Unit 4 Cram

U4 M25

• Demand Deposit:

  • money deposited in a commercial bank in a checking account

• Reserves

  • money that is in a bank that the bank chooses NOT to loan out either by Fed req or bank’s own policy

• Required Reserves

  • percent banks must hold by law

• Excess Reserve

  • amount that the bank can loan out

    • any asset that the bank owns other than money CANNOT be considered reserves

      • i.e. bonds are not reserves

• Balance Sheet

  • a record of a bank’s assets, liabilities, and net worth

• Demand deposits are a liability for the bank, asset to the depositor

• Money Multiplier = 1/RR

  • New Money Supply = Monetary Base * Money Multiplier

    • don’t forget to subtract initial monetary base if it’s looking for CHANGE

• M1 vs M2

  • M1:

    • currency outside US Treasury

    • Currency Outside Federal Reserve Banks

    • Currency outside vaults of institutions

    • Demand deposits at commercial banks

    • other liquid deposits

  • M2:

    • Small denomination time deposits (less than 100k) and Keough Accounts

    • Money Market Funds less IRA and Keough

  • everything in M1 is in M2

M27

• 3 Shifters of Money Supply

  • Setting Reserve Requirements

  • Central Bank Lending Money to Banks (Discount Rate)

  • Open Market Operations (Buying and Selling Bonds)

• Setting Reserve Requirements

  • reduces required reserve ratio, banks will lend a larger percentage of their deposits → more loans and an increase in the money supply via money multiplier

  • increase required reserve ratio, banks will lend a smaller percentage of their deposits → less loans and a decrease in the money supply via money multiplier

  • Recession → Decrease RR

  • Inflation → Increase RR

• Discount Rate

  • Federal Funds Rate is the interest rate that banks charge each other

  • However, when borrowing from the Fed itself, the Discount Rate is the interest rate the Fed charges commercial banks on loans

  • To increase money supply, FED should DECREASE the discount rate

  • To decrease money supply, FED should INCREASE the discount rate

• Open Market Operations

  • when the FED buys or sells government bonds (securities)

  • to increase money supply, FED should BUY bonds

    • Buy → Big (buying bonds increases money supply)

  • to decrease money supply, FED should SELL bonds

    • Sell → Small (selling bonds decreases money supply)

• When money supply increases, AD increases as now there is more money available for businesses and people to use.

  • Increase in demand lead to an increase in price

• When money supply decreases, AD decreases as now there is less money available for businesses and people to use

  • decrease in demand leads to decrease in price

• Think money supply → interest rate → AD → prices/wages

• Reserve Market Model

  • There is an inverse relationship btwn the Federal Funds Rate and the quantity of reserves demanded

  • When FFR is too high, banks want to hold less reserves (bank gets paid more by other bnaks)

  • When FFR is low, banks want to hold more reserves

  • Discount rate acts as a cap on Federal Funds Rate → if FFR is higher than discount rate then banks will borrow from Fed

    • x-axis (quantity of reserves → amount of reserves that banks want to hold at Fed)