Unit 4

Uses of Money

• medium of exchange (barter or trade)
• unit of account, hives money its economic worth
• store of value

Types of Money

1. Representative Money- paper money backed by a tangible product
2. Commodity Money- gold and silver coins, gets its value form materials made
3. Fiat Money- it is money b/c the government says so (US)

Characteristics of Money 

1. Durability - how long is money good for 
2. Portability - can carry it anywhere
3. Divisibility - can be broken into smaller units
4. Scarcity
5. Acceptability

M1 Money

• consists of currency in circulation (paper and coins) (travelers check)
• Checkable deposits- checking accounts, demand deposits (DD)
• Account for 75% of $ in circulation

M2 Money 

• Includes
• savings accounts
• money- market accounts
• accounts held by banks outside the U.S
• adding M1 money as well
• money market account- accounts interests; large money account

ASSETS = LIABILITIES + NET WORTH 

RESERVE RATIO = (commercial banks required reserves/ commercial banks checkable deposit liabilities)

3 Important Issues

1. Excess Reserves = actual reserves - required reserves
2. control of lending ability
3. asset or liability to which bank

- Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money

-Monetary Multiplier = 1 / (required reserve ratio)

- Maximum checkable deposit creation = excess reserves x monetary multiplier

Reserve Requirement

• the Fed. requires banks to always have some money readily available to meet condumers demand for cash
• the amount, set by the Fed., is the Required Reserve Ratio 
• The required reserve ratio is the % of demand deposits (checking account balances) that must not be loaned out 
• Typical Reserve Ratio = 10%

The Monetary Policy

• shows us the impact of a change in demand deposits on loans and eventually the money supply

Monetary Policy

• ·         Controlled by the FED(Federal Reserve Bank)
• ·         Influencing the economy through changes in reserves, which influences the money supply and available credit

4 Options of Monetary Policy

1. 1.       Reserve Requirement- the % that is set by the FED of the minimum reserves that a bank must keep; decrease -> expansionary monetary policy; increase -> contractionary monetary policy
2. 2.       Discount Rate- the rate of interest that the FED charges for overnight loans to banks; decrease    -> expansionary monetary policy; increase -> contractionary monetary policy
3. 3.       Federal Fund Rate- the rate that FDIC members charge each other for overnight loans; decrease    -> expansionary monetary policy; increase -> contractionary monetary policy
4. 4.       OMO (Open Market Operation):

a.       Buy or sell securities (bonds) – “FED”

b.      FED buys bonds -> expand money supply (expansionary)

c.       FED sells bonds -> decreases money supply (contractionary)

Prime Rate- the interest rate that banks charge their most credit worthy borrowers

	Expansionary Or Easy Money (Recession) (Increase MS)	Contractionary or Tight Money (Inflation) (Decrease MS)
OMO	Buy Bonds	Sell Bonds
Discount Rate	Decrease	Increase
Federal Fund Rate	Decrease	Increase
Required Reserve Ration	Decrease	Increase

·         Tight money has a higher interest rate

·         Easy money is depreciating

Single Bank:

•  amount of money single bank cant create (loan out) = ER
• AR-RR=ER

Banking System

• Can create money by a multiple of its initial ER
• Deposit Multiplier = 1/RR

System New $

• Deposit Multiplier x Initial ER
• Total change in the money supply as a result of the deposit

Money Market

Loanable Funds or Bond Market

Crowding Out