Transcript Modern macroeconomics: monetary policy

is whatever is generally
accepted in exchange for goods and
services — accepted not as an object
to be consumed but as an object that
represents a temporary abode of
purchasing power to be used for
buying still other goods and services.”
— Milton Friedman (1992)
What is Money?
1. A medium of exchange:
Used to buy and sell goods and services.
Avoids barter
2. A store of value:
Allows transfer of purchasing power
from one period to another.
3. A measure of value:
Converts worth to a monetary value.
4. A standard of deferred payment:
Makes future payments possible.
1. Commodity Money:
has value itself, deer skins
2. Fiat money:
just because
1. Acceptable:
used by most people
2. Standardized quality :
all looks the same
3. Durable:
goes through the wash
4. Valuable
large enough and portable
5. Divisible
allows impulse buying
• Two basic measurements of the money
supply are M1 and M2:
• The components of M1 are:
• Currency
• Checking Deposits
(including demand deposits and
interest-earning checking deposits)
• Traveler's checks
• M2 (a broader measure of money) includes:
• M1,
• Savings,
• Time deposits under $100,000, and,
• Money mutual funds
The Supply of Money
Measuring the Money Supply, August 2011
M1= $2,108.8 billion
M2 = $9,545 billion
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The Composition of Money in the U.S.
The M1 and M2 Money Supply of the U.S
–––––––––– (as of May 2009) ––––––––––
Money Supply, M1 (in billions)
Currency (in circulation)
Demand deposits
Other checkable deposits
Traveler’s checks
Total M1
$850
407
334
5
$1,596
$1,596
Money Supply, M2 (in billions)
M1
$1,596
Savings deposits a
4,445
Small time deposits
1,308
Money market mutual funds 979
Total M2
$8,328
$8,328
a Including money market deposit accounts. Source: http://www.federalreserve.gov.
• The size and composition of the two most widely used
measures of U.S. money supply (M1 & M2) are shown
above.
a
b
c
1. __ A $100 bill
2. __ A 6-month certificate of deposit
3.__ A $10,000 retirement account invested in
stocks
4. __ A $50 traveler’s check
5. __ A $5,000 American Express credit line
6. __ A quarter
7. __ A $1 off coupon clipped from the paper
8. __ A $100 balance in a checking account
9. __ A $200 balance in a savings account
10. __ A $10,000 treasury bill
The Changing Nature of M1
Total
$1,293
Billions of $
1,350
M1
1,200
1,050
900
$309
Interest-earning
checkable deposits
$312
750
Demand
deposits
600
450
$672
300
Currency
150
1970
1975
1980
1985
1990
1995
2000 2003
• In the 1980s, interest-earning checking accounts M1
• In the 1990s, money market mutual funds
M1
The Changing Nature of M1
M1 Total
Billions of $
900
$1,388
750
600
450
300
Currenc
y
Demand
deposits
Interest-earning $309
checkable deposits
150
1970
$761
$318
1975
1980
1985
1990
1995
2000
2005
• In the 1980s, interest-earning checking accounts M1
• In the 1990s, money market mutual funds
M1
Function:
1. accept and maintain deposits.
2. make loans.
Types:.
1. Commercial Banks.
2. Savings and Loans
3. Credit Unions
4. Savings Banks.
The Functions of
Commercial Banking Institutions
Consolidated Balance Sheet of Commercial Banking Institutions
Assets
April 2009 (billions of $)
Vault cash
$
40
Reserves at the Fed
672
Loans outstanding
7,051
U.S. government securities
1,265
Other securities
1,412
Other assets
1,630
Total
$ 12,070
Liabilities
Checking deposits
$
600
Savings and time deposits 6,851
Borrowings
2,400
Other liabilities
928
Net worth
1,291
$ 12,070
• Banks provide services and pay interest to attract checking,
savings, and time deposits (liabilities).
• Most of these deposits are invested and loaned out, providing
interest income for the bank.
• Banks hold a portion of their assets as reserves (either as cash
or deposits with the Fed) to meet their daily obligations toward
their depositors.
Balance Sheet for a Large Bank, 12/31/10
The items on a bank’s balance sheet of greatest economic importance
are its reserves, loans, and deposits.
.
The left side of the balance sheet always equals the right side.
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• Banks maintain only a fraction of their
assets (deposits) as reserves to meet the
requirements of depositors.
• an decrease in required reserves lets
banks make more loans, expand the money
supply
1. Printing Money
2. Making Loans
a. Key Ingredients:
• Deposits – Household savings
• Required Reserves – money held at the
bank or at the FRS (around 10%)
• Excess Reserves – loan able funds
= Deposits – Required Reserves
A depository institution can
make loans up to the value of
its excess reserves
Main Street Bank Situation:
Demand deposits
= $50,000
Reserve requirement
=
10 %
Actual reserves at bank = $10,000
Excess Reserves:
Demand deposits
= $50,000
Reserve requirement= 10 %
Actual reserves
= $10,000
- Required reserves = $5,000
= Excess reserves
= $5,000
Excess Reserves ($5,000) can be loaned
By making a loan, the bank has created
money.
The original deposits are still in Main Street
Bank, but now there is an additional $5,000
out floating around.
If the Excess Reserves are loaned
The borrowed money is spent and deposited
at another bank.
The second bank’s reserves are now up $5,000
- it must keep 10% or $500
- it can then loan out $4,500 ($5,000 – $500)
This process can be repeated at each step.
