1. Money, Banking, & Financial Markets
Unit 4, Section 1

2. What is money good for? Medium of exchange – buy stuff!
Unit of account – measure and compare
Store of value – accumulation of wealth

3. Types of Money Cash and checking accounts = transaction accounts or M1
M1 is about 50% checking accounts!
Credit cards are NOT a part of the money supply! These are essentially serving as loans from a bank. Basically, this money is already counted in M1 – no double counting!
M2 = Everything in M1 PLUS money from savings accounts, Certificate of Deposit accounts, & retail money market mutual funds.
Retail money market mutual funds = this is an interest earning account at a mutual fund company, but is specifically offered to individuals.

4. Fiat Money Have you heard of the Gold Standard
Fiat Money Have you heard of the Gold Standard? Do we still utilize this in the US today?
Most countries around the world today utilize Fiat money, which means there is nothing standing behind them other than the fact that they are “legal tender”
More flexibility
Countries must be careful not to OVER supply
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5. How does money move & circulate?
There is a correlation between money, price, & GDPr In order to assess this relationship, we utilize the equation of exchange MV=PQ
Money Side:
M = money in circulation
V = the income velocity of the money
- basically, how many times do we use the same dollar to buy goods!
Goods & Services:
P = Price Level Q = rate of real output

6. Equation of Exchange Theory
Milton Friedman – A monetary History of the United States,
Argued that monetary policy was the most important factor in establishing economic stability = monetarist economics
If this is the most important way to stabilize the economy, monetarists believe they can intervene with inflation and drive it down.
If they can control inflation to a degree, they can also predict and manipulate future interest rates
Keynesian Economists countered this idea by continuing to argue that government intervention and expenditures are the most important factor in manipulating the economy.

7. Fractional Reserve Banking https://www. federalreserve
Recall our simulation from the other day – the banks are required by the Fed to keep a FRACTION of money in the actual bank.

8. Fractional Reserve Banking
Only TRANSACTION ACCOUNTS have a reserve requirement
Savings Accounts & CDs do not
Regardless of the reserve requirement, banks, as financial institutions will want to make sure they have enough money on hand to take care of withdrawals needs.
The Fed utilizes T-accounts to balance money.
Ex. A customer deposits 100 – money supply….
10% must be saved as require reserves
Money supply stays the same!
Assets
Liabilities
Transactions regarding the banks assets
Changes in liabilities
+100 currency
+100 demand deposits
+90 excess reserves

9. Fractional Reserve Banking
Ex. Continued : what is the bank makes a loan with the excess reserves?
Assets
Liabilities
Transactions regarding the banks assets
Changes in liabilities
+100 currency
+100 demand deposits
+90 excess reserves
-90 excess reserves
+90 loan
The bank no longer has $90 in excess reserves, but the -$90 in loans is still an asset as it will be repaid with interest in the future

10. Money Market

11. Money Market - Demand
The demand for money is the relationship between the quantity of money people want to hold and the factors that determine that quantity.
We will assume there are only two ways to hold wealth:
as money in a checking account
funds in a bond market fund that purchases long-term bonds- recall this is not money!
We must also consider the liquidity of accounts, or how easy it is to turn an asset into cash WITHOUT LOSING WEALTH

12. Money Market - Demand
We must consider the tradeoffs between these two types of wealth.
Checking Deposits are easy to are highly liquid which means they can be transferred to money and spent easily.
With bonds, you are able to accrue interest, but you it is less liquid.
The difference between the interest rates paid on money deposits and the interest return available from bonds is the cost of holding money.
When interest rates rise relative to the rates that can be earned on money deposits, people hold less money. When interest rates fall, people hold more money. 

13. Money Market - Demand
We draw the demand curve for money to show the quantity of money people will hold at each interest rate, all other determinants of money demand unchanged.

