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Macroeconomics Test 3 Class NotesMoney:Definition: any good that is widely accepted for purposes of exchange (paymentof goods and services) and the repayment of debtTypes:oCommodity money:dual value; something to exchange (not money)oFiat Money:nothing backs it up, money we have to, “no intrinsic value”Gresham’s Law: Bad money drives good money out of circulationoCauses instability in the supply of moneyMoney Supply: Currency: paper bills and coinsoCash outside of the backo“currency in circulation”M1= currency (C) + checks (Demand Deposits, DD)M1 = C + DDoMost liquidM2 = M1 + savings accounts + small time deposits oLess liquidFederal Reserve: provides stability for banks; prints moneyFractional Reserve System: M1 = C + DC = currency (paper bills and coins)oCoins treasuryoPaper bills FedDD = demand deposits oChecks banksRequired Reserves (RR): when you make a deposit, the bank has to keep a fraction in the bank vault or in Fed accounts to back you upExcess reserves (XR):anything above RRRequired Reserve Ratio (r):the fraction banks must keep of their customer’s deposits set by the FedM1 = C + DDTR = RR + XRRR = r x DDMoney Supply Creation: Assumptions:1.Only one bank2.The bank is fully loaned up (XR = 0)3.No cash leakages (C = 0)4.Required reserve ratio = .10 (r = 10%)1
Bank 1: $5000 was found and taken to Bank AAssetsLiabilitiesCustomerRR = $500XR = $4500DD = $5000Austin- XR $4500+ Loan $4500AnnaRR $450XR $4050DD = $4500Anna - XR $4050+ Loan $4050TR = $4050DD = $4050TylerM1 = C + DD= 0 + 5000 +4500 + 4050= $13,550Newly Created Money:$13,550 - $5000 = $8550oMoney Supply: M1 = C + DDoFractional Reserve System: TR = RR + XR; RR = r + DDoPotential for Money Supply Creation: ΔMs= XR mpoPotential Money Multiplier: mp = 1/rMiddle of the ProcessRR = 0.1 4000 = $400XR = 1000 – 400 = $600ΔMs= 600 x 10 = $6000Ms= 4000 + 6000 = $10,000Loans how much has already been createdEnd of the ProcessRR = 0.1 6000 = $600XR = 600 – 600 = $0ΔMs= 0 x 10 = $0Ms= 0 + 6000 = $6000oNo more excess reservesBeginning of ProcessRR = 0.1 8000 = $800XR = 8000 – 800 = $7200ΔMs= 7200 x 10 = $72,0002AssetsLiabilitiesTR = $1000Loans = $3000DD = $4000AssetsLiabilitiesTR = $600Loans = $5400DD = $6000AssetsLiabilitiesTR = $8000DD = $6000
Ms= 72,000 + 8000 = $80,000What happens if we break our assumptions:1.One bank2.XR = 03.C = 04.R = 0.11.More than one bank: nothing, the money supply process doesn’t change2.Excess Reserves ≠ 0oThey can do what they choose with the excess reservesoNot fully loaned up reduces money supply diversifiedoCreation of the money supply isaffected3.When all cash is not in the bank (C ≠ 0)oThe money you keep out of the bank will not reproduceoThe money supply being created isaffectedoMoney is leaked each step because of people keeping cashActual Money Multiplier:ma=MsMBoMB = monetary base (high powered money)oMB = C + RR Currency (paper bills out of banks)RR (paper bills in banks)Example: (Ms= $900)(C = $200)(R = 10%)MB=200+(.1) (700)=270Ms=C+DD900=200+DDDD=700ma=900270=13=0.33Changes in Required Reserves: