to M2) 

• Changes in rGDP → larger quantity of GDP (goods and services to buy), the larger want to hold at any given interest rate

• Changes in technology → decrease demand for money / ie now we have venmo vs going to bank in person

• Changes in regulation → ie allowing banks to pay interest on checking account funds, demand for money rose and shifted the money demand curve to the right

• An increase in money demand shifts right / quantity of money demanded rises at any given interest rate

• A decrease in money demanded shifts left / quantity of money demanded decreases at any given interest rate

Supply → set by central bank (control of currency and reserve / open market operations)

Money supply is independent of the nominal interest rates

The money supply curve (MS) shows the relationship between the quantity of money supplied and the nominal interest rate – the money supply curve is independent of the nominal interest rate

*vertical line

Equilibrium interest rate /// Ei

• MD and MS (MD curve intersects vertical M line at E interest rate)

• Is nominal equilibrium, in disequilibrium

  • Quantity demanded greater than supplied, shortage

  • Quantity demanded less than supplied, surplus

• Changes = change in money demand or money supply

**central banks ability to affect eh eq nominal interest rate through control of money supply shows how monetary policy can be used to affect the macroeconomy

• Increases when, MS decrease or MD increase / decrease when MASS increase or MD decrease

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