Transcript Unit 4 - AP-Macro-DHS

Unit 4
Money, Monetary Policy
and Economic Stability
Unit IV Lesson 1
Money
Before money, economies used a barter
system
Problem – double coincidence of wants
Basic properties of any commodity used
as money
Portability, uniformity, stability in value and
acceptability
Unit IV Lesson 1
Functions of Money
Medium of Exchange function eliminates
the need for the double coincidence of wants
The Store-of-value function permits money
to be held for use at a later time
The Unit-of-Account, or Standard-ofValue function means there is an agreed-to
measure for stating the prices of goods and
services. This simplifies price comparisons.
Unit IV Lesson 1
Complete Activity 34 and
review answers
Unit IV Lesson 1
Definitions of Money
in the U.S.
M1
Consists of currency, traveler’s checks, and
checkable deposits
M2
Includes M1 plus savings deposits, small
time deposits, money market deposit
accounts (MMDAs), noninstitutional money
market mutual funds (MMMFs) and other
deposits
M3
Includes M2 plus large ($100,000 or more)
time deposits
Unit IV Lesson 1
Complete Activity 35 and
review answers
Unit IV Lesson 2
Equation of Exchange
MV=PQ
“M” – M1, stock of money
“V” – Income (GDP) velocity of circulation or
average number of times $1 is spent on final
goods and services in a particular time period
“P” – average price level of final goods and
services in GDP, also known as the GDP
deflator
“Q” – real output, the quantity of goods and
services in GDP
Unit IV Lesson 2
Evidence shows that income velocity (V) is
highly predictable with its value remaining in
a very narrow range over a multiyear period
Thus, changes in the money supply (M) result
in changes in Nominal GDP (PxQ)
Depending on the state of the economy, the
changes in the money supply can result in
changes in prices, in output only or in some
combination of both
Unit IV Lesson 2
Complete Activity 36 and
review answers
Unit IV Lesson 3
Financial Intermediaries
Bringing people who want to borrow funds
together with people who want to lend funds
Examples: commercial banks, savings and loans
associations, savings banks, credit unions &
money market mutual fund companies
Functions:
liquidity creation, minimization of the cost of
borrowing, minimization of the cost of monitoring
borrowers and risk reduction through pooling
Unit IV Lesson 3
Fractional Reserve
System of Banking
Banks – any depository institution
whose deposits are a part of M1.
Banks must hold a specific percentage
of deposits as reserves; this percentage
is called the required reserve ratio
The deposit that is not part of required
reserves is called excess reserves
Unit IV Lesson 3
Banks may loan excess reserves or buy
government securities
A bank makes a loan by creating a a
checkable deposit for the borrower; this
results in an increase in the money
supply
Unit IV Lesson 3
Money Expansion Multiplier
Exists because the reserves & deposits lost by
one bank are received by another bank
It magnifies excess reserves into a larger
creation of checkable-deposit money
Deposit expansion multiplier = ____1____
reserve requirement
Expansion of the money supply =
excess reserves x deposit expansion multiplier
Unit IV Lesson 3
Higher reserves = lower money expansion
multipliers and a decrease in the money
supply
Total increase in money supply may be less
than predicted by the money expansion
multiplier if
Borrowers do not spend all the money they
borrow
Banks do not lend out all their excess reserves
People hold part of their money as cash
Unit IV Lesson 3
Complete Activity 37 and
review answers
Unit IV Lesson 4
The Federal Reserve System
Has the responsibility to control the money supply to
promote the economic goals of full employment,
price stability and stable economic growth
Board of Governors
Central authority, 7 member board, serve 14 year
terms
Chairman – Alan Greenspan
Federal Open Market Committee (FOMC)
7 members of the board and 5 of the presidents of
the Federal Reserve Banks
Sets the Fed’s monetary policy and directs the
purchase and sale of gov’t securities
Unit IV Lesson 4
Tools of the Fed
Open-Market Operations
The buying of bonds or securities from
(increase money supply), or the selling
of bonds to (decrease the money
supply), commercial banks and the public
Fed’s most important instrument for
influencing the money supply
Unit IV Lesson 4
Reserve Ratio
Raising the reserve ratio = decrease in money
supply
Lowering the reserve ratio = increases the money
supply
The Discount Rate
Interest Rate charged on short-term loans from
the Fed to commercial banks
Lower discount rate = increase in money supply
Higher discount rate = decrease in the money
supply
Unit IV Lesson 4
Complete Activity 38 and
review answers
Unit IV Lesson 5
The Money Market
The Demand for Money
Transactions demand – the demand for money to
make purchases of goods & services
Precautionary (liquidity)demand – the demand for
money to serve as protection against unexpected
need
Speculative demand – the demand for money
because it serves as a store of wealth
How much of your wealth do you want to
hold as money & how much do you want to
hold as interest-bearing assets?
Unit IV Lesson 5
Explain and Illustrate
Visual 4.1
Unit IV Lesson 5
Explain and Illustrate
Visual 4.2
Unit IV Lesson 5
Explain and Illustrate
Visual 4.3
Unit IV Lesson 5
Complete Activity 39 and
review answers
Unit IV Lesson 5
Explain and Illustrate
Visual 4.4
Unit IV Lesson 5
Understand?
Fed purchases Treasury securities
Money supply increases
Interest rate decreases
Investment increase (& interest-sensitive
components of consumption spending
increase)
Aggregate Demand increases
Output increases and the Price Level
increases
Unit IV Lesson 5
Fed sells Treasury securities
Money supply decreases
Interest rate increases
Investment decreases (& interest-sensitive
components of consumption spending
decrease)
Aggregate Demand decreases
Output decreases and the Price Level
decreases
Unit IV Lesson 5
Complete Activity 40 and
review answers
Unit IV Lesson 6
Interest Rates and Monetary Policy in
the Short Run & the Long Run
Nominal interest rate
Rate that appears on the financial pages of
newspapers & ads for financial institutions
Not adjusted for inflation
Real interest rate
Increase in purchasing power the lender wants to
receive to forego consumption now for
consumption in the future
Adjusted for inflation
Real interest rate = Nominal interest rate –
inflation rate “Fisher Equation”
Unit IV Lesson 6
Two Relationships between the
real and nominal interest rates
Ex ante real interest rate (expected
interest rate)
equals the nominal interest rate minus the
expected inflation rate
Ex poste real interest rate (real interest
rate actually received)
Equals the nominal interest rate minus the
actual rate of inflation
Unit IV Lesson 6
Equation of exchange
MV=PQ
Looking at this equation, we see that
changes in the money supply – holding
velocity & real output constant – lead to
changes in the price level
These changes in the price level change
the nominal interest rate once they are
anticipated
Unit IV Lesson 6
Complete Activity 41 and
review answers
Unit IV Lesson 6
Complete Activity 42 and
review answers
REVIEW FOR
UNIT IV EXAM