3/31/17: Tools of Monetary Policy

• Tools of Monetary Policy
1. Open market operation
2. Reserve requirement 

• The Reserve Requirement
• The FED sets the amount that banks must hold
• Reserve ratio is the percent of deposit that banks must hold in reserve (% they can NOT loan out)

• Money Multiplier
• If triple R is .2, MM= 5
• Used to find change in money supply, change in DD.

• Using Reserve Requirement
• For Recessions
• Decrease the reserve ratio
1. Banks hold less money & have more excess reserves.
2. Banks create more money by loaning out excess.
3. Money supply increases, interest rates fall, AD goes up.
• RR down, MS up, I up, i down, AD up
• For Inflation
• Increase the reserve ratio
1. Banks hold more money & have less excess reserves.
2. Banks create less money.
3. Money supply decreases, interest rates up, AD down.
1. RR up, MS down, I down, i up, AD down

• Open Market Operations (OMO)
• FED buys or sells government bonds (securities)
• This is the most important & widely used monetary policy.
• If the  FED buys bonds: it takes bonds out of the economy & replaces them with money.
• MS up
• If the FED sells bonds: it takes money & gives the security to the investor.
• MS down

• The Discount Rate
• The discount rate is the interest rate that the FED charges commercial banks for short term loans.
• Federal Funds Rate
• The federal funds rate is the interest rate that banks charge one another for overnight loans.

3/24/17: Money Creation Formula

• A single bank can create $ by the amount of its excess reserves.
• The banking system as a whole can create $ by a multiple of the excess reserves.
• MM x ER = Expansion of Money
• Money Multiplier = 1 / RR (required reserves)

• New vs. Existing $
• New Money
• If the initial deposit in a bank comes from the FED or bank purchase of a bond or other money out of circulation (buried treasure), the deposit immediately increases the money supply.
• The deposit then leads to further expansion of the money supply through the money creation process.
• Total change in MS = Initial deposit is new $ = Deposit + $ Created by banking system
• Existing Money
• If a deposit in a bank is existing $ (already counted in MI. Ex: currency or checks) depositing the amount does NOT change the MS immediately because it is already counted.
• Existing currency deposited into a checking account changes only the composition of they money supply from coins/paper money to checking account deposits. 



• Total change in MS if deposit is existing money = Banking system created money only.

3/23/17: Fractional Reserve System

• Demand deposits are created through the fractional reserve system.
• Fractional Reserve System
• Process in which banks hold a small portion of their deposits in reserves & loan out the excess.

• Total Reserves/Actual Reserves
• TR or AR = Required Reserves (RR) + Excess Reserves (ER)
• Required Reserves
• Cash that banks keep on hand.
• Excess Reserves
• Loans; the bank lends out.

3/22/17: The Money Market (Supply & Demand for Money)

• Demand for money has an inverse relationship between nominal interest rate & the quantity of money demanded.

1. What happens to the quantity demanded of money when interest rates increase?
• Quantity demanded falls bc individuals would prefer to have interest earning assets instead of borrowed liabilities.
2. What happens to the quantity demanded when interest rates decrease?
•  Quantity demanded increases. There is no incentive to convert cash into interest earning assets.

• Money Demand Shifters
1. Changes in Price Level
2. Change in Income
3. Change in taxation that affect investment

• Increasing Money Supply
• If the FED increases the money supply, a temporary surplus of money will occur at 5% interest.
• The surplus will cause the interest rate to fall to 2%

3/22/17: Bonds & Stocks

• Bonds are loans. Stocks you own.

