Unit IV

Uses of Money

1. Medium of exchange
1. Barter
2. Unit of account
3. Store of value
1. Money holds value over time

Types of Money

1. Fiat money
1. Money, government said so
2. Commodity Money
1. Goods
2. Get its value from the type of material from which its made
3. Representative money
1. IOU
2. Paper money backed by something tangible

Characteristics of Money

1. Durability
2. Portability
3. Visibility
4. Uniformity
5. Scarcity
6. Acceptability

Money Supply

• M1 Money
• Currency in circulation
• Coins and paper money 
• Check able deposits (demand deposits) (checks)
• Traveler's check
• M2 Money
• M1 money + Savings accounts + money market accounts + deposits + deposits held by banks outside the US

Fractional Reserve Banking

• Process by banks of holding a small portion of their deposits in reserve and loaning out the excess
• banks keep cash on hand (required reserves) to meet deposits needs
• banks must keep reserve deposits in the vaults or at the federal reserve banks
• total reserves - total funds held by a bank = required reserve + excess reserves
• banks can legally lend only to the extent of their excess reserves
• reserve ratio = required reserve / TR

Significance of a fractional reserve system

1. Banks can create money, by lending more than their reserves
2. Required reserves do not prevent bank panics because banks must keep their required reserves (FDIC)
3. reserve requirement gives the FED control over how much money banks can create

Functions of the Federal Reserve Bank

1. Control the money 
1. Circulation of currency and adjusting the interest rate
2. Issues paper money
3. Serve as a clearing house for checks
4. regulating banking activities
1. serve as a bank for banks

Balance sheet

• Statement of assets and claims summarizing the financial position of a firm or a bank at some point in time
• must balance at all times

Reserve requirement is usually 10%

The required reserve ratio

• The % of demand deposits that must be stores at vaults cash or kept on reserve as federal funds in the banks account with the federal reserve.
• the required reserve ratio determines the money multiplier
• monetary multiplier ( 1/RR)
• decreasing the reserve ratio increasing the rate of money creation in the banking system is expansionary
• increasing the reserve ratio decreases the rate of money creation in the banking system and is contractionary.
• changing the reserve ratio is the least used tool of monetary policy held at 10%

The monetary multiplier

• showes us the impact of a change in demand deposits on loans and eventually the money supply
• indicates the total % of $ created in the banking system by each 1$ addition to the monetary base (bank reserves and currency in circulation)
• to calculate money multiplier, divide 1 by RR

RR = Amount of deposit x required reserve ratio

Excess reserve = Total reserve = RR

Maximum amount a single bank can loan = change in excess reserves  caused by a deposit

money multiplier  = 1/RR

total change in loans = amount single bank can lend x money multiplier

total change in money supply = total change in loans + $ amount of fed action

total change in demand desposits = total change in loans + any cash deposits

Loanable Funds Market

• Market where savers and borrowers exchange at the real rate of interest
• The demand for loanable funds or borrowing comes from housholds, firms, government and the foreign sector, the demand for loanable funds is in fact the supply of bonds
• supply of loanable funds, or savings comes from households, firms, government and the foreign sector. The supply of loanable funds is also the demand for bonds.

Change in demand for loanable funds

• Remember that demand for loanable funds = borrowing 
• more borrowing = more demand for loanable funds
• less brrowing = less demand for loanable funds

Government deficit  spending = more borrowing

=more demand for loanable funds

• Dlp -> and r% ^^

VISE VERSA

Changes in the supply for loanable funds

• remember supply = saving (ie demand for banks)
• more saving = more supply of loanable funds ->

Government budget surplus = more saving

=more supply of loanable funds

• Slf -> r% v

Prime rate = rate banks charge their most credit worthy customer