How is money created?
There is transactions demand, precautionary demand, speculative demand
FRACTIONAL RESERVE SYSTEM- every bank must hold reserves (reserve
requirement- ensure safety and ability to meet deposit withdrawals)—CREATES new
money by giving out loans/investments and the changing reserve requirement, lower the
requirement, higher the money multiplier—higher reserve requirement, less money they
What is the money multiplier? What are excess and required reserves?
Measures max amount of commercial bank money that can be created- amt of loans
banks can extend is a multiple of reserves (multiple is reciprocal of reserve ratio)
EXCESS RESERVES- bank reserves in excess of reserve requirement set by bank
(uneconomical because no interest is earned on excess amount)
REQUIRED RESERVES- minimum reserves bank must hold to customer deposits
How does Fed affect money supply? (three ways) What do they mainly do,
historically to change money supply?
1) change reserve requirement- most powerful tool.
.increase in reserve
requirement absorbs large changes in excess reserves
2) open market operations- purchase treasury bonds, bills, notes- affect money
supply, interest rates
3) discount rate- rate at which depository institution can borrow from the Fed
historically, up to 70s, focus on money supply, then Paul Volker focused on interest
.70s and 80s, greenspan who raised discount and fed funds rates, lowering
inflation…90s, “bubble” for housing and high interest rates
Why did Keynes believe fiscal was more effective than monetary policy?
In times of depression, economy would act in liquidity trap- no matter how much the
money supply increased, rate of interest would fall no lower because business had such
low expectations, permanently discouraged investment…also, changing money supply
like “pushing on a string” bc of changing consumer and business expectations
How is the Fed structured? How are decisions made? What is the Fed’s economic
Central banking system in US- independent of gov. 1913. 7 board of governors. Federal
open market committee, 12 regional feds, creates currency, also to pursue full
employment, price stability, inflation, control money supply…argued too powerful,
independent, business oriented.
.find interest rates to be important (unlinke monetarists,
How does expansionary monetary policy affect economy?
It affects the money supply and interest rates, but is tricky because it’s difficult to
coordinate with fiscal, and often they cancel each other out
How does Keynesian monetary policy differ from Monetarist policy?