the This is Macroeconomics In this chapter, we will examine the role of money and banks in the economy. We will look at how central banks, such as the

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1 This is Macroeconomics the In this chapter, we will examine the role of money and banks in the economy. We will look at how central banks, such as the FED (the Federal Reserve in the U.S.), regulate the money supply in our country. The Fed also regulates banks and makes sure people have faith in our financial system. Page 1

2 What is Your Mone}' Worth?-Present Value If you met someone in college and they told you that they had $100,000 and that they had invested money for only one year at 5% to earn it, how much did they start with/originally invest? Present value= $ present value (1 + the interest in decimals) to the nth power (the length in years) $l00,000 = $ (1.05) 1 ' *If you have $100 after investing your money for 3 years at 8% interest, how much did you start with? * At 12% interest for 4 years? Page 2

3 What is Your Mone}' Worth?-Future Value Would you rather have $100 today or $200 in two years? You can determine how much your money will be worth in the future. if you know the interest rate and the number of years. Future value== $ present value x (1 + the interest in decimals) to the nth power ( the length in years) 1 $100 X (1.05)== $105 1 A present value of $100 at 5% interest for one year would equal $105: $100 (1.05). 2 *At the end of a second year $100 x (1.05) 3 *At the end of a third year $100 x (1.05) 4 * At the end of a fourth year $100 x (1.05) Page 3

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5 What is Your Mone>' Worth?-Questions _ 5. If the nnual int r t r t i 5 perc nt then the pr nt alu f$1.00r c i d n y rfrotn no i cl t t $ $1.00 $0.95 E $0.05 Page 7

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7 Measures of the Money Supply Economists define the money supply, M, as currency plus checking, savings, and time deposits. Currency and checking are considered assets and by themselves are reff ered to as Ml and are considered a demand deposit ( currency that you deposit into a bank account from which you can withdraw "on demand" - at any time without any advance notice to the bank; liquidity). Page 8

8 Measures of the Money Supply-Questions 7. Of the following~ the mo t liquicl a et i Page 9 A mutual fund B C D E currency time depo it demand depo it a ing depo i I 0. An increa e in government pending will affect the demand for money and nominal intere t rate in which of the following way? Demand for Money Nominal [ntere t Rate (A Increa e [ncrea e B Increa e Decrea e C Increa e [ndeterminate D Decrease [ncrea e E Decrea e Decrea e

9 Measures of the Money Supply-Questions 7. Of the following~ the mo t liquicl a et i Page 10 mutual fund currency time depo it demand depo it a ing depo i I 0. An increa e in government pending will affect the demand for money and nominal intere t rate in which of the following way? Demand for Money Increa e B Increa e C Increa e D Decrease E Decrea e Nominal [ntere t Rate [ncrea e Decrea e [ndeterminate [ncrea e Decrea e

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The Velocit)' and Quantity Theory of Money Velocity of money is an incredibly important component /part of an economy's GDP calculation. GDP cannot be controlled through the money supply alone.

11 The Velocit)' and Quantity Theory of Money Velocity of money is an incredibly important component /part of an economy's GDP calculation. GDP cannot be controlled through the money supply alone. If the money supply is increased, but velocity decreases, GDP may stay the same or even decline. Price levels will also rise because of the abundance of money. Along the same idea, the quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. The theory states that the quantity of money is positively related to nominal ouput and nominal GDP. An increase in the money supply causes prices to rise (inflation). A decrease first causes disinflation (when the rate of inflation slows down) which then leads to deflation ( a declining inflation rate). Page 17

12 The Velocit)' and Quantity Theory of Money-?s 44. Given a con tant velocity of money~ in the hort run a 5 percent increa e in money upply will tran late to a 5 percent increa e in Page 18 (A governmen t budoet deficit (B real gro dome tic product C nominal gro dome tic product (D real intere t rate (E norninal intere t rate 7. According to the quantity theory of money, the quantity of money i related (A negatively to the nominal intere t rate B negatively to the price level C po itively to the elocity of money D po itively to the unemployment rate (E po itively to the nominal gro dome tic product

13 The Velocit)' and Quantity Theory of Money-?s 44. Given a con tant velocity of money~ in the hort run a 5 percent increa e in money upply will tran late to a 5 percent increa e in Page 19 (A governmen t budoet deficit (B real gro dome tic product (. nominal gro dome tic product (D real intere t rate (E norninal intere t rate 7. According to the quantity theory of money, the quantity of money i related (A negatively to the nominal intere t rate B negatively to the price level C po itively to the elocity of money D po itively to the unemployment rate (. po itively to the nominal gro dome tic product

14 The Velocit)' and Quantity Theory of Money-?s 13. If the velocity of money i con tant and the aggregate upply curve i vertical, a doubling of the money upply would rno t likely re ult in a doubling of Page 20 (A the unemployment rate (B real output (C the price level D nominal intere t rate E) real intere t rate 3. If nominal gro dome tic product in a country i $1,600 and the money upply i $400, what i the elocity of money? A 400 (B 10 C 4 D 2 (E 0.5

15 The Velocit)' and Quantity Theory of Money-?s 13. If the velocity of money i con tant and the aggregate upply curve i vertical, a doubling of the money upply would rno t likely re ult in a doubling of Page 21 (A the unemployment rate (B real output the price level nominal intere t rate real intere t rate 3. If nominal gro dome tic product in a country i $1,600 and the money upply i $400, what i the elocity of money? A 400 (B 10 4 (D 2 (E 0.5 velocity of money == GDP / starting money supply L\ ~ \>\~OC)(\~O'D

16 The Banks A commercial bank, like Chase or Bank of America, accepts deposits from individuals and makes loans. To understand how a bank functions, it is necessary to look at its balance sheet, which shows its assets, liabilities, and net worth. The table below shows a balance sheet. The different items are divided into assets and liabilities. An asset is something of value owned by a person or firm. A liability is something of value that a person or firm owes, such as a debt, to someone else. Bank Balance Sheets Assets Liabilities Loans $8,000 Demand Deposits $5,000 Reserves $500 Owner's Equity $5,000 Treasury Bonds $1,500 Total Assets $10,000 Total Liabilities $10,000 Page 25 It is ''balanced'' because the totals must equal

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The Banks (cont.) Treasury bond s (T-bonds) are long-term bonds issued by the U.S. Treasury. Demand deposits are currency that you deposit into a bank account from which you can withdraw "on demand" - at any time without any advance notice to the bank; liquidity.

