Monetary Policy Video

Loanable Funds Market

April 3, 2017

Loanable Funds Market

• Private sector supply and demand of loans
• Bring together lenders and borrowers
• Shows effect on real interest rate
• Demand: inverse relationship between real interest rate and quantity loans demanded
• Supply: Direct relationship between real interest rate and quantity loans supplied
• NOT the same as money market (supply is not vertical)

Federal funds rate: interest rate that banks charge one another for overnight loans

Prime rate: interest rate banks charge their most creditworthy customers

Tools of Monetary Policy

Tools Of Monetary Policy

FED adjusts money supply by changing 1 of the following….

1. Setting reserve requirements
2. Lending money to banks and thrifts
1. Discount rate
3. Open Market Operations
1. Buying and selling bonds

1. Reserve Requirement
1. Fed sets amount that bank must hold (fractional reserve banking).
2. RR ration is % of deposits banks must hold in reserve (can NOT loan out)
2. Open Market Operations
1. If the Fed buys bonds- it takes bonds out of the economy and replaces them with money. MS increases.
2. Most important and widely used monetary policy
3. To increase MS, Fed should buy govt securities
4. To decrease money supply, fed should sell govt securities
3. Discount Rate
1. Interest rate that the Fed charges commercial banks for short term loans.

New vs. Existing Money

New vs. Existing Money

Single bank can create money by amount of ER

Banking system as a whole can create money by a multiplier of the ER

• MM•ER = expansion of Money
• Money multiplier = 1/RR

If initial deposit in a bank comes from the Fed or a bank purchase of a bond or other money out of circulation (buried treasure), the deposit immediately increases money supply.

The deposit can then lead to further expansion of money supply through money creation process.

• Total change in MS if initial deposit is new money= deposit + money created by banking system.
• If deposit in a bank is already existing money (already counted), depositing amount does not change MS immediately because it is already counted.
• Existing currency deposited into a checking account changes only the composition of money supply from coins/paper money to checking account deposits

Supply and Demand For Money

March 22, 2017

Supply and Demand for Money

• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded
• Ex: quantity demanded increases when interest rate decreases

What causes money demand shift?

• Changes in price level, income, taxation that affects investment.

Demand deposit is created through fractional reserve system.

FRS: process by which banks for a small portion of the deposit in reserve and loan out excess. Banks keep cash on hand(required reserves) to meet depositors needs.

Bonds v. Stocks

March 22, 2017

Bonds v. Stocks

• Bonds are loans or “IOU’s” that represent debt that the government or a corporation must repay to an investor. The bondholder has no ownership of the company
• If a corporation issues and then sells a bond, it is a liability for corporation but asset for the buyer

** if nominal interest rate falls, value of the bond increases (inverse relationship)**

Stocks

Stockowners can earn a profit in 2 ways:

1. Dividends- portion of a corporation's profits are paid out to stockholders
1. the higher the corporate profit, the higher the dividend
2. Capital gain-  earned when stockholder sells stock for more than he or she paid for it. stockholder that sells stock at a lower price than the purchase price suffers a capital loss

Financial Institutions

March 21 2017

Purpose of Financial Institutions:

1. Store Money
2. Save Money
1. Saving account
2. Checkable Deposits
3. Money Market account
4. Checking account
3. Loan Money

Principal - amount that you borrow

Interest - Price paid for the use of borrowed money

 

Types of Financial Intermediaries:

• Commercial bank
• saving and loans institutions
• credit unions
• mutual fund companies
• finance companies

The financial system

• Assets: anything of monetary value owned by a person or business
• Financial asset: paper claim that entitles the buyer to future income from the seller
• Physical asset: A claim on tangible object (ex: house or car)
• Liability: requirement to pay money in the future (usually with interest)

Five major financial assets

1. Loans
2. stocks
3. bonds
4. Loan-backed securities
5. bank deposits

Interest rates and inflation

Time value of money- A dollar is worth more today than it is tomorrow. You are losing money every second you are not investing it.

• Future value (FV)- If you invest or lend money to someone it will compound/girl according to the following equation: FV = PV(I+i)^t
• Present value (PV)- amount of money you need to invest now in order to get some amount in the future. PV= FV/(I+i)^N

Formulas

Time Value of Money

• Simple interest formula
• V= (I + r) ^n • P
• Compound Interest Formula
• V= (I +r/k)^nk • P

Where r= nominal interest rate, k= Number of times interest is credited per year, n= years, and V= future value of money

Money

If we had no money, we would use barter system: goods/ services traded directly with no money exchanged.

Money

• Anything generally accepted in payment for goods and services
• NOT wealth or income
• Wealth: total collection of assets that store value
• Income: Flow of earnings per unit of time

Can be used as:

1. Medium of exchange: buying goods and services
2. Unit of Account: measuring value of goods and services
3. Store of Value

3 types of Money

1. Representative Money: Represents something of value. Ex: IOU’s
2. Commodity Money: Something that performs functions of money and has alternative uses. Ex: good, silver, salt
3. Fiat Money: Money because government says so. Ex: paper money, coins

6 Characteristics Of Money

• Durability
• Portability
• Divisibility
• Limited Supply
• Uniformity
• Acceptability

Liquidity: ease in which an asset an be accessed and converted into cash (liquidized)

• M1 (high liquidity) coins, currency, and checkable deposits (checks) (personal and corporate checking accounts which are largest components of M1) AKA demand deposits. MONEY SUPPLY
• M2 (medium liquidity)  M1 + savings deposits (money market accounts), time deposits (CD’s = certificates of deposit), and mutual funds below $100k
• M3 (low liquidity) M2 + time deposits above $100k