Transcript E 13-14 Unit V CHAPTER 17 PPT

17.1 How Banks Work
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Money Creation, the Federal
Reserve System, and
Monetary Policy
17.1 How Banks Work
17.2 Monetary Policy in the
Short Run
17.3 Monetary Policy in the
Long Run
CONTEMPORARY ECONOMICS
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17.1 How Banks Work
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Operating a Bank
Getting a charter
Bank balance sheet
Reserve accounts
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17.1 How Banks Work
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Getting a Charter
Charter—the right to operate
Net worth—assets minus liabilities, also
called owners’ equity
Asset—any physical property or financial
claim owned by the bank
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17.1 How Banks Work
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Bank Balance Sheet
Liability—an amount owed
Balance sheet—a financial statement
showing assets, liabilities and net worth at
a given time; assets must equal liabilities
plus net worth, so the statement is in
balance
Assets = Liabilities + Net worth
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17.1 How Banks Work
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Reserve Accounts
Required reserve ratio—a Fed regulation
that dictates the minimum fraction of
deposits each bank must keep in reserve
Required reserves—the dollar amount
that must be held in reserve; checkable
deposits multiplied by the required reserve
ratio
Excess reserves—bank reserves in
excess of required reserves
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15.1 The Evolution of Fiscal Policy
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Monetary Policy in Action
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15.1 The Evolution of Fiscal Policy
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The Federal Reserve
and Open Market Operations
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Money supply—the supply of money
available in the economy at a particular
time
The Fed increases the money supply by
buying US government bonds
The Fed decreases the money supply by
selling US government bonds
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17.1 How Banks Work
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Money Multiplier
 Money multiplier—the multiple by which the
money supply can increase as a result of an
increase in excess reserves in the banking system
 The Fed makes a move (text pg. 513 – buys bond
and increases the money supply)
 Round one (MS increased by $10,000)
 Round two and beyond (supports up to $100,000
in checkable deposits)
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15.1 The Evolution of Fiscal Policy
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Money Multiplier (cont’d)
Formula for the multiple expansion of
checkable deposits 
Change in checkable deposits = change in
excess reserves x 1/r
Contraction of the money supply works in
the same way, but in reverse.
It begins with the Fed selling a $10,000
US bond to Home Bank.
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17.2 Monetary Policy in the Short Run
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Demand for Money
 The money demand
curve, Dm, slopes
downward.
 As the interest rate falls,
so does the opportunity
cost of holding money.
 The quantity of money
demanded increases.
 Therefore, when interest
rates are low, people hold
more of their wealth as
money.
Figure 17.2
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17.2 Monetary Policy in the Short Run
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Ways to Expand the Money Supply
Purchasing U.S. government securities
Reducing the discount rate
Lowering the required reserve ratio
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17.2 Monetary Policy in the Short Run
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Effect of an Increase
in the Money Supply
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Figure 17.3
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Effects of the Lower Interest Rate
A lower interest rate 
1) Encourages households to
borrow more and save less
2) Encourages businesses to
invest more
More C + I increases AD
AD shifts to the right
thereby increasing
employment and output (real
GDP) and the price level
Figure 17.4
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17.2 Monetary Policy in the Short Run
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Ways to Reduce the Money Supply
Selling U.S. government securities
Increasing the discount rate
Raising the required reserve ratio
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17.2 Monetary Policy in the Short Run
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The Federal Funds Rate
 In order to stimulate the economy the Fed could
 Cut the federal funds rate
 In order to cool down the economy the Fed
could
 Increase the federal funds rate
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17.2 Monetary Policy in the Short Run
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Ups and Downs in the
Federal Funds Rate Since 1996
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Figure 17.5
CONTEMPORARY ECONOMICS
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15.1 The Evolution of Fiscal Policy
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CONTEMPORARY ECONOMICS
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