ECON 11:7 - use the rest to make loans-Venezuela requires...

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Money provides liquidity service – can easily conduct transactions with assets – money allows a person to buy (or sell) on a short notice without a penalty. If you own an asset such as a bond, a stock, or a house – you know that money is more liquid. For example, if you want to get rid of a house quickly you may have to lower its price, thus indirectly you pay a “liquidity penalty.” Money has no such penalty - a credit card is not money – you cannot store money o it creates debt for you (it is a liability, not an asset) o a debit card is considered money Commodity money – takes the force of a commodity with intrinsic value e.g. gold Fiat money – money without intrinsic value, used as money because of government decree e.g. US dollar, coins, check deposits Commercial bank – takes your deposits and loans it out - The Fed says that the commercial banks has to keep some reserves on the deposits - Fractional reserve bank system – banks keep a fraction of deposits as reserves and
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Unformatted text preview: use the rest to make loans-Venezuela requires its banks to hold on to 84% of its deposits with respect to loans, the US only has a 10% reserve requirement o Fractional reserve system – two subsets 1) Assume no banking system money supply = currency + deposits = 100 2) Assume 100% reserves currency = 0, deposits = 100, so money supply is still 100 3) Fractional reserve banking system a) Individuals and firms do not hold a lot of money, THE BANKS hold the majority a. Suppose rr = 10%, so FNB loans all but 10% b. Deposits = 100, currency = 90, so money supply = 190 (!!!!) i. If we go through this process over and over again, we see that the total money supply = $1,000 (from a mere 100) ii. Money multiplier = initial deposit / rr but this is not an accurate way of describing it, since people may hold on to some of their money b) Households and firms are allowed to hold on to cash...
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