• Bonds-
• Loans that represents debt that the government or a corporation must repay to an investor.
• The bondholder has NO ownership of the company.
• If a corporation issues & then sells a bond, it is a liability
• It's an asset for the buyer
• NIR (Nominal Interest Rate)
• NIR Up = Decrease in value of bonds
• NIR Down = Increase in value of bonds
• Socks owners can earn a profit in 2 ways
1. Dividends, which are portions of a corporation's profits, are paid out to stockholders.
• Higher corporate profit, higher dividend
2. Capital gain is earned when a stockholder sells stock for more than he or she paid for it.
• A stockholder that sells stock at a lower price than the purchase price suffers capital loss.
• Federal Reserve Bank = FED = Capital Bank
• Goals of FED



• Maintain economy
• Full employment

3/20/17: Money

• The Barter System
• Goods & services are traded directly. There is no money exchanged.
• What is Money?
• Anything that is generally accepted in payment for goods & services.
• Money is NOT the same as wealth & income.
• Wealth is a total collection of assets that store value.
• Income is a flow off earnings per unit of time.
• Money Can Be Used as a
1. Medium of Exchange
• Buy goods & services 
2. Unit of Account
• Measuring the value of goods & services
3. Store of Value 

                                 

• 3 Types of Money
• Representative Money
• Money that represents something of value
• IOU's
• Commodity Money
• Something that performs the function of money & has alternative uses.
• Salt, gold, silver & cigarettes
• Fiat Money
• Money because government says so
• Coins, paper money
• Six Characteristics of Money
1. Durable
2. Portability
3. Divisibility
4. Uniformity
5. Limited Supply
6. Acceptability
7. 
   
• 3 Types of Money Supply
• Liquidity
• Ease with which an asset can be accessed and converted into cash (liquidized)
1. M1 (high liquidity)- 
• Coins, currency, and checks 
• Personal & corporate checking accounts which are the largest components of M1.
• In general, this is the money supply
2. M2 (medium liquidity)-
• M1 plus savings deposits (money market accounts)
• Time deposits (CD's: Certificates of deposit)
3. M3 (low liquidity)-
• M2 plus time deposits above $100k

3/6/17: Fiscal Policy

• How does the Government stabilize the economy?
• The government has two different tool boxes it can use:
1. Fiscal Policy
• Actions by congress to stabilize the economy.
• Changes the expenditures or tax revenues of the federal government.
2. Monetary Policy
• Actions by the Federal Reserve Bank to stabilize the economy. 
• Two Tools of Fiscal Policy
• Taxes: Government can increase or decrease taxes.
• Spending: Government can increase or decrease spending.
• Fiscal Policy is enacted to promote our nation's economic goals..
• Full employment
• Price stability
• Economic growth
• Deficits, Surpluses & Debt
• Balanced Budget
• Revenues = Expenditures
• Budget Deficit
• Revenues < Expenditures
• Budget Surplus
• Revenues > Expenditures
• Government Debt
• Sum of all Deficit - Sum of all Surpluses
• Government must borrow money when it runs a budget deficit.
• Government borrows money from..
• Individuals
• Corporations
• Financial Institutions
• Foreign entities or Foreign governments
• Fiscal Policy Two Options
• Discretionary Fiscal Policy (Action)
• Expansionary fiscal policy- think deficit
• Contractionary fiscal policy- think surplus
• Non-Discretionary Fiscal Policy (No Action)
• Three Types of Taxes
1. Progressive Taxes
• Takes a larger percent of income from high income groups (taxes more from rich people)
• Ex) Current federal income tax system.
2. Proportional Taxes (Flat rate)
• Takes the same percent of income taxes from all income groups.
• Ex) 20% flat income tax on al income groups. 
3. Regressive Taxes
• Takes a larger percentage from low income groups (poor people).
• Ex) Sales tax; any consumer tax.

• Contractionary Fiscal Policy (Break- Close inflation gap)
• Laws that reduce inflation & decrease GDP
• Decrease government spending
• Tax increases
• Combinations of the two
• Expansionary Fiscal Policy (Gas- Close recession gap)
• Laws that reduce unemployment & increase GDP
• Increase government spending
• Decrease taxes on consumers

• Automatic or Built-in Stabilizers
• Anything that increases the governments budget deficit during a recession & increases its budget surplus during inflation w/o requiring explicit action by policymakers. 
• Transfer Payments
• Welfare
• Food stamps
• Unemployment checks
• Corporate dividends
• Social Security 
• Veterans benefits