Federal Reserve, Banking, Currency, and the Money Multiplier, Exercises for Macroeconomics
ashley-kreitzer
ashley-kreitzer

Federal Reserve, Banking, Currency, and the Money Multiplier, Exercises for Macroeconomics

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Money and Banking Lecture material. Federal Reserve functions and types of money
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THE MONETARY SYSTEM

Mankiw CH. 11

FUNCTIONS OF MONEY

1. Medium of Exchange: An item exchanged when buyers want to purchase goods and services

• Money (Dollars) is the commonly accepted medium of exchange in the U.S.

2. Unit of Account: The measure used to quantify and record economic value.

• You don’t take a loan out for one car, you take a loan out for $30,000 3. Store of Value: Used to store purchasing power over time

• An item used to transfer purchasing power from the present to the future

• i.e. holding currency, holding stocks and bonds

THE KINDS OF MONEY

• Commodity Money: Has intrinsic value. (It would have value even if it was not used as currency) • i.e. Gold, Granola Bars, Cigarettes etc.

• Fiat Money: Money without intrinsic value that is used as currency because of government decree. • i.e. US Dollars, Euros, Yen • “This note is legal tender for all debts, public and private”

MEASURING MONEY IN THE U.S. ECONOMY

• Money Stock: Money circulating in the economy How much money is in the U.S. Economy? 1. Currency- Paper bills and coins in hands of the public (Most widely accepted

currency) 2. Demand Deposits- Balances in bank accounts that depositors can access on

demand - You can access your checking account fairly easy by making withdrawals,

writing checks, using debit cards etc.

THE FEDERAL RESERVE

• The Federal Reserve is the central bank of the United States • Made up of 7 Members (Including one Chairman) • The Federal Reserves 2 main functions: 1. Regulate banks and the overall health of our banking system 2. Control the quantity of money that is made available in the economy.

(The Money Supply) • Policy is made by the Federal Open Market Committee (FOMC) • Money supply is increased or contracted by open-market operations. (Buying or

Selling government bonds)

BANKS AND THE MONEY SUPPLY

• We have accounted for the amount of money held as currency, now we need to discuss demand deposits (the balance in your checking account).

Some Preliminary Need to Know Information.. Reserves: the portion of deposits that banks have not, and will not lend out. • A bank’s liabilities include deposits, assets include reserves and outstanding loans. • 100-percent-reserve banking: a system in which banks hold all deposits as

reserves. • Fractional-reserve banking: a system in which banks hold only a fraction of their

deposits as reserves.

T- ACCOUNTS

• T-Account: Simplified accounting statement showing a banks assets and liabilities • 100% Reserve Banking: Gives depositors safe place to store money • Fractional Reserve Banking: Only holds a fraction of money as reserves • Reserve Ratio: The fraction of deposits that a bank holds as reserves

• (This can be determined by government regulation and bank policy) • Reserve Requirement: The minimum amount of reserves banks must hold (Set

by the FED) • Excess Reserves: Reserves held that are above the legal minimum

• (So banks can be more confident they will not run short of cash)

THE MONEY MULTIPLIER

The Money Multiplier: The amount of money the banking system generates with each dollar of reserves • If $100 of reserves generates $1000 of money, the money multiplier

is 10 • The money multiplier is the reciprocal of the reserve ratio!

Reserve Ratio= 10% 10/100 or 1/10 Money multiplier is 10! The higher the reserve ratio, the less of each deposit banks loan out,

thus a smaller money multiplier

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