18 The Banks (cont.) Treasury bond s (T-bonds) are long-term bonds issued by the U.S. Treasury. Demand deposits are currency that you deposit into a bank account from which you can withdraw "on demand" - at any time without any advance notice to the bank; liquidity. Owner's equity is the investment at the bank made by its owners. Because demand deposits and owner's equity can be removed from the bank at any time, they are liabilities. Finally, capital stock is the stock a company issues to obtain increased funding. Bank Balance Sheets Assets Liabilities Loans $8,000 Demand Deposits $5,000 Reserves $500 Owner's Equity $5,000 Treasury Bonds $1,500 Page 27 Total Assets $10,000 Total Liabilities $10,000

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21 The Banks (cont.) See in detail how bank deposits are multiplied. Banks are the lenders and businesses are the borrowers. There is a 10% reserve requirement or reserve ratio 1. Bank of America lends 7-11 $1,000, who then pays a supplier 2. StrawCo the supplier then deposits the money in its own bank account 3. Chase (StrawCo's bank) can then lend out 90% of the deposit, or $ Chilis borrows $900 and puts it into its bank, First Fidelity 5. First Fidelity can now lend out 90% of the $900 depositied, or $810 This leads to the fallowing series of payments with a 10% reserve requirement or reserve ratio: Page $1, $900 because the bank has to keep $100 in reserve 3. $810 because the bank has to keep $90 in reserve 4. $729 because the bank has to keep $81 in reserve 5. and so on

22 The Banks-Questions 42. As ume that Atlantic National Bank has demand depo its of $100,000 and no exces re erve, and that the re erve requirement i 10 percent. A cu tomer withdraw $5 000 from the bank. To meet the reserve requirement, the bank rnu t increase its re erve by Page 31 (A) $500 (B) $1 000 (C) $2,000 (D) $4 000 (E) $ As ume that Linda deposits in her checking account the $1,000 cash he was keeping at home for an emergency. If the required re erve ratio is 0.20 what i the maximum change in the money upply from her depo it? (A) $1,000 (B) $1 250 (C) $2 000 (D) $4 000 (E) $5,000

The Banks-Questions 42. As ume that Atlantic National Bank has demand depo its of $100,000 and no exces re erve, and that the re erve requirement i 10 percent.

23 The Banks-Questions 42. As ume that Atlantic National Bank has demand depo its of $100,000 and no exces re erve, and that the re erve requirement i 10 percent. $100,000 - $5,000= $95,000 A cu tomer withdraw $5 000 from the bank. $95,000 / 10 /o = $9,500 Page 32 To meet the reserve requirement, the bank rnu t $5 000 still in reserves = increa se its re erve by needed (A) $500 (B) $1 000 (C) $2,000 (D) $4 000 e) $4 500 $4:soo IC\5 required reserves or initial amount required reserve ratio bank deposits or ending amount 45. As ume that Linda deposits in her checking account the.$_!,000 cash he was keeping at home for an emergency. If the required re erve ratio is 0.20 what i the maximum chan_g~ in the money upply from her deeo ilj (A) $1,000 (B) $1 250 required reserves or initial amount required reserve ratio 0 ~ \) I,,.. r-_,,~.lr---- (C) $2 ooo =.ft 5000-\\ F>')O::. (e ) $ 4 OOO bank deposits or ending amount ' LI. u,o OO (E) $5, ,

24 The Banks-Questions 9. Which of the following i a determinant of the amount of money the cornrnercial banking y tern can create? (A The rnarginal propen ity to con urne B The marginal propen ity to ave C The total number of bank (D The ize of the federal debt (E The re erve requirement 19. A bank ha $ 00 milli n in demand d p it and $100 rnilli n in r rv. If the re, er er quir 1n nt i l Op re nt th bank x r r qual (A) $10 million (B $20 milli n (C $ 0 million (D) $100 milli n (E $200 milli n Page 33

25 The Banks-Questions 9. Which of the following i a determinant of the amount of money the cornrnercial banking y tern can create? (A The rnarginal propen ity to con urne B The marginal propen ity to ave C The total number of bank (D The ize of the federal debt (. The re erve requirement 19. A bank ha $ 00 milli n in demand d p it and $100 rnilli n in r rv. If the re, er er quir 1n nt i IO p re nt th bank x r r qual I, (A) $10 million i'800 rn -,<. \ 0 /o ~ Sl),n $20 milli n (C $ 0 million (D) $100 milli n (E $200 milli n Page 34

the This is Macroeconomics In this chapter, we will examine the role of money and banks in the economy. We will look at how central banks, such as the

the This is Macroeconomics In this chapter, we will examine the role of money and banks in the economy. We will look at how central banks, such as the This is Macroeconomics the In this chapter, we will examine the role of money and banks in the economy. We will look at how central banks, such as the FED (the Federal Reserve in the U.S.), regulate the