10% of the money is lost at each step
The more that is required to be held in
reserve, the less money can be created
The lower the reserve requirement, the greater
the amount of money that can be created
Creating Money from New Reserves
New cash
deposits:
Actual Reserves
Bank
Initial deposit (bank A)
Second stage (bank B)
Third stage (bank C)
Fourth stage (bank D)
Fifth stage (bank E)
Sixth stage (bank F)
Seventh stage (bank G)
All others (other banks)
Total
New
Required Reserves
Potential demand
deposits created by
extending new loans
$1,000.00
800.00
640.00
512.00
409.60
327.68
262.14
1,048.58
$200.00
160.00
128.00
102.40
81.92
65.54
52.43
209.71
$800.00
640.00
512.00
409.60
327.68
262.14
209.71
838.87
$5,000.00
$1,000.00
$4,000.00
• When banks are required to maintain 20% reserves
against demand deposits, the creation of $1,000 of new
reserves will potentially increase the supply of money by
$5,000.
From the table a deposit of $1000, with a
20% reserve requirement led to a $4000
expansion of the money supply
Is there a pattern here?
It just takes 3 easy steps
1. Find the reciprocal of the required reserve
1/20% = 1/1/5= 5
2. Multiply the initial change in the excess
reserves by the money multiplier
$1000 * 5 = $5000
3. Subtract out the initial change
$5000 - $1000 = $4000
1.
2.
3.
a.
b.
Deposit of $10,000
1. ________
Required reserve 10%
2. ________
Increase in the money supply? 3. ________
10,000
c. 100,000
9,000
d. 90,000
1. ________
How about if the reserve
2. ________
requirement was 20%?
3. ________
a. 200,000
c. 100,000
b. 40,000
d. 50,000
1. Deposit of $16,000
2. Required reserve 25%
3. Increase in the money supply?
a. 144,000
c. 80,000
b. 48,000
d. 64,000
How about if the reserve
requirement was 20%?
How about if the reserve
requirement was 10%?
1. ________
2. ________
3. ________
1.
2.
3.
1.
2.
3.
________
________
________
________
________
________
1. Loan making changes the money supply
2. Increases in loans leads to increased
spending which increases the money
supply.
3. BUT, decreases in loan making, or even
paying back a loan decreases the money
supply.
Type of Deposit
Current Requirement
Checkable Deposits
$0 - $6 million
$6 - $42.1 million
Over 42.1 million
0 %
Limits
3%
3
10
3
8-14
0
0-9
Non-checkable non-personal
savings and time deposits
1. Created in 1913
2. Responsible for:
a. overseeing the money supply
b. coordinating commercial bank
operations
c. regulating depository institutions
• The Board of
Governors is at the
center of the banking
system in the U.S.
• The seven members
of the Board of
Governors also serve
on the Federal Open
Market Committee
• The FOMC is a 12member board that
establishes Fed policy
regarding the buying
and selling of
government securities.
Federal Reserve
Board of Governors
7 members appointed by the president,
with the consent of the U.S. Senate
Open Market
Committee
Board of Governors &
5 Federal Reserve Bank
Presidents (alternating
terms, New York Bank
always represented).
12 Federal Reserve
District Banks
(25 branches)
Commercial Banks
Savings & Loans
Credit Unions
Mutual Savings Banks
The Public:
Households & businesses
1. Board of Governors –
7 members appointed by President
- 14 yr terms at 2 yr intervals for continuity & independence
-not more than one from each district
http://www.federalreserve.gov/
1
9
2
7
12
10
11
4
8
3
.
(Board of Governors)
5
6
• Each district bank monitors the commercial banks in their
region and assists them with the clearing of checks.
• The Board of Governors of the Federal Reserve System is
located in Washington D.C.
1
9
2
7
12
10
11
4
8
3
5
6
1.____________________
2.____________________, ____________________
3.____________________
4._________________, _________________, _________________
5.________________, _________________, _________________,
6._________________, ________________, _________________, _________________,
_________________, _________________
7._________________, _________________
8._________________, ________________, _________________, _________________
9._________________, _________________
10._________________, ________________, ________________, __________________
11._________________, _________________, _______________,
12._________________, ________________, _________________, _________________,
_________________, _________________
.
1 Boston
2 New York City, Buffalo
3 Philadelphia
4 Cleveland, Pittsburgh, Cincinnati
5 Richmond, Baltimore, Charlotte
6 Atlanta, Nashville, Birmingham, Miami,
Jacksonville, New Orleans
7 Chicago, Detroit
8 St. Louis, Louisville, Memphis, Little Rock
9 Minneapolis, Helena
10 KC, Denver, Omaha, Oklahoma City
11 Dallas, San Antonio, El Paso
12 SF, Salt Lake City, LA, Port., Seattle, Honolulu
2. Federal Open Market Committee
-12 members = 7 Governors (for majority) plus
5 Pres or VP from
1 NY
2 Bost, Phila, or Richmond,
3 Atl, Dallas, or StL
4 Minn, KC, or SF, LA
5 Clev, or Chicago
set policy on buying & selling bonds on open mkt
3. Federal Advisory Council outsiders
12 members - 1 each selected by Board of
each Region
Make sure they are following the rules
Makes clearing check easier
Replace money or increase or decrease money in circulation
Moves checks from region to region
Borrows, writes checks, takes deposits
M * V = P *Y
Mone
y
Output
V
Velocity
P
rice
P
Y
- the amount of money in circulation
- the number of times each $ is spent in a
year (considered to be stable)
- the level of prices
- the actual output of goods and services
M * V = P *Y
Money
• P
Velocity
*Y =
Y =output
Price
Total Sales (GDP)
• If V and P are constant, then an increase in
M will lead to a proportional increase in Y
GDP increases.
• but if V and Y are constant (at full
employment), then an increase in M will lead
to a proportional increase in P =Inflation.