Notesale: Turn your study into money

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Chapter 14
4/6/2015
Functions of Money
1) Medium of Exchange
• Used to buy / sell goods
• Anything we pay for
• Ease of payment
2) Unit of Account
• Goods valued in dollars (#)
• Used as “unit of account” to measure GDP
3) Store of Value
• Can be saved to buy things
• Better off spending $ on assets that don’t lose money as time
progresses due to inflation
• Hold some wealth in money form
Barter trade: item for an item
Different Degrees of Liquidity
Money most liquid asset
• Selling a house has many degrees of liquidity
*Writing a check to purchase a new computer is an example of using money
primarily as a
a) unit of account
b) standard of value
c) medium of exchange
d) store value
Money Definition M1
Ø M1
Currency (paper money and coins) a
...
a
...
Can be regulated by the FDIC & National Credit
Union Association (NCUA)
FDIC à Federal Deposit Insurance Corporation
- keep all money in savings and checking accounts insured

Ø M2
• Includes all of M1 and also near-monies
• Savings deposits including Money Market Deposit Accounts (MMDA)
o Bank takes and invests (restrictions on transactions)
• Small denominated time deposits (CDs)
o Agree not to touch money for a specific time period (less than
$100,000)
• Money Market Mutual Fund (MMMF)
o Offered by savings account
o Combines different people’s money to purchase stocks and
bonds
o Allows person to own thousands of small stock and bonds
o Invested with money market securities (short term, safe liquid
assets)
*Which of the following is not a part of U
...
money supply M1?
Time deposits (CDs)
Majority of Money is Electronic
M1 = 2 trillion
M2 = 10 trillion
M1 is 20% of M2
• Cash is about $1 trillion out of $10 trillion
• U
...
population = $300 million on average each person should carry
about $3000 cash
4/7/2015
What “Backs” money supply?
• Government guarantees ability to keep value stable
• You believe everyone will be happy to accept it
• Gold standard à every dollar in circulation had to be backed by actual
gold (that’s where paper value came from, money is no longer backed
this way)
o Commodity money = gold
• Stabilizing money’s purchasing power
o Intelligent management of money supply – monetary policy
o Appropriate fiscal policy
• Inflation has “self fulfilling prophecy” if people think the inflation will
rise, then it does
• Bubble – when the price of something is raising increasingly fast

•

o Ex: real estate “bubble” busted when prices kept rising and then
market came crashing down
o Causes big losses on everyone in the economy
Reason government tries to control how fast we are growing is to
prevent crashes in economy

Why is money valuable?
1
...
Legal tender
3
...
S
...
Headquarters = Board of Governors, in Washington D
...

appointed by president and confirmed by senate for 14 years of
non-renewable term (they can’t be fired for doing bad job)
§ 7 governors, one of them is appointed as a chair for 4
year terms (currently a woman Janet Yellen)
§ Each president may only appoint 3 so the president
cannot influence entire reserve
2
...
)
§ Distribution of 12 locations based on population back in
early 1900s (Missouri only one with 2)
3
...
)
• Lend money to commercial banks, this makes sure there is enough
credit in the economy (discount window)
o Interest that bank pays to the Fed when they borrow money =
0
...
Louis
o Maintain interbank settlement system called Fedwire, between
commercial banks in U
...

§ Fedwire: suppose you buy shoes from Amazon
...
Both banks keep reserve account at the
Fed (similar to checking account), Fed takes $100 from
your bank’s reserve account and put it in Amazon’s bank
account
4/9/2015
Act as fiscal agent for U
...
government
Supervise banks through regulation
o At local level with each district
Control money supply and influence interest rates
o Fed has direct control on spending decisions of the country due
to interest rates

Federal Reserve Independence
• Congress established the Fed as an independent agency separate
from the rest of the government
• Don’t want Fed to be under political pressures (politicians very short
sided just & worried about things up until their term is over and do not
have the expertise to make economic decisions)
o Raising interest rates is very unpopular so politicians would be
afraid to raise them
...
S
...
2 = 5
Then we can take the money multiplier (5) multiplied by the excess
reserve to find the Maximum checkable-deposit provided by the new
money entering the system
Quantity Theory of Money
Quantity equation
MxV=PxY
Velocity of money…average number of times each dollar is used to
purchase goods in GDP
V=

P xY
M
• velocity of money is the speed at which money turns over in the
economy
• rising velocity means more GDP is produced per dollar
• falling velocity means the economic impact is the same as if money
shrank by that same percentage

Multiple Deposit Creation Story

1) Tom deposits $100 in our bank (reserve ratio is 10%, so by law we
must keep $10 in reserves & lend out $90 to Lakota Coffee Shop)
Lakota deposits $90 at its own bank, Landmark Bank
2) Landmark Bank keeps 10% in bank ($9) and lends out the rest ($81)
to Sparky’s
...
Chipotle deposits $73 into its own bank,
Hawthorne Bank,
4) Hawthorne Bank keep 10% of $73 and loans out $66 to El Rancho,
El Rancho…
Have $ in checking/savings accounts at their banks
Tom à $100
Lakota à $90
Sparky’s à $81
Chipotle à $73
El Rancho à $66
Sum à $1000
So the initial $100 creates $1000
• A single deposit creates because then the bank lends the money out
• All the money is “there” just not technically tangible
...
1

bigger the reserve ratio, the smaller the money multiplier
(example of 20% reserve ratio)
1
----------------------- = 5
0
...
The system initially has no excess
reserves
...
This will
initially create excess reserves of
18 billion
*Continuing the previous example

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