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Final ExamFinal Exam
Exam Date: May 6, 2006Exam Date: May 6, 2006 Exam Time: 2:00-4:00pmExam Time: 2:00-4:00pm Room: Terrill Hall 121Room: Terrill Hall 121
Request to Reschedule Final ExamRequest to Reschedule Final Exam
Taking both 1100 and 1110Taking both 1100 and 1110 3 or more finals scheduled for that day3 or more finals scheduled for that day Religious reasonsReligious reasons Other? (appropriate documentation)Other? (appropriate documentation) All requests must be submitted to Kari All requests must be submitted to Kari
Battaglia, by Monday, May 1Battaglia, by Monday, May 1stst
NATURE OF MONEYNATURE OF MONEY
widely acceptable in exchange for goods widely acceptable in exchange for goods and servicesand services
acceptable as payment for debtsacceptable as payment for debts
MONEY vs. BARTERMONEY vs. BARTER
Money is more efficient than barter because Money is more efficient than barter because itit– decreases transaction timedecreases transaction time– increases the number of transactionsincreases the number of transactions
Exchange is easier and less time-consuming in Exchange is easier and less time-consuming in a money economya money economy
PHYSICAL PHYSICAL CHARACTERISTICSCHARACTERISTICS
OF MONEYOF MONEY portableportable divisibledivisible RecognizableRecognizable
Money is any good that is widely accepted for Money is any good that is widely accepted for purposes of exchangepurposes of exchange
WHAT GIVES MONEY WHAT GIVES MONEY VALUE?VALUE?
no longer backed by goldno longer backed by gold ““fiat money” backed by the governmentfiat money” backed by the government value lies in peoples trust in the government value lies in peoples trust in the government
and their willingness to accept it for G & S.and their willingness to accept it for G & S.
Three Functions of MoneyThree Functions of Money
Medium of exchangeMedium of exchange money is the medium through which exchange money is the medium through which exchange
occursoccurs Unit of accountUnit of account a common measure in which values are a common measure in which values are
expressedexpressed Store of valueStore of value ability to maintain its value over timeability to maintain its value over time
Three Functions of Money Three Functions of Money (cont.)(cont.)
A pizza maker lists the price of pizza A pizza maker lists the price of pizza as $10as $10
A $50 traveler’s checkA $50 traveler’s check A $10 food stampA $10 food stamp A vacation home in the CaribbeanA vacation home in the Caribbean
M1M1NARROWLY DEFINED NARROWLY DEFINED
MONEYMONEY currencycurrency checkable depositscheckable deposits traveler’s checkstraveler’s checks
CURRENCYCURRENCY
coins and billscoins and bills currency in circulation and currency held currency in circulation and currency held
outside the bank are equivalentoutside the bank are equivalent
CHECKABLE DEPOSITSCHECKABLE DEPOSITS
all checkable deposits whether at a bank, all checkable deposits whether at a bank, savings and loan, or credit union.savings and loan, or credit union.
also called transactions accounts and also called transactions accounts and demand depositsdemand deposits
debit cards that draw directly from your debit cards that draw directly from your account are includedaccount are included
Exhibit 1 The Components of M1
SOURCE: Board of Governors of the Federal Reserve System.
MONEY SUPPLYMONEY SUPPLY
checkable deposits are the largest checkable deposits are the largest component of M1 (almost 70%)component of M1 (almost 70%)
the term Money Supply refers to M1 unless the term Money Supply refers to M1 unless otherwise notedotherwise noted
M2M2BROADLY DEFINED MONEYBROADLY DEFINED MONEY
M1M1 small time depositssmall time deposits savings depositssavings deposits money market deposit accounts (MMDA)money market deposit accounts (MMDA) money market mutual fund (MMMF)money market mutual fund (MMMF)
M3 and LM3 and L
M3 and L add less liquid assets such asM3 and L add less liquid assets such as– large time deposits (M3)large time deposits (M3)– bankers acceptances (L)bankers acceptances (L)
Money supply measures, Money supply measures, April 2002April 2002_Symbol_Symbol Assets includedAssets included Amount (billions)_Amount (billions)_
CC CurrencyCurrency $598.7$598.7
M1M1 C + demand deposits,C + demand deposits, 1174.01174.0 travelers’ checks, travelers’ checks, other checkable deposits other checkable deposits
M2M2 M1 + small time deposits,M1 + small time deposits, 5480.15480.1 savings deposits, savings deposits, money market mutual funds, money market mutual funds, money market deposit accounts money market deposit accounts
M3M3 M2 + large time deposits,M2 + large time deposits, 8054.48054.4 repurchase agreements, repurchase agreements, institutional money market institutional money market mutual fund balances mutual fund balances
CREDIT CARDSCREDIT CARDS
Credit cards are NOT moneyCredit cards are NOT money Credit cards are short term loans - you Credit cards are short term loans - you
borrow from the bank and then must repay borrow from the bank and then must repay that loan.that loan.
The existing money is shifted around but The existing money is shifted around but Ms does not changeMs does not change
100-PERCENT-RESERVE 100-PERCENT-RESERVE BANKINGBANKING
All deposits are held as reservesAll deposits are held as reserves Banks accept deposits, place the money in Banks accept deposits, place the money in
reserve, and leave the money there until the reserve, and leave the money there until the
depositor makes a withdrawaldepositor makes a withdrawal
FRACTIONAL RESERVE FRACTIONAL RESERVE BANKINGBANKING
Banks are not required to keep every dollar Banks are not required to keep every dollar that you deposit on reserve.that you deposit on reserve.
The Federal Reserve sets the required The Federal Reserve sets the required reserve ratio which determines the reserve ratio which determines the percentage of deposits that must be held.percentage of deposits that must be held.
BANK RESERVESBANK RESERVES
TOTAL RESERVES - cash in the vault and TOTAL RESERVES - cash in the vault and bank deposits at the Fed.bank deposits at the Fed.
REQUIRED RESERVES - total deposits X REQUIRED RESERVES - total deposits X required reserve ratio required reserve ratio
EXCESS RESERVES - total reserves - EXCESS RESERVES - total reserves - required reservesrequired reserves
ExamplesExamples
Calculate required reserves (RR) when total Calculate required reserves (RR) when total deposits are $80,000 and the required-reserve ratio deposits are $80,000 and the required-reserve ratio is is r r = 20%= 20%
What is the required-reserve ratio if banks are What is the required-reserve ratio if banks are required to hold $100 in reserves to support $500 required to hold $100 in reserves to support $500 in deposits?in deposits?
Calculate deposits if required reserves are $150 Calculate deposits if required reserves are $150 and the required-reserve ratio is and the required-reserve ratio is r r = 20%= 20%
ExamplesExamples
What are excess reserves if $40 of the $100 What are excess reserves if $40 of the $100 in total reserves held by banks are required in total reserves held by banks are required reserves?reserves?
How much do banks have in excess How much do banks have in excess reserves if total reserves are $400, deposits reserves if total reserves are $400, deposits are $2,000 and the required-reserve ratio is are $2,000 and the required-reserve ratio is 20%?20%?
BANK ACTIVITIESBANK ACTIVITIES
Banks accept deposits and offer checking Banks accept deposits and offer checking servicesservices
Banks keep a percentage of the deposits on Banks keep a percentage of the deposits on reservereserve
Excess reserves are available to be loaned Excess reserves are available to be loaned outout
Banks earn money from loansBanks earn money from loans
Exhibit 3 The Money Supply Expansion and Contraction Processes
T - AccountsT - Accounts
BANK TWOBANK TWO
AssetsAssets LiabilitiesLiabilities
Total ReservesTotal Reserves Demand DepositsDemand Deposits
LoansLoans
MONEY EXPANSIONMONEY EXPANSION
When banks make loans they create moneyWhen banks make loans they create money When the loans are spent, it finds its way When the loans are spent, it finds its way
into other banks.into other banks. These banks keep a portion of these These banks keep a portion of these
deposits on reserve and then loan the rest deposits on reserve and then loan the rest out.out.
BANK TWOBANK TWOr = .10r = .10
AssetsAssets LiabilitiesLiabilities
Reserves 100 Demand Deposits 1,000
Loans 900
BANK TWOBANK TWOr = .10r = .10
(fully loaned up)(fully loaned up)AssetsAssets LiabilitiesLiabilities
Reserves 100 Demand Deposits 1,000
Loans 900
RR 100
ER 0
BANK TWOBANK TWOr = .10r = .10
AssetsAssets LiabilitiesLiabilities
Reserves 200 Demand Deposits 1,000
Loans 800
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)
$1,000.00
900.00
810.00
729.00
656.10
$100.00
90.00
81.00
72.90
65.61
$900.00
810.00
729.00
656.10
590.49
A
B
C
D
E
.
.
.
.
.
.
.
.
.
.
.
.
TOTALS (rounded) $10,000 $1,000 $9,000
ExamplesExamples
By how much can the banking system By how much can the banking system expand deposits if total reserves are $600, expand deposits if total reserves are $600, deposits are $2,500 and the required-reserve deposits are $2,500 and the required-reserve ratio is 20%?ratio is 20%?
Money ExpansionMoney Expansion When banks make loans they increase the money When banks make loans they increase the money
supply (M1)supply (M1) The maximum change in checkable deposits is The maximum change in checkable deposits is
( 1/r x change in reserves )( 1/r x change in reserves ) simple deposit creation multiplier = 1/rsimple deposit creation multiplier = 1/r Reasons actual creation may be less than the Reasons actual creation may be less than the
maximummaximum– cash leakagescash leakages– nonzero excess reservesnonzero excess reserves
SIMPLE DEPOSIT SIMPLE DEPOSIT MULTIPLIERMULTIPLIER
If r = .10 then the simple deposit multiplier If r = .10 then the simple deposit multiplier is 10is 10
If r = .15 then the simple deposit multiplier If r = .15 then the simple deposit multiplier is 6.67is 6.67
If r = .20 then the simple deposit multiplier If r = .20 then the simple deposit multiplier is 5is 5
MONEY DESTRUCTIONMONEY DESTRUCTIONcontractionary policycontractionary policy
The FED can also choose to remove money The FED can also choose to remove money from the economyfrom the economy
When the FED reduces the amount of money When the FED reduces the amount of money in circulation this impacts banksin circulation this impacts banks
as bank deposits fall, banks are forced to as bank deposits fall, banks are forced to reduce the amount of loans (call in loans)reduce the amount of loans (call in loans)
The decrease in loans reduces the money The decrease in loans reduces the money supplysupply