Unit IV

Uses of Money

• Medium of exchange
• Unit of account
• Store of value

Types of Money

• Fiat money (because the government says so)
• Commodity money (goods)
• Representative money (is backed by precious metals)

Characteristics of Money

• Durability
• Portability
• Divisibility
• Uniformity
• Scarcity
• Acceptability

Money Supply

1. M1 Money
• Currency in circulation (coins, paper money, checkable deposits, traveler's check)
2. M2 Money
• M1 money, saving's accounts, money market accounts, deposits, deposits held by bank outside

Fractional Reserve Banking

• process by banks of holding a small portion of their deposits in reserve and loaning out the excess

1. Banks keep cash on hand
2. Banks must keep reserved deposits in their vaults at the Fed
3. Total Reserves - total funds held by a bank
• TR = RR + ER
4. Banks can lend only to the extent of their ER
5. Reserve ratio = required reserves / total reserves

• Significance of a Fraction Reserve System
• Banks can create more money by lending more than their reserves
• The amount, set by the Fed, is the Require Ratio
• RR gives the Fed control over how much money banks can create

Functions of the Federal Reserve Bank

1. Control the money supply through monetary policy
2. Issue paper money
3. Serve as a clearing house for checks
4. Regulate banking activities
5. Serve as a bank for bankers

Balance sheet - statement of assets and claims summarizing the financial position of a firm/bank at some point in time

• must balance at all times!

Assets

• Own
• Reserves (RR and ER)
• Loans to firms, consumers, and other banks
• Loans to the government
• Bank property

Liabilities

• Owe
• Claims of non-owners
• DD, CDs
• Loans from the Fed and other banks
• Shareholders equity

Reserve Requirement - ratio is 10% and is set by the Fed.

• 100% reserve banking has no impact on the size of money supply

In a fractional banking system, BANKS CREATE MONEY!

Required Reserve Ration

• % of DD that must be stored as federal reserve funds in the bank's account with Fed
• RRR determines the money multiplier ( 1 / reserve ratio)
• Increase in reserve ration, Decrease in rate of money creation = contractionary

Money Multiplier

• shows the impact of a change in demand deposits on loans and eventually the money supply
• indicates the total number of money created in the banking system by each $1 addition to the monetary base

4 Types of Multiple Deposit Expansion Questions

1. Calculate the initial change in ER
2. Calculate change in loans in a banking system
3. Calculate change in money supply
4. Calculate change in DD

Monetary Policy

1. OMO (open market operations) - buy/sell bonds (securities)
• preferred monetary tool because it is flexible
2. RR - amount the bank has to keep
3. Discount rate - interest charged by the Fed for overnight loans to commercial banks

Federal Fund Rate - interest charged by one commercial bank to another for overnight loans

Expansionary (MS increase / recession) 

• OMO - buy bonds from the public
• RR - decrease
• DR - decrease
• FFR - decrease

Contractionary (MS decrease / inflation)

• OMO - sell bonds
• RR - increase
• DR - increase
• FFR - increase

Loanable Funds Market

• Market where savers and borrowers exchange funds at the real rate of interest
• The demand for loanable funds/borrowing comes from households, firms, government, and the foreign sector
• Demand for loanable funds = supply of bonds
• Supply comes from households, firms, government, and foreign sector

Change in demand for LF

• More borrowing = more demand (shift right)
• Less borrowing = less demand (shift left)

Change in supply for LF

• More saving = more supply of LF (shift right)
• Less saving = less supply of LF (shift left)