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Principles of Macroeconomics 3250:201

Principles of Macroeconomics 3250:201. Richard W. Stratton. Administration. 6 graded assignments this week Homework 07, 08, 09, 10 Essay 02 CBT Test 03 (Friday - Monday) 6 graded assignments next week Homework 11, 12 Essay 03 CBT Test 04 (Friday - Monday). Decision Tree. Decision Tree.

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Principles of Macroeconomics 3250:201

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  1. Principles of Macroeconomics3250:201 Richard W. Stratton

  2. Administration • 6 graded assignments this week • Homework 07, 08, 09, 10 • Essay 02 • CBT Test 03 (Friday - Monday) • 6 graded assignments next week • Homework 11, 12 • Essay 03 • CBT Test 04 (Friday - Monday) The University of Akron Decision Tree

  3. Decision Tree Student questions Money concepts Worksheet 09 The financial (monetary) system Money creation Stage 1 (WS 10) Summary Questions Extensions

  4. 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 The University of Akron

  5. Review Readings – Chp 11 • Share with a neighbor • Share with the class The University of Akron

  6. Decision Tree Student questions Money concepts Worksheet 09 The financial (monetary) system Money creation Stage 1 (WS 10) Summary Questions Extensions

  7. The concept of money Economy without money • Barter • Need for coincidence of wants Advantages of using money • Increases efficiency of trades • No need for coincidence of wants The University of Akron

  8. The concept of money Functions (4) performed by money • Unit of account • Store of value • Medium of exchange • Standard of deferred payment The University of Akron

  9. The concept of money Necessary characteristics • Recognizable • Divisible • Universal value • Acceptable The University of Akron

  10. The concept of liquidity Define Liquidity as a characteristic of an asset In groups • List as many assets as possible • Arrange these assets from the most liquid to the least liquid The University of Akron

  11. The concept of money So which of these asset shall we label as money? What differentiates money from other assets? • Generally accepted as a means of payment. The University of Akron

  12. The concept of money • Official definitions of various monetary aggregates • http://research.stlouisfed.org/publications/mt/notes.pdf • M1 • M2 • M3 • MZM – money; zero maturity • Near money The University of Akron

  13. The concept of money M1 money • Currency held by non-banking public • Travelers’ checks • Checkable deposits The University of Akron

  14. The concept of money M2 money • M1 • Savings deposits • Small time deposits • Money market funds • Other short term interest bearing deposits The University of Akron

  15. Decision Tree Student questions Money concepts Worksheet 09 The financial (monetary) system Money creation Stage 1 (WS 10) Summary Questions Extensions

  16. Worksheet 09 • 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. increase increase a. The University of Akron

  17. Worksheet 09 • When a bank purchases government securities, those securities provide the bank with • reserves with which to make loans. • a safe income-earning asset. • more bank capital. The University of Akron

  18. Worksheet 09 • Open market operations are used • infrequently because their effect is too \drastic. • infrequently because they do not have a strong effect. • to change the quantity of reserves in the banking system. The University of Akron

  19. Worksheet 