Principles of Macroeconomics 3250:201

Principles of Macroeconomics3250:201

Richard W. Stratton

04/19/23 The University of Akron 2

Administration

6 graded assignments this weekHomework 07, 08, 09, 10Essay 02CBT Test 03 (Friday - Monday)

6 graded assignments next weekHomework 11, 12Essay 03CBT Test 04 (Friday - Monday)

Decision Tree

Decision Tree

Student questionsMoney conceptsWorksheet 09The financial (monetary) systemMoney creation Stage 1 (WS 10)Summary Questions

Extensions


Review Readings – Chp. 11

Recall - List 3 main ideas in chapter 11 Summarize – In your own words describe

the purpose of chapter 11 Question - Write 1 unanswered question

you have from chapter 11 Comment – What is your general

impression of this chapter? Connect something in chapter 11 to your

life


Review Readings – Chp 11

Share with a neighborShare with the class

Decision Tree


Extensions


The concept of money

Economy without money BarterNeed for coincidence of wants

Advantages of using moneyIncreases efficiency of tradesNo need for coincidence of wants



Functions (4) performed by money

Unit of accountStore of valueMedium of exchangeStandard of deferred payment



Necessary characteristics

RecognizableDivisibleUniversal valueAcceptable


The concept of liquidity

Define Liquidity as a characteristic of an asset

In groupsList as many assets as possibleArrange these assets from the most

liquid to the least liquid



So which of these asset shall we label as money?

What differentiates money from other assets?

Generally accepted as a means of payment.



Official definitions of various monetary aggregates

http://research.stlouisfed.org/publications/mt/notes.pdf

M1 M2 M3 MZM – money; zero maturity Near money



M1 moneyCurrency held by non-banking publicTravelers’ checksCheckable deposits



M2 moneyM1Savings depositsSmall time depositsMoney market fundsOther short term interest bearing

deposits

Decision Tree


Extensions


Worksheet 09

1. When a bank sells $500,000 shares of stock to raise capital, the bank’s assets by $500,000 and its owners’ equity by $500,000.

increaseincrease

a.


Worksheet 09

2. When a bank purchases government securities, those securities provide the bank with

a. reserves with which to make loans.

b. a safe income-earning asset.

c. more bank capital.


Worksheet 09

3. Open market operations are useda. infrequently because their effect is too \

drastic.

b. infrequently because they do not have a strong effect.

c. to change the quantity of reserves in the banking system.


Worksheet 09

4. When the general public deposits currency in a bank the

a. bank’s assets and liabilities both increase.

b. bank assets increase, but the liabilities remain the same.

c. bank liabilities increase, but the assets remain the same.


Worksheet 09

5. The maximum additional loans a bank can make is the value of its

a. total reserves.

b. required reserves.

c. excess reserves.


Worksheet 09

6. Banks create money when they, a. sell government securities.

b. make additional loans.

c. accept currency from the general public.


Worksheet 09

7. When a bank buys a government security, its excess reserves

a. increase.

b. decrease.

c. are unchanged.


Worksheet 09

8. When a bank’s customer sells a government security and pays for it by check, the bank’s excess reserves

a. increase.

b. decrease.

c. are unchanged.


Worksheet 09

9. If the Fed lowers the required reserve ratio, the quantity of money will

a. not change.

b. decrease as banks make more loans.

c. increase as banks make more loans.


Worksheet 09

10. Barter –

11. Electronic check –

12. Liquidity –

Functions Characteristics

Definition Types of financial institutions

Near money FED

Function Function

Characteristic


Worksheet 09

13. Monetary base –

14. Savings and loan association –

Functions Characteristics

Definition Types of financial institutions

Near money FED

FED

Types of financial institution


Worksheet 09

What is the Monetary Base?

Note this is NOT money!!! WHY?

Reserves at the FED ~ 1.5%

Coins ~ 4.5%

Federal Reserve Notes ~94.0%


Worksheet 09

Checks are not money

E-Checks are not money

How are Checks & e-Checks related to money?

Both are documents that allow checking account balances to be transferred

The checking account balances are money


Worksheet 09 TERM ASSET LIABILITY

1.$2 million dollars in vault X

1.$3 million account at the regional federal reserve bank X

1.$25 million of owner’s equity X

1.$25 million in outstanding loans X

1.$50 million of checkable deposits X

1.$25 million in property (buildings and equipment) X

1.$20 million government bonds X

Decision Tree


Extensions


The monetary system

What do households do with saving?

Hide under the mattressBuy high value, durable precious

goods (gold, silver, jewels, art, etc.)Store in financial assets (saving

accounts, money markets, bonds, etc.)


The monetary system

The role of Financial Intermediaries Functions

Create liquidityLower costsPool risksFacilitate transactions

Make payments


The monetary system

Financial Intermediaries create liquidity when they borrow short and loan long

Expain


The monetary system

How do Financial Intermediaries Lower costs?

They reduce the search costs in the market

They increase available alternatives


The monetary system

How do Financial Intermediaries Pool risks?