14. Money Market – Demand Shifters
the level of income and real GDP
money is a normal good:
as income increases, people demand more money at each interest rate
as income falls, they demand less money at each interest rate
the price level
The higher the price level, the more money is required to purchase a given quantity of goods and services.
EX: the higher the price level, the greater the demand for money.
Expectations of Bonds & Future Prices
Bonds
if people expect bond prices to fall, they will increase their demand for money.
If they expect bond prices to rise, they will reduce their demand for money.
Future Prices
The expectation of a higher price level means that people expect the money they are holding to fall in value. Given that expectation, they are likely to hold less of it in anticipation of a jump in prices.

15. Money Market – Demand Shifters
transfer costs
For a given level of expenditures, reducing the quantity of money demanded requires more frequent transfers between nonmoney and money deposits.
The demand for money will increase as it becomes more expensive to transfer between money and nonmoney accounts.
The demand for money will fall if transfer costs decline.
Preferences
Some people place a high value on having a considerable amount of money on hand. For others, this may not be important.

16. Money Market - Supply
We draw the supply curve equal to the money supply.
This functions independently from the interest rate
This is determined by the Federal Reserve

17. Money Market
Supply Curve – shows the relationship between Qs of money and the interest rate. Since the Fed determines this, we simply have a vertical line!
Demand Curve – downward slope as it is influenced by the interest rate!
Money market equilibrium occurs at the interest rate at which the quantity of money demanded is equal to the quantity of money supplied.

18. Money Market – Supply Shifters
Open Market Operations
Most commonly when the Federal Reserve buys or sells bonds.
If the Fed BUYS bonds, they are giving out money in exchange for the bond  the money supply increases or shifts right
If the Fed SELLS bonds, they are giving out bonds in exchange for the money  the money supply decreases or shifts left
Discount Rate
This is the interest rate the Federal Reserve charges banks
If the discount rate increases, the money supply decreases (banks don’t want to pay high interest!)
If the discount rate decrease, the money supply increases
Reserve Ratio
This is the ratio of deposits the bank must hold – think of our simulation
If the RR increases, the money supply decreases
If the RR decreases, the money supply increases

19. Money Market Practice The Fed sells bonds on the open market
For each of the following indicate if there will be a shift on the Money Market Graph and the impact on the nominal interest rate:
The Fed sells bonds on the open market
The Fed raises the reserve requirement
The Fed lowers the discount rate
The economy expands and the volume of financial transactions increases
The Fed buys bonds on the open market
The economy enters a recession
The Fed buys bonds on the open market and at the same time the economy is expanding.

20. Money Market Practice
For each of the following indicate if there will be a shift on the Money Market Graph and the impact on the nominal interest rate:
The Fed sells bonds on the open market = MS down / IR up
The Fed raises the reserve requirement = MS down/ IR up
The Fed lowers the discount rate = MS up / IR down
The economy expands and the volume of financial transactions increases – D curve shifts up/ IR up
The Fed buys bonds on the open market - MS up / IR down
The economy enters a recession- D curve shifts down / IR down
The Fed buys bonds on the open market and at the same time the economy is expanding.- Ambiguous

21. What is the FED and How does it work?
ties/about-us/what-we-do

22. True or Myth?
You will each receive a card. Each has either a factual statement or a common myth about the Federal Reserve.
You will have 5 minutes to find the person in the room who has the complementary card to yours. I.E. the myth that goes with your truth or the truth that goes with your myth.
Once you have found your match, stand together in the front of the room and try to determine which one is the truth and which one is the myth.
Be prepared to share your cards and conclusion (with explanation) with the class. No phones!
The class will be polled to see if they agree with your logic.
You will be given a source that correlates to your pair. You will read this and re- organize if necessary and then share with the class.

23. Groups of four : Primary source One Organizer per group.
1. Who or what produced this document?
2. When was the document created?
3. Who was the intended audience?
4. What are the key words and ideas?
5. What words and/or phrases are difficult to understand even when using context clues?
6. Why was this document created?
7. What is the significance of this document?
8. What is the lasting value of the document?