Week 3:
Preparation: Chap 4: The monetary System: What It Is
and How It Works
Two arms of macroeconomics policy:
- Monetary policy: the decisions about the nation’s system of coin, currency
and banking.
- Fiscal policy: encompasses the government’s decisions about spending
and taxation – usually made by elective representatives
Economic meaning of money: the stock of assets that can be readily used to
make transactions.
3 purposes:
- Store of value: transferring purchasing power from the present to the
future.
- Unit of account: providing the terms in which prices are quoted and debts
are recorded.
- Medium of exchange: used to buy goods and services.
Money generates a Barter economy and allow us to trade without needing a
double coincidence of wants, permitting only simple transactions.
Money without intrinsic value is fiat money cuz established as money by gov. or
fiat (décret): most economies’ norm.
Intrisic value: commodity money (i.e. gold)
The monetary policy is the government’s control over money supply. Usually
delegated to a partially independent institution: the central bank (i.e. US Federal
Reserve -> Money is Federal Reserve Note)
Supply of money control: open-market operations – the purchase and sale of
government bonds.
Assets to include in the quantity of money are currency, demand deposits, or
even funds in savings accounts, money market mutual funds …
Money Supply (M) =
Currency (C) + Demand
Deposits (D)
Reserves: deposits that banks
have received but have not lent
out.
100-percent-reserve banking=
banks accept deposits, place the
money in reserve and leave it
there until the depositor
withdraw it or writes a check against it.
If banks hold a 100 percent of deposits in reserve, the banking system does not
affect the supply of money.
Fractional-reserve banking: system under which banks keep only a fraction of
their deposits in reserve.
, In a system of fractional-reserve banking, banks create money.
The process of transferring funds from savers to borrowers is called financial
intermediation.
The creation of money by the banking system increases the economy’s liquidity,
not its wealth.
The model of money supply
Three exogenous variables:
- The monetary base B is the total number of dollars held by the public as
currency C and by the banks as reserves R.
- The reserve-deposit ratio rr is the fraction of deposits that banks hold in
reserve. It is determined by the business policies of banks and the laws
regulating banks.
- The currency-deposit ratio cr is the amount of currency C people hold as a
fraction of their holdings of demand deposits D. It reflects the preferences
of households about the form of money they wish to hold.
M C+ D
M=C+D and B=C+R =
B C+ R
C
+1
M D
=
B C R
+
D D
And C/D = cr and R/D= rr
cr +1
M= ∗B
cr +rr
cr +1
And =m or money multiplier
cr +rr
So M = m x B Money base is also called high-powered money.
Federal Reserve controls the money supply indirectly through different
instruments:
- The discount rate: interest rate charged by the Fed on loans.
- Reserve requirements are Fed regulations that impose a minimum
reserve-deposit ratio on banks. (if above the minimum required: excess
reserves).
- Interest on reserves: when a bank holds reserves on deposit at the Fed
which pays interest to the bank.
Chap 5: Inflation: Its Causes, Effects, and
Social Costs
Inflation: overall
increase in price ->
hyperinflation
Preparation: Chap 4: The monetary System: What It Is
and How It Works
Two arms of macroeconomics policy:
- Monetary policy: the decisions about the nation’s system of coin, currency
and banking.
- Fiscal policy: encompasses the government’s decisions about spending
and taxation – usually made by elective representatives
Economic meaning of money: the stock of assets that can be readily used to
make transactions.
3 purposes:
- Store of value: transferring purchasing power from the present to the
future.
- Unit of account: providing the terms in which prices are quoted and debts
are recorded.
- Medium of exchange: used to buy goods and services.
Money generates a Barter economy and allow us to trade without needing a
double coincidence of wants, permitting only simple transactions.
Money without intrinsic value is fiat money cuz established as money by gov. or
fiat (décret): most economies’ norm.
Intrisic value: commodity money (i.e. gold)
The monetary policy is the government’s control over money supply. Usually
delegated to a partially independent institution: the central bank (i.e. US Federal
Reserve -> Money is Federal Reserve Note)
Supply of money control: open-market operations – the purchase and sale of
government bonds.
Assets to include in the quantity of money are currency, demand deposits, or
even funds in savings accounts, money market mutual funds …
Money Supply (M) =
Currency (C) + Demand
Deposits (D)
Reserves: deposits that banks
have received but have not lent
out.
100-percent-reserve banking=
banks accept deposits, place the
money in reserve and leave it
there until the depositor
withdraw it or writes a check against it.
If banks hold a 100 percent of deposits in reserve, the banking system does not
affect the supply of money.
Fractional-reserve banking: system under which banks keep only a fraction of
their deposits in reserve.
, In a system of fractional-reserve banking, banks create money.
The process of transferring funds from savers to borrowers is called financial
intermediation.
The creation of money by the banking system increases the economy’s liquidity,
not its wealth.
The model of money supply
Three exogenous variables:
- The monetary base B is the total number of dollars held by the public as
currency C and by the banks as reserves R.
- The reserve-deposit ratio rr is the fraction of deposits that banks hold in
reserve. It is determined by the business policies of banks and the laws
regulating banks.
- The currency-deposit ratio cr is the amount of currency C people hold as a
fraction of their holdings of demand deposits D. It reflects the preferences
of households about the form of money they wish to hold.
M C+ D
M=C+D and B=C+R =
B C+ R
C
+1
M D
=
B C R
+
D D
And C/D = cr and R/D= rr
cr +1
M= ∗B
cr +rr
cr +1
And =m or money multiplier
cr +rr
So M = m x B Money base is also called high-powered money.
Federal Reserve controls the money supply indirectly through different
instruments:
- The discount rate: interest rate charged by the Fed on loans.
- Reserve requirements are Fed regulations that impose a minimum
reserve-deposit ratio on banks. (if above the minimum required: excess
reserves).
- Interest on reserves: when a bank holds reserves on deposit at the Fed
which pays interest to the bank.
Chap 5: Inflation: Its Causes, Effects, and
Social Costs
Inflation: overall
increase in price ->
hyperinflation