If you only have one loan it will either be repaid or not

If not you lose everything


The monetary system

How do Financial Intermediaries Pool risks?

By making many loans a bank can spread the risk, only a % will default

Stock market analogy – size of portfolio and mutual funds


The monetary system

List as many types of financial intermediaries as you can

Where shall we draw the line to delineate the monetary system from the more general financial system?


The monetary system

The monetary system

The Federal Reserve Systemhttp://www.federalreserveeducation.org/

Commercial banksThrift institutionsMoney market funds


The monetary system

Do we need to describe the FED?

Board of Governors FOMCChairmanRegional Federal Reserve Branches


The monetary system

Do we need to describe the FED’s policy tools?

Required reserve ratioDiscount rateOpen market operations

Announcement today on interest target


The monetary system

Impact of FED toolsRequired reserve ratio

Changes amount of reserves neededDiscount rate

Changes the cost of borrowing from FEDOpen market operations

Changes the banks’ reserves

Decision Tree


Extensions


Money Creation – the start

Assume there are 12 banks with identical beginning balance sheets. Each has assets and liabilities as follows:


Money Creation – the start

Asset or Liability to the bank? $2 million dollars in vault $3 million account at the regional federal

reserve bank $25 million of owner’s equity $25 million in outstanding loans $50 million of checkable deposits $25 million in property (buildings and

equipment) $20 million government bonds

L

A

AL

A

A

A


Stage 1 - Money Creation

Remember there are 12 banks with identical beginning balance sheets:

There is $100 million of currency in public’s hands (that is me!)

Federal Reserve requirement is 10%. In groups, what will your bank’s

balance sheet look like?



First Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000



1. The value of total reserves held by your bank is

2. The actual reserve ratio is

3. The value of the bank’s required reserves is

4. Your bank’s in excess reserves are

$5,000,000

5/50 = 10%

$5,000,000

$0



Remembering that there are 12 banks and that I hold $100 million, the total money supply represented in this example is

$600,000,000 (12*50)

+ $100,000,000

$700,000,000



First Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000



Assume that I deposit $1 million in one bank.

If I choose your bank, determine what changes would occur in your balance sheet



First Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000

$6,000,000

$3,000,000

$51,000,000

$76,000,000 $76,000,000

2







$6,000,000

6/51 = 11.7%

$5,100,000

$900,000




$550,000,000 (11*50)

+ $ 51,000,000

+ $ 99,000,000

$700,000,000



First Bank Sheet 2

Assets Liabilities

Reserves $6,000,000 DD $51,000,000

Cash $3,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $76,000,000 Total $76,000,000



Stage #3

Assume you are able to make a loan to “David’s Electrical Services”.

What is the maximum dollar amount your bank can loan?

In groups, determine what changes would occur in your balance sheet

$900,000



First Bank Sheet 2

Assets Liabilities

Reserves $6,000,000 DD $51,000,000

Cash $3,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $76,000,000 Total $76,000,000

$25,900,000

$76,900,000

$51,900,000

$76,900,000

3







$6,000,000

6/51.9 = 11.6%

$5,190,000

$6,000,000 - $5,190,000 = 810,000




$550,000,000 (11*50)

+ $ 51,900,000

+ $ 99,000,000

$700,900,000



First Bank Sheet 3

Assets Liabilities

Reserves $6,000,000 DD $51,900,000

Cash $3,000,000

Fed. $3,000,000

Loans $25,900,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $76,900,000 Total $76,900,000


Money Creation

Your homework 09 continues this process

Decision Tree


Extensions


Money Creation - Summary

What is the maximum loan a bank can safely make?

The amount of excess reservesWhat is the maximum loans that can be made

within the system?1 / FRR * excess reservesWhat is the deposit multiplier?1 / FRR

Extentions



Extensions Deposit multiplier = 1 / FRR

Chg in deposits = Chg in reserves * 1 / FRR

X = $1 million * 1/0.10 = $10 million



Extensions Currency drain

Money multiplier = 1 / (1 – L)

Some currency held outside of banks

Chg in money = Chg in monetary base * 1 / (1- L)

Where L = % actually loaned out

Not loaned = RR + Drain

Decision Tree


Extensions


Money Creation - extensions

Extensions Bank sells a bond an individual Bank buys a bond from an individual Your customer sells a bond to

another individual



Third Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000



Extensions Your bank sells a $1 million bond

to an individual to the FED



Third Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000

$19,000,000

$6,000,000

$4,000,000



Extensions Your bank buys a $1 million bond

from an individual from the FED



Third Bank Sheet 1

Assets Liabilities

Reserves $5,000,000 DD $50,000,000

Cash $2,000,000

Fed. $3,000,000

Loans $25,000,000

Bonds $20,000,000

Property $25,000,000 Equity $25,000,000

Total $75,000,000 Total $75,000,000

$21,000,000

$4,000,000

$2,000,000



Extensions If reserves are insufficient Bank borrows from

other banks through the Federal Funds Market – at market rate

the FED at the discount window – at discount rate

Decision Tree


Extensions

Documents

Principles of Macroeconomics 3250:201