Macro Chapter 13 Money and the Banking System

6 Learning Goals 1) 1)List and describe the functions of money (on your own) 2) 2)Define the alternative measures of money and distinguish between M1 and M2 (on your own) 3) 3)Explain fractional reserve banking 4) 4)Investigate how banks create money by extending loans 5) 5)List the tools used by the Fed to control the money supply 6) 6)Analyze how those tools change the money supply

What is Money?

6 Learning Goals 1) 1)List and describe the functions of money (on your own)

Clicker Extra Credit: video about money titled “History Channel US Mints- paper and coin production” Look for the following: When and why the federal government started printing money Where the US Mint locations are Where the Bureau of Engraving and Printing has locations How much currency is printed and where it is

Video that illustrates how someone can be irrational about money:

How is the Money Supply Measured?

6 Learning Goals 2) 2)Define the alternative measures of money and distinguish between M1 and M2 (on your own)

The Business of Banking

Clicker Extra Credit: video about banks titled “History Channel Banks-Banking history” Look for the following: When and where was the first bank formed in the US? How did Bank of America get started? When were credit cards first created and how did they change to the way they are today?

Explanation of fractional reserve banking Video:

Example of bank run:

Discuss this question with a neighbor before answering

Q13.2 If you have a checking account at a local bank, your bank account there is 1.an asset to the bank and an asset to you. 2.a liability of the bank and a liability of yours. 3.a liability of the bank and an asset to you. 4.an asset to the bank and a liability of yours. 60

Typical assets and liabilities of banks: Assets: –Vault cash –Reserves at the Fed –Loans to customers –Bonds (i.e. securities) Liabilities: –Checking deposits –Savings deposits –Borrowings

How Banks Create Money by Extending Loans

Explanation of money creation process:

Class Activity: Illustration of how excess reserves are used to “create” money Create this table:

BankDepositRequired ReservesLoans

Here’s how excess reserves are used to “create” money: See files “deposit creation.pdf” and “deposit multiplier.pdf” on BB deposit creation.pdfdeposit multiplier.pdfdeposit creation.pdfdeposit multiplier.pdf

Key points: (1) Commercial banks are required to keep a portion of their deposits as reserves at the Federal Reserve Bank or as cash in the vault –These are required reserves –Equal to 10% of deposits (for most banks); called the required reserve ratio

Key points: (2) Commercial banks may keep or loan out additional reserves –These are excess reserves –Excess reserves earn interest from the Federal Reserve Bank, so the commercial bank must decide where it’s earning the biggest return- by loaning them out or by keeping them with the Fed

Key points: (3) The potential deposit expansion multiplier is equal to 1 / required reserve ratio –Example: 1 / 0.10 = 10 –So $1 could create $10 in new deposits (4) But the actual deposit expansion multiplier could be less –If one or more banks lend less than all of their excess reserves the multiplier is less –If one banks doesn’t lend any, the whole process stops and the multiplier is less

Caution and Clarification! “The multiplier” will refer to the Keynesian multiplier in Chapters 11 & 12 The “deposit multiplier” will refer to the deposit expansion multiplier in Chapters 13 & 14 Any quiz or exam question should put the multiplier in context and it should be easy to determine which one to think about

2 Transmitter Questions Next

Q13.3 Suppose you withdraw $1,000 from your checking account. If the reserve requirement is 20 percent, how does this transaction affect the supply of money and the excess reserves of your bank? 1.There is initially no change in the supply of money; your bank's excess reserves are reduced by $ There is initially no change in the supply of money; your bank's excess reserves are reduced by $ The money supply immediately increases by $1,000, and the excess reserves of your bank are reduced by $ The money supply immediately increases by $1,000, and the excess reserves of your bank are reduced by $

Now discuss that question with your partner and we’ll redo the question

Q13.4 Suppose you withdraw $1,000 from your checking account. If the reserve requirement is 20 percent, how does this transaction affect the supply of money and the excess reserves of your bank? 1.There is initially no change in the supply of money; your bank's excess reserves are reduced by $ There is initially no change in the supply of money; your bank's excess reserves are reduced by $ The money supply immediately increases by $1,000, and the excess reserves of your bank are reduced by $ The money supply immediately increases by $1,000, and the excess reserves of your bank are reduced by $

Q13.5 (MA) Suppose you deposit $1,000 into your checking account. If the reserve requirement is 10 percent, what impact does this transaction have? 1.The money supply increases 2.The money supply remains the same 3.The bank’s required reserves increase by $100 4.The bank’s required reserves decrease by $100 5.The bank’s required reserves increase by $900 6.The bank can make new loans of $900 7.The bank can make new loans of $1,000

Banks do not create money like this:

The Federal Reserve System

A quick look at the Fed:

13-6a Structure of the Fed Skim this section, pages You will not be asked any detailed questions about the Fed structure on the exam

Four tools of the Fed to control the money supply: 1)Reserve requirements 2)Open Market Operations 3)Extend loans 4) Interest paid on excess and required reserves

Expansionary Monetary Policy: Buy securities (i.e. bonds, Treasury or other) Extend more loans Reduce the interest rate paid on reserves

Restrictive Monetary Policy: Sell securities (i.e. bonds, Treasury or other) Extend fewer loans Increase the interest rate paid on reserves

Transmitter question next

Q13.6 If the Fed lends to member banks, what happens to reserves and the money supply? 1.Reserves increase and the money supply decreases. 2.Both increase. 3.Reserves decrease and the money supply increases. 4.Both decrease. 60

Open market operations is the key tool the Fed uses Open market operations is the buying and selling of bonds, usually US Treasury securities

Class Activity: Let’s see how this works Copy this activity into your notes. I think it will be helpful to study later. First, we need to look like bankers

Create the following three T accounts

AssetsLiabilities + Net Worth Required ReservesDeposits5,000 Excess Reserves0 Bonds800Net Worth Loans TotalTotal Bank: (make up your own name)

Suppose the Fed buys $100 of bonds Two-step process

AssetsLiabilities + Net Worth Required ReservesDeposits Excess Reserves BondsNet Worth Loans TotalTotal Step 1: The bond transaction

AssetsLiabilities + Net Worth Required ReservesDeposits Excess Reserves BondsNet Worth Loans TotalTotal Step 2: The actions of the bank

Results: New excess reserves at your bank = $100 Impact on money supply = $100 / 0.10 = $1,000

Two Transmitter Questions Next

Q13.7 (MA) When the Fed sells Treasury Bonds on the open market, it will tend to 1.increase the money supply 2.decrease the money supply 3.increase interest rates 4.decrease interest rates 60

Q13.8 (MA) When the Fed buys Treasury Bonds on the open market, it will tend to 1.increase the money supply 2.decrease the money supply 3.increase interest rates 4.decrease interest rates 60

How do open market operations affect the discount rate and federal funds rate? The Fed is referred to as the “lender of last resort” If a bank needs money to meet its required reserve ratio, it goes to the federal funds market first- borrow from other banks at the federal funds interest rate If it can’t borrow there, then go to the Fed and pay the discount rate

When the Fed buys and sells securities, it shifts supply in the federal funds market Buy securities- shift supply right Sell securities- shift supply left

Graph:

See Fed press release press releasepress release

What is Quantitative Easing (QE)? It’s nothing more than the Fed buying certain kinds of bonds to lower interest rates

Important section to read: 13-6d The Fed and The Treasury, pages

6 Learning Goals 1) 1)List and describe the functions of money (on your own) 2) 2)Define the alternative measures of money and distinguish between M1 and M2 (on your own) 3) 3)Explain fractional reserve banking 4) 4)Investigate how banks create money by extending loans 5) 5)List the tools used by the Fed to control the money supply 6) 6)Analyze how those tools change the money supply