Unit 4

3/6 Uses of Money 

•  Medium of Exchange- using money to barter or trade
• Unit of account- what gives money its economic worth
•  Store of value- dollar does not fluctuate, meaning its value never changes

-Types of Money

• Representative money- paper money that is backed by a tangible product (a certificate)
• Commodity money- gold and silver coins; gets its value from the material from which it is made
•  Fiat money- it is money because the government says so

-Characteristics of Money

•  Durability- coins last a long time; paper money lasts not as long, but still a long time
•  Portability- you can carry it anywhere on you
•  Divisibility- can be broken down into smaller units
•  Uniformity- all money is pretty much identical
•  Scarcity
•  Acceptability- accepted everywhere in the country

-M1 Money

•  Consists of currency in circulation (paper money and coins)
•  Travelers checks
•  Called checkable deposits (checking accounts, demand deposits)
•  accounts for 75% of all money used

-M2 Money

•  Savings accounts
•  Money market accounts- earning interest on checking accounts
• Accounts held by banks outside of the US
•  Accounts for 25% of all money used
•  Consists of M1 money

-Difference between M1 and M2 money

• - M1 is more liquid (available for immediate use)
• M2 is not as available for immediate use from savings accounts

-How banks and thrifts make money

•  When you deposit money into the bank, the bank uses your money to give out loans to make themselves money
•  Assets = Liabilities + Net worth
• Assets are what you earn
• Liabilities are what you owe

• Our money is backed by faith
•  Reserve ratio = Commercial bank's required reserves / commercial bank's checkable deposits
•  Banks create money by lending out excess reserves and destroy it by loan repayment
•  Purchasing bonds from the public also creates money

3/17 Monetary Policy

- Influencing the economy throughout changes in reserves, which influences the money supply, and available credit

-4 Options of Monetary Policy

1. Reserve requirement- % that is set by the Federal Reserve Bank (Fed) of the minimum reserves that a commercial bank must keep

2. Discount Rate- the rate of interest that the Fed charges for overnight loans to banks

3. Federal fund rate- the rate that FDIC members (commercial banks) charge each other for loans

• commercial banks can either borrow from each other or from the Fed
• they choose whichever has the lower interest rate
• if the reserve requirement, the discount rate, and the federal fund rate decrease, it is expansionary monetary policy
• if the reserve requirement, the discount rate, and the federal fund rate decrease, it is expansionary monetary policy

4. OMO (Open Market Operations)

• either buy or sell securities (bonds)
• only done by the FED
• if the Fed buys bonds, money supply expands
• if the Fed sells bonds, money supply contracts

- The prime rate- the interest rate that banks charge their most credit worthy borrowers

• good creditors get better rates
• bad creditors get worse rates

Equations

- For a single commercial bank

• The amount of money a single bank can create (loan out)
• AR - RR = ER

- For the entire banking system

•  How much money an entire banking system can create
• system new money = deposit multiplier (1/RR) x initial ER
• Total change in the money supply
• system new money + initial deposit

Recession (Expansionary/Easy money)

• Open Market Operation: Buy bonds

• Discount Rate: Goes down

• Federal fund rate: Goes down

• Required reserve ratio: Goes down

Inflation (Contracting/tight money)

• Open market operation: sell bonds

• Discount rate: Goes up

• Federal fund rate: Goes up

• Required reserve ratio: Goes up