UNIT IV

UNIT IV

Uses of Money:

• Medium of exchange - where one is able to buy goods and services
• Unit of account - establishes economic work
• Store of value - money holds its value over a period of time

- Types of money:

• Commodity money - swapping goods
• Representative money - I.O.U.s
• Fiat money - a government-established money 

- Characteristics of money:

1. Durability
2. Portability
3. Divisibility - can be divided down
4. Uniformity - same throughout the nation
5. Scarcity
6. Acceptibility

 - Money Supply:

• M1 money:
• consists of currency in circulation
• check-able deposits (demand deposits)
• traveler's checks
• M2 money:
• consists of M1 money + savings accounts + money marker accounts + deposits held by banks outside the U.S.

- Fractional Reserve Banking - process by banks of holding a small portion of their deposits in reserve + loaning out the excess

- Significance of a Fractional Reserve System

1. Banks can create money by lending more than their reserve
2. Required reserves doesn't prevent bank panics because banks must keep required reserves
3. Reserve requirement gives federal government control of how much money banks can create

- Functions of the FED

1. Control the nation's money supply through monetary policy
2. Issue paper currency
3. Serve as a clearing house for checks
4. regulate banking activity
5. serve as a bank for banks

- Balance sheet:

•  Is a statement of assets and claims summarizing the financial position of a firm or bank during a certain point in time
• MUST BE BALANCED AT ALL TIMES
• Assets - what you own
• Liabilities - What you owe

Multiple Deposit Expansion:


- Assets:

• Reserves
• required reserves - % required by the Federal Government to keep on hand to meet demand
• excess reserves - % of reserves over and above the amount needed to satistfy the minimum reserve ratio
• loans to firms, consumers and other banks
• loans to the government
• bank property - if bank fails, buildings can be liquidated

- Liabilities:

• Demand deposits - $$ put into an account
• timed deposits
• loans from - Fed reserves and other banks
• Shareholders Equity - to set up a bank, you must invest your own money in it

- Reserve requirement:

• The Fed. requires banks to always have some money readily available
• The amount set b the Fed is the required reserve ratio
• Required reserve ratio is the % of demand deposits that must nit be loaned out
• Typical required reserve ratio is 10%

Required Reserve Ratio:

- It is the amount of demand deposits that must be stored as vault cash or as Federal funds in the bank's account with the Federal Reserve

- The required reserve ratio determines the money multiplier (1 / required reserve ratio)

•  Decreasing the reserve ratio increases the rate in which money is created = expansionary
•  Increasing the reserve ratio decreases the rate in which money is created = contractionary

- Changing the required reserve ratio is the least used method for monetary policy

- Money multiplier:

• Shows the impact of a change in demand on loans and eventually the money supply
• Indicates the total number of dollars created into the banking by each $1 addition to the monetary bank

Fiscal and Monetary Policy:

- Congress controls fiscal policy - can either tax or spend
- FED controls monetary policy - open-market operation

• Required reserve - money needed to keep in vault or reserves
• Discount rate - interest rate charged by the FED for overnight loans to commercial banks
• Federal Fund Rate - interest rate charged by one commercial bank for overnight loans to another bank

Loanable Funds Market:

- Market where savers and borrowers exchange funds (Qlf) at the real interest rate (r%)

- The demand for loanable funds, or borrowing comes from households, firms, government and the foreign sector.

- Supply of loanable funds or savings comes from households. Supply of loanable funds is also the demand for bonds

- Change in the demand for loanable funds:

• More borrowing = more demand for loanable funds = shift to the right
• Less borrowing = less demand for loanable funds = shift to the left

- Change in the supply of loanable funds

• More saving = more supply of loanable funds = shift to the right
• Less saving = less supply of loanable funds = shift to the left