Money, Money Supply, Bank Accounting, & Fiscal and Monetary Policy Review Day #3: Block May 3rd or 4th Unit-4 Macro Review Money, Money Supply, Bank Accounting, & Fiscal and Monetary Policy

Fed vs. Government The Federal Reserve creates money By buying bonds in open market operations Too much money can lead to inflation The Government creates debt By borrowing money for deficit spending Too much debt can lead to crowding out Loanable Funds = Gov’t Money Market = Fed

Money Market Use for Gov’t Debt Use for Monetary Policy Model of Saver & Borrowers Supply = National Savings Demand = Investment (I) (borrowers for capital goods => leads to innovation Crowding Out: Gov’t borrows too much => real interest rates rise = Business Investment falls (I ↓) Use for Monetary Policy MS is is fixed by Fed MD = Desire to “hold money” [transaction demand) Fed buys/sell bonds to shift MS => this changes short term interest rates (federal funds rate) MD rarely shifts

MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓ 2 Types of Monetary Policy Expansionary Contractionary Currently 1.50% Currently 0.75% target Contractionary Policy => ↑ reserve requirement, ↑ discount rate & Sell Bonds MS1 MD Nominal Interest Rate Qty of $ MS2 LRAS1 Price Level Real GDP AD1 SRAS1 Affects AD AD2 ------------------ -------------- P1 Y1 Y* E1 ---------- i2 E2 Q2 -------------- P2 E2 MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓ --------------- i1 E1 Q1

MONEY Commodity money Fiat money Types of Money (Std. of value) Measuring Money Supply M1 - most liquid (cash, checking deposits, travelers checks, etc…) M2 - slightly less liquid (M1 + savings acct., money markets,…) M3 = least liquid (M2 + large time deposits (over $100,000) )

Banks Create Money by lending Fractional Reserve Banking System Banks Create Money by lending Example: $100 Deposit 10% Reserve Ratio 1st Bank Balance Sheet This loan causes money creation Excess Reserves can be lent out by bank .

Money Multiplier = 1/R 10 * $90 = $900 increase Money Supply Reserve Requirement = 10% Money Multiplier = 1/10% = 10 Money Supply Change = Money Multiplier X 1st Loan 10 * $90 = $900 increase Money Supply

Practice Test 16 Practice Multiple Choice

Quantity Theory of Money Monetarists economists believe that money is neutral! That is changes in Money Supply (MS) have no affect on real GDP in long run Qty Theory of Money Equation Velocity of money is relatively constant Real GDP is fixed in short run ↑ MS only will ↑Price Level

2011 Practice Free Response

DEMAND FOR MONEY Demand for money is downward sloping Money Market MS The Money Market is not the Loanable Funds market! (It is a much broader market) Money Market Nominal Interest Rate MS Demand for Money: Transactions Demand Precautionary Demand Speculative Demand MD Qty $ Price Level changes shifts Demand Curve for Money ↑ Px level shifts MD right ↓Px level shifts MD left