Macro Test 3 Class Notes - Macroeconomics Test 3 Class Notes Money Definition any good that is widely accepted for purposes of exchange(payment of goods

Macro Test 3 Class Notes - Macroeconomics Test 3 Class...

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Macroeconomics Test 3 Class Notes Money: Definition: any good that is widely accepted for purposes of exchange (payment of goods and services) and the repayment of debt Types: o Commodity money: dual value; something to exchange (not money) o Fiat Money: nothing backs it up, money we have to, “no intrinsic value” Gresham’s Law: Bad money drives good money out of circulation o Causes instability in the supply of money Money Supply: Currency : paper bills and coins o Cash outside of the back o “currency in circulation” M1 = currency (C) + checks (Demand Deposits, DD) M1 = C + DD o Most liquid M2 = M1 + savings accounts + small time deposits o Less liquid Federal Reserve: provides stability for banks; prints money Fractional Reserve System: M1 = C + D C = currency (paper bills and coins) o Coins treasury o Paper bills Fed DD = demand deposits o Checks banks Required 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 up Excess reserves (XR): anything above RR Required Reserve Ratio (r): the fraction banks must keep of their customer’s deposits set by the Fed M1 = C + DD TR = RR + XR RR = r x DD Money Supply Creation: Assumptions: 1. Only one bank 2. The bank is fully loaned up (XR = 0) 3. No cash leakages (C = 0) 4. Required reserve ratio = .10 (r = 10%) 1
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Bank 1: $5000 was found and taken to Bank A Assets Liabilities Customer RR = $500 XR = $4500 DD = $5000 Austin - XR $4500 + Loan $4500 Anna RR $450 XR $4050 DD = $4500 Anna - XR $4050 + Loan $4050 TR = $4050 DD = $4050 Tyler M1 = C + DD = 0 + 5000 +4500 + 4050 = $13,550 Newly Created Money: $13,550 - $5000 = $8550 o Money Supply : M1 = C + DD o Fractional Reserve System : TR = RR + XR; RR = r + DD o Potential for Money Supply Creation : Δ M s = XR m p o Potential Money Multiplier : m p = 1/r Middle of the Process RR = 0.1 4000 = $400 XR = 1000 – 400 = $600 Δ M s = 600 x 10 = $6000 M s = 4000 + 6000 = $10,000 Loans how much has already been created End of the Process RR = 0.1 6000 = $600 XR = 600 – 600 = $0 Δ M s = 0 x 10 = $0 M s = 0 + 6000 = $6000 o No more excess reserves Beginning of Process RR = 0.1 8000 = $800 XR = 8000 – 800 = $7200 Δ M s = 7200 x 10 = $72,000 2 Assets Liabilities TR = $1000 Loans = $3000 DD = $4000 Assets Liabilities TR = $600 Loans = $5400 DD = $6000 Assets Liabilities TR = $8000 DD = $6000
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M s = 72,000 + 8000 = $80,000 What happens if we break our assumptions: 1. One bank 2. XR = 0 3. C = 0 4. R = 0.1 1. More than one bank: nothing, the money supply process doesn’t change 2. Excess Reserves ≠ 0 o They can do what they choose with the excess reserves o Not fully loaned up reduces money supply diversified o Creation of the money supply is affected 3. When all cash is not in the bank (C ≠ 0) o The money you keep out of the bank will not reproduce o The money supply being created is affected o Money is leaked each step because of people keeping cash Actual Money Multiplier: m a = M s MB o MB = monetary base (high powered money) o MB = C + RR Currency (paper bills out of banks) RR (paper bills in banks) Example : (M s = $900) (C = $200) (R = 10%) MB = 200 + ( .1 ) ( 700 ) = 270 M s = C + DD 900 = 200 + DD DD = 700 m a = 900 270 = 1 3 = 0.33 Changes in Required Reserves:
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