Final Exam n Exam Date: May 6, 2006 n Exam Time: 2:00-4:00pm n Room: Terrill Hall 121

Request to Reschedule Final Exam n Taking both 1100 and 1110 n 3 or more finals scheduled for that day n Religious reasons n Other? (appropriate documentation) n All requests must be submitted to Kari Battaglia, by Monday, May 1 st

NATURE OF MONEY n widely acceptable in exchange for goods and services n acceptable as payment for debts

MONEY vs. BARTER n Money is more efficient than barter because it –decreases transaction time –increases the number of transactions  Exchange is easier and less time-consuming in a money economy

PHYSICAL CHARACTERISTICS OF MONEY n portable n divisible n Recognizable  Money is any good that is widely accepted for purposes of exchange

WHAT GIVES MONEY VALUE? n no longer backed by gold n “fiat money” backed by the government n value lies in peoples trust in the government and their willingness to accept it for G & S.

Three Functions of Money n Medium of exchange  money is the medium through which exchange occurs  money is the medium through which exchange occurs n Unit of account  a common measure in which values are expressed  a common measure in which values are expressed n Store of value  ability to maintain its value over time  ability to maintain its value over time

Three Functions of Money (cont.) n A pizza maker lists the price of pizza as $10 n A $50 traveler’s check n A $10 food stamp n A vacation home in the Caribbean

M1 NARROWLY DEFINED MONEY n currency n checkable deposits n traveler’s checks

CURRENCY n coins and bills n currency in circulation and currency held outside the bank are equivalent

CHECKABLE DEPOSITS n all checkable deposits whether at a bank, savings and loan, or credit union. n also called transactions accounts and demand deposits n debit cards that draw directly from your account are included

Exhibit 1The Components of M1 SOURCE: Board of Governors of the Federal Reserve System.

MONEY SUPPLY n checkable deposits are the largest component of M1 (almost 70%) n the term Money Supply refers to M1 unless otherwise noted

M2 BROADLY DEFINED MONEY n M1 n small time deposits n savings deposits n money market deposit accounts (MMDA) n money market mutual fund (MMMF)

M3 and L n M3 and L add less liquid assets such as –large time deposits (M3) –bankers acceptances (L)

Money supply measures, April 2002 _SymbolAssets includedAmount (billions)_ CCurrency$598.7 M1C + demand deposits, travelers’ checks, other checkable deposits M2M1 + small time deposits, savings deposits, money market mutual funds, money market deposit accounts M3M2 + large time deposits, repurchase agreements, institutional money market mutual fund balances

CREDIT CARDS n Credit cards are NOT money n Credit cards are short term loans - you borrow from the bank and then must repay that loan. n The existing money is shifted around but Ms does not change

100-PERCENT-RESERVE BANKING n All deposits are held as reserves n Banks accept deposits, place the money in reserve, and leave the money there until the depositor makes a withdrawal

FRACTIONAL RESERVE BANKING n Banks are not required to keep every dollar that you deposit on reserve. n The Federal Reserve sets the required reserve ratio which determines the percentage of deposits that must be held.

BANK RESERVES n TOTAL RESERVES - cash in the vault and bank deposits at the Fed. n REQUIRED RESERVES - total deposits X required reserve ratio n EXCESS RESERVES - total reserves - required reserves

Examples n Calculate required reserves (RR) when total deposits are $80,000 and the required-reserve ratio is r = 20% n What is the required-reserve ratio if banks are required to hold $100 in reserves to support $500 in deposits? n Calculate deposits if required reserves are $150 and the required-reserve ratio is r = 20%

Examples n What are excess reserves if $40 of the $100 in total reserves held by banks are required reserves? n How much do banks have in excess reserves if total reserves are $400, deposits are $2,000 and the required-reserve ratio is 20%?

BANK ACTIVITIES n Banks accept deposits and offer checking services n Banks keep a percentage of the deposits on reserve n Excess reserves are available to be loaned out n Banks earn money from loans

Exhibit 3The Money Supply Expansion and Contraction Processes

T - Accounts BANK TWO AssetsLiabilities Total ReservesDemand Deposits Loans

MONEY EXPANSION n When banks make loans they create money n When the loans are spent, it finds its way into other banks. n These banks keep a portion of these deposits on reserve and then loan the rest out.

BANK TWO r =.10 AssetsLiabilities Reserves100Demand Deposits1,000 Loans900

BANK TWO r =.10 (fully loaned up) AssetsLiabilities Reserves100Demand Deposits1,000 Loans900 RR 100 ER 0

BANK TWO r =.10 AssetsLiabilities Reserves200Demand Deposits1,000 Loans800 RR 100 ER 100

(1) BANK (2) NEW DEPOSITS (new reserves) (3) NEW REQUIRED RESERVES (4) CHECKABLE DEPOSITS CREATED BY EXTENDING NEW LOANS (equal to new excess reserves) $1, $ $ A B C D E TOTALS (rounded)$10,000$1,000 $9,000

Examples n By how much can the banking system expand deposits if total reserves are $600, deposits are $2,500 and the required-reserve ratio is 20%?

Money Expansion n When banks make loans they increase the money supply (M1) n The maximum change in checkable deposits is ( 1/r x change in reserves ) n simple deposit creation multiplier = 1/r n Reasons actual creation may be less than the maximum –cash leakages –nonzero excess reserves

SIMPLE DEPOSIT MULTIPLIER n If r =.10 then the simple deposit multiplier is 10 n If r =.15 then the simple deposit multiplier is 6.67 n If r =.20 then the simple deposit multiplier is 5

MONEY DESTRUCTION contractionary policy n The FED can also choose to remove money from the economy n When the FED reduces the amount of money in circulation this impacts banks n as bank deposits fall, banks are forced to reduce the amount of loans (call in loans) n The decrease in loans reduces the money supply