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MONEY AND INTEREST

MONEY AND INTEREST. 3. 3.1 The Money Supply 3.2 Money Creation and Circulation 3.3 Interest and Interest Rates. Lesson 3.1 THE MONEY SUPPLY. GOALS. Define money supply, and explain how it is measured Describe two types of money, and explain the fractional-reserve system.

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MONEY AND INTEREST

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  1. MONEY AND INTEREST 3 3.1 The Money Supply 3.2 Money Creation and Circulation 3.3 Interest and Interest Rates

  2. Lesson 3.1THE MONEY SUPPLY GOALS Define money supply, and explain how it is measured Describe two types of money, and explain the fractional-reserve system

  3. WHAT IS THE MONEY SUPPLY? • Defined as the liquid assets held by banks and individuals • Amount has a direct effect on how the economy performs

  4. EXPANDING THE MONEY SUPPLY • Why might extra money in the economy cause inflation? • Demand for goods and services increase • Supply decreases, causing prices to rise • As a result – the dollar buys less • If trend continues for a short period – ok • Of trend continues for a longer period – results in inflation

  5. More Liquid Less Liquid MEASURING THE MONEY • Liquidity is a measure of how quickly things may be converted to something of value like cash. • Liquidity is variable, depending on the nature of the asset or liability Change in your pocket Your savings account A certificate of deposit that matures next June

  6. AGGREGATE MEASURES OF THE MONEY SUPPLY M1 Money that can be spent immediately M2 All the money in M1 plus short-term investments M3 All the money in M1 and M2 plus large deposits MZM Money at zero maturity

  7. THE NATURE OF MONEY • Two types of money • Commodity • based on some item of value, i.e. gold or precious stones • Fiat money • deemed legal tender by the government, • not based on or convertible into a commodity • The fractional-reserve system • Adopted by the goldsmiths in England around 1200 • Keep back a reserve/fraction of money deposited

  8. Lesson 3.2MONEY CREATION AND CIRCULATION GOALS Describe how money is created by bank activities Explain how money circulates in the United States

  9. HOW MONEY IS CREATED • Printing currency and creating money - two different things • Money created by • The interaction of the demand for it • Banks’ use of it – key role in the creation of money by transacting their business • Federal Reserve’s supply and control of it

  10. DEPOSITS AND RESERVES • Primary reserves • Cash on hand • Deposits due from other banks • Percentage required by Federal Reserve • Secondary reserves • Securities purchased from Federal government • Excess reserves • Not part of the reserve requirement (leftover) • Used to create money through business transactions

  11. THE MULTIPLIER EFFECT • Amount of money in system expanded by • Excess reserves - loaned to customers • New deposits created • Excess reserves go out to customers as loans • New deposits created • And so on……

  12. HOW MONEY CIRCULATES • Transfers and circulation • The Fed and fiat money • Money as an IOU

  13. Lesson 3.3INTEREST AND INTEREST RATES GOALS List factors that affect interest rates Explain which factors the Federal Reserve affects

  14. INTEREST RATES AND BUSINESS • Money supply and the economy linked closely to interest rates • Generally, when rates are high, money is “tight” • When rates drop, more credit is accessible

  15. FACTORS AFFECTING INTEREST RATES • Federal funds rate - amount of interest charged for short-term, interbank loans • Discount rate - interest rate the Federal Reserve sets and charges for loans to member banks • Prime rate - rate that banks charge their best and most reliable customers

  16. MONETARY POLICY AND INTEREST RATES • Goals of Federal Reserve’s monetary policy are • To maintain economic growth • To stabilize prices • Help international payments flow • Tools Fed uses to achieve these goals • Adjusting reserves • Setting the discount rate • Influencing federal funds rate

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