Unit 4: Monetary Policy

Money, Banking, and Monetary Policy

Money is anything that is generally accepted in payment for goods and services 

Commodity money is something that performs the function of money and has intrinsic value. Ex: Gold, and silver

Fiat Money is something that serves as money but has no other value or uses. Ex: paper money, coins, digital money

3 Functions of Money

1. A medium of exchange

   1. Money can be used for goods and services with no complications of a barter system

2. A unit of account

   1. Money measures the value of all goods and services, acting like a measurement of value

3. A store of value

   1. Money allows you to store purchasing power for the future.

The Demand for Money

Demand for money is downward sloping:

Inverse relationship between interest rates and the quantity of money demanded

The Supply for Money

The US money supply is set by the Board of Governors of the Federal Reserve System(FED)

3 Shifters of the money supply   -   1/RR

The FED adjusting the money supply by changing any one of the follow:

1. Setting Reserve Requirements(ratio) 

   1. This is now set at ZERO- 2020! Why?

      1. Only a small percent of your money is held in reserve. The rest of your money has been loaned out. This is called “Fractional Reserve Banking”.The FED sets the amount that banks must hold the reserve requirements.

2. Lending money to banks

   1. Discount rate

3. Open Market Operations

   1. Buying and selling bonds

      1. When the FED buys or sells government bonds (securities)

      2. To increase the money supply the FED should BUY government securities. To Decrease money supply, the FED should SELL government securities

      3. Buying -  Big

      4. Selling - Small

The FED is now chaired by Jerome Powell.

The Money Multiplier

Money multiplier=1/Reserve Requirement(ratio)   1/RR

The Discount Rate

The discount rate is the interest rate that the FED charges commercial banks.

Example:If bank of america needs $10 Million, they borrow it from the US treasury but they must pay the bank with 3% interest

Money Supply

• To increase Money supply, the fed should decrease the discount rate

• To decrease the money supply the FED should increase the discount rate

Federal Funds Rate

The federal funds rate is the interest rate that a bank charges on another bank for loans for reserves.

The FED can’t tell banks what interest rate to use. Banks decide on their own

The FED influences them by setting a target rate and using open market operation to hit the target

NEW STUFF NOT IN TEXTBOOK

Interest on Reserves(IOR) - the interest rate that the federal reserve pays commercial banks to hold reserves

To stimulate the economy you would not put your money with the FED if the interest rates are too low. If the interest on reserves is raised, it hurts the economy because they are not incentivized to send out money.

Administered rates- Interest rates set by the FED rather than being determined by the market

When there are limited reserves:

• Banks deposit few reserves with the central bank

When there are ample reserves:

• Banks deposit a lot of reserves with the central bank

Y - Federal Funds Rate(Policy Rate)

X - Quantity of Reserves

IOR is the lowers rate

Fractional Reserve Banking

When banks hold only a small portion of deposits to cover potential withdrawals and then loan out the rest of the money.

Classifying Money

Liquidity- ease with which an asset can be accessed and used as a medium of exchange(turned into cash).

M1 (Highest Liquidity)

1. Currency in circulation

2. Checkable bank deposits(checking account)

M2 (Near-Moneys) M1 plus the following:

1. Savings deposits (money market accounts)

2. Time deposits (CDs=Certificates of deposit)

3. Money market funds

Assets- Anything tangible or intangible that is owned

Liability- Anything that is owed

Demand Deposits- Money deposited in a commercial bank in a checking account

Required Reserves- The percent that banks must hold by law

Excess Reserves- The amount that the bank can loan out

MP

1. RR = Bank Balance Sheet

2. DR   FFR

3. OMO

4. IOR

Loanable Funds Market

Is the private sector supply and demand of loans.