Transcript Session 1: Micro-Economics

Session 4: Multipliers, Money and Banking (1)
• I. The Multiplier Model
– The Basic Model
• Woodsheds and Carpenters
– The Basic Graphs and Approaches
• Approach 1 and 2.
• Impact of Higher “G”
– Numerical Presentation
– Tax Effect does not equal “G” Effect
– Multipliers in Actions
• Past Estimates
• Defense Spending
– Keynesian Model and AS-AD Paradigm
– Some Take-Away Points
Session 4: Multipliers, Money and Banking (2)
• II. Money, Interest rates, and Commercial Banking
– Functions of Money
– Its Evolution (Barter, Commodity and Modern money)
– Interest rates
• What are they?
• Time value of money
• Array of rates (real vs. nominal)
– Commercial Banking
• The Goldsmiths
– Chain repercussions
– Modern Fractional-Reserve Banking
– Final system equilibrium
• The Money-Supply multiplier
– Two Qualifications
» Money stays at home and doesn’t go to banks
» Bank holds excess reserves
The Basic Model
(in a “Simple” Economy World)
• Q = C + I on output side (I is injection);
• Q = C + S on consumption side (S is
leakage).
• We know that: C = a +b*(DI) or DI = Q
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So: Q = a + b*Q + I, or
Q(1-b) = a + I, or
Q = 1/(1-b) * (a + I), or
∆ Q = 1/(1-b) * ∆ a === ∆ Q/∆ a = 1/(1-b)
∆ Q = 1/(1-b) * ∆ I === ∆ Q/∆ I = 1/(1-b)
The Basic Graphs and Approaches
Approach 1: GDP Determined by Intersection
of Saving and Investment Schedules
Approach 2: GDP Determined by TE = 45% Line
Detail on the Output Multiplier
The Effect of Higher G on Output
Government Purchases Add On Just like
Investment to Determine Equilibrium GDP
Taxes Reduce Disposable Income and
Shift CC Schedule to the Right and Down
Expenditure Multipliers in
Macroeconomic Models
Keynesian Model and the AS-AD Approach
Some Take-Away Points
• Ideal Conditions for Multipliers
– Must have unemployed or slack resources
– Prices and wages are fixed in the short run
– Differences in planned (or forecast) and actual is
really important
– Investment is exogenous (at this time)
• If conditions hold, multipliers can give some
insights into SR determination of how output will
be determined
II. Money, Interest Rates and
Commercial Banking
• Money
• Its’ Functions, Evolution, Barter, Commodity and Modern money
• Components of the Money Supply
– Transaction Money
– Broad Money
• Interest rates
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What are they?
Time Value of Money
An array of rates
Real versus Nominal
• Commercial Banking
• The Goldsmiths
– Chain repercussions
– Modern Fractional-Reserve Banking
– Final system equilibrium
• The Money-Supply multiplier
– Two Qualifications
» Money stays at home and doesn’t go to banks
» Bank holds excess reserves
Money
• Money is “what money does”.
– Money is any stock of items with widespread
acceptability for the purpose of payment.
– Functions:
• Medium of exchange
• Store of value
• Measure of value
– Main sources of Demand for Money
• Transaction demand
• Asset demand
Transaction instruments, examples and some problems.
Barter
Actual commodities
Double
coincidence
of wants
Commodity
Money
Gold, silver, fullbodied monies
Backed by
intrinsic
value
Modern
Money
Fiat money, paper,
fiduciary notes,
bank notes
Inflation/
Deflation
Money is, what money does.
Item
Medium of
Exchange
Store of
Value
Unit of
Account
Transaction Cost
Wampum, shells
Yes
Varies
Yes
Little
Cigarettes in WWII
POW camp
Yes
Varies
Yes
Little
Large stationary object
Yes
Varies
Yes
Little
Cattle, oil
Yes
No
Yes
Feed cost
Commodity money
Yes
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Inflation
Fiat $
Gov’t strong?
Yes
Yes
Opportunity of earning
interest
Casino chips
Within casino.
Yes
Yes
Exchange Conversion
Yes
Yes
Yes
Check costs/ processing
For some
commodities
Yes
Yes
Depends on commodity
group.
Yes
Yes
Yes
Risk from rate movements
Defers payment
No
No
Cost to user and seller
Checks and bank notes
Food stamps
Foreign currency
Credit cards
Interest Rates
• Especially with transaction demand, if you
don’t have money, many may be willing to
“rent” money at a cost.
– To buy non-durables (consume this period) and
durables (consumer while you are paying back).
• The cost of money is the interest rate, that is the
cost of borrowing, measured in $/yr/$ borrowed
The rate of interest charged depends on:
• Length of term (time)
– Lenders are willing to give up their money to people
for longer periods of time only if they can charge
more.
• Risk level (risk premium)
– Lenders must cover the probability of possible default
• Liquidity
– Lenders perceive more risk and inability to quickly
extract borrowers’ investment with illiquid assets
• Administrative costs
– Lenders with increased administrative and service
costs must charge a higher interest rate.
Banking and the Supply of Money
• Banking as a business
– How Banks developed – the Goldsmith Story
– Modern Fractional-Reserve Banking
– Legal Reserve requirement
• The Process of Deposit Creation
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First-generation banks
Chain repercussions
Final system equilibrium
Two qualifications and the Money Multiplier
Some myths on what banks do.
• Banks store $$ that
customers deposit.
• Banks lend or invest
most $$ deposited.
• Banks are government
agencies.
• Banks are businesses.
• Banks aren’t concerned
about/with people.
• Banks serve customers
or they fail.
• You can not buy $$.
• Most people rent $$ by
paying interest.
The Goldsmiths
• Goldsmiths or gold holders held gold for people,
gave them certificates to transact business.
• In effect, they created money as long as:
– Depositors would accept someone else’s gold.
– Some people were coming in with gold as some gold
was going out.
– Some “static” amount of gold was always in the till.
• Found out that they could lend out or give out a
deposit slip and charge “interest”
Two Qualifications of
Money-Supply Multipliers
• Leakage in hand-to-hand circulation
• Possible excess reserves held by banks
• Both actions would not allow all $$$ to be spent
and create the desired circular impacts.
Formula for the Session 4:
Derivation of Output Multipliers
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Using the Definition of GDP:
(1) GDP = C + I from the Product Side
We know that: C = a + b GDP, then insert in (1)
(2) GDP = a + b*GDP + I, then
GDP*(1-b) = a + I or
GDP = (1/(1-b)) * (a + I), or
▲GDP = (1/(1-MPC)) * ▲a or ▲I.