Transcript CRAM Unit-4 Macro Review

Unit-4 Macro Review
Money, Money Supply, Bank Accounting, &
Fiscal and Monetary Policy
Fed vs. Government
• The Federal Reserve creates money
– By buying bonds in open market operations
– Too much money can lead to inflation
• The Government creates debt
– By borrowing money for deficit spending
– Too much debt can lead to crowding out
Money Market = Fed
Loanable Funds = Gov’t
Real
Interest
Rate
--------------
-------------
R1
S1
Q1
E1
D1
Qty
Loanable Funds
Money Market
Loanable Funds
Real
Interest
Rate
--------------
-------------
R1
S1
Q1
Private + Public
Savings
E1
D1
Qty
Loanable Funds
Use for Gov’t Debt questions
Illustrates Fed’s Monetary Policy
Supply of Money is fixed by Fed
Fed buys/sell bonds to shift MS which changes
short term interest rates (federal funds rate)
Model of National Savings &
Private Investment => (I) in GDP
Supply = National Savings
Demand = Investment (borrow $)
• The Fed has 3-tools to implement monetary policy:
2 Types of Monetary Policy
Expansionary
Contractionary
Contractionary Policy
Nominal
Interest
Rate
– reserve requirement
– discount rate
– open-market operations
(currently 10.0%)
(currently
Currently6.25%)
0.75%
Currently5.25%
0.0%target)
target
(currently
=> Sell Bonds, ↑ discount rate & ↑ reserve requirement
MS2 MS1
LRAS1
Price
Level
SRAS1
Affects AD
-----------------P2 --------------
--------------
P1
i2 ----------i1 --------------MD
Qty of $
Y*
MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓
E1
Y1
AD2
Real
GDP
AD1
MONEY
Types of Money
Commodity money
Fiat money
3 Functions of Money
• Medium of exchange
(Std. of value)
• Unit of account
• Store of value
Measuring Money Supply
M1 - most liquid
M2 - slightly less liquid
M3 = least liquid
(cash, checking deposits, travelers checks, etc…)
(M1 + savings acct., money markets,…)
(M2 + large time deposits (over $100,000) )
Fractional Reserve Banking System
Banks Create Money by lending
Example:
– $100 Deposit
– 10% Reserve Ratio
1st Bank Balance Sheet
Assets
Required Reserves
$10
Excess
Loans Reserves
$90
Total Assets
$100
Liabilities
Deposits
This loan causes
money creation
$100
. First National Bank
Total Liabilities
$100
Assets
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
Excess Reserves can
Second National Bank
Assets
Reserves
$9.00
Liabilities
Deposits
$90.00
Loans
$90.00
$81.00
be lent out by bank
Total Assets
Total Liabilities
$100.00
$100.00
Total Assets
$90.00
Total Liabilities
$90.00
Money Multiplier = 1/R
First National Bank
Assets
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
Second National Bank
Assets
Reserves
$9.00
Liabilities
Deposits
$90.00
Reserve Requirement = 10%
Money Multiplier = 1/10% = 10
Loans
$90.00
Total Assets
Total Liabilities
$100.00
$100.00
$81.00
Total Assets
$90.00
Total Liabilities
$90.00
Money Supply Change = Money Multiplier X Initial Excess Reserves
$90 * 10 = $900 increase Money Supply
Quantity Theory of Money
Monetarists economists believe that money
is neutral!
That is changes in Money Supply (MS) have affect on real GDP in long run
Qty Theory of Money Equation
MV = PQ
where:
V = velocity
P = the price level
Q = real GDP
M = the quantity of money
Velocity of money is relatively constant
Real GDP is fixed in short run
↑ MS only will ↑Price Level
CROWDING OUT
Loanable Funds
S2
Real
Interest
Rate
1) Government Borrowing reduces Supply of Loanable Funds
--------------
-------------
R1
S1
Q1
2) Real Interest Rates rise
E1
3) Private Investor is “crowded out” of debt market
D1
Qty
Loanable Funds
Review
• Practice Questions
• Practice Free Response
1
D
14
A
2
B
15
D
3
D
16
D
4
E
17
A
5
D
18
D
6
B
19
B
7
C
20
E
8
B
9
D
10
D
11
A
12
C
13
E