Banking & Finance: Sect. 4.2

 Explain how the Federal Reserve measures the money supply.  Describe how changes in the money supply affect interest rates.  Explain how banks create money.

Inflation

 Total amount of money available at a given time in an economy  aka money stock  Watched and measured by Federal Reserve

M1 Currency (coins and bills) + Funds deposited in checking accounts M2 Savings account deposits < $100,000 Money market account deposits < $100,000 Certificates of deposit (CDs) M3 Savings account deposits > $100,000 Money market deposits > $100,000 Institutional Money Market Mutual Funds

 The Federal Reserve uses which three measures to calculate the money supply?

 Primary way banks make money is by charging _________ to customers for __________.  Demand affects interest rates  More people wanting loans, higher interest rates will be  Dramatic drop in loans during the Great Recession. Why?

 Writing Prompt:  What is the money supply and describe (in narrative form) how it is measured.  Use your own words with subjects and predicates.

FRACTIONAL RESERVE SYSTEM  Requires banks and other depository institutions to keep a fraction of their deposits in reserves  As banks make loans with remaining funds, (excess reserves) money is created  Most money is just numbers in a computer  Reserves (required reserves) are deposits kept back and not available to make loans  May be in vault or at Federal Reserve district bank (Where’s ours?)  Banks must keep ___% of deposits in reserves $1500 (Nia’s deposit) - $150 (10% required reserves) = $1350 (excess reserves)

 What is the fractional reserve system?  What are reserves?

Money Multiplier Effect Our money is increased by the deposit- and-loan process of banks.

Creation of Money Money Multiplier Effect: A new deposit increases the money supply by more than the original deposit Excess reserves: amount available by the bank to loan Initial deposit Amount to be held by the bank as 20% reserve requirement

 Small increase in deposits can lead to a much larger increase in the money supply  Fed. Reserve increases bank deposits by purchasing securities  Counts on multiplier effect to increase money supply by a larger amount  With a 20% reserve requirement: $500 (increase in dep) /.20 (% of reserve requirement) = $2500 (potential increase in money supply)

 If deposits leave banks, there will be less money to make loans.  So, money supply will decrease.  When Fed. Reserve sells securities and receives money from customers, bank deposits fall.  With a 10% reserve requirement: $500 (decrease in deposits) /.10 (% of reserve requirement) = $5000 (potential decrease in money supply)

 When economy slows down (recession), Fed tries to stimulate economy by increasing money supply  With a threat of inflation (rising prices), Fed decreases the money supply

 How is money created?  If a bank’s deposits increase initially by $2500 and the reserve requirement is 10%, what is the potential increase in the money supply?

 Describe, in narrative form, how money is created. Be sure to use and define at least 2 vocabulary terms in your narrative.  Submit in drawer.

 Complete the online post test for Chapter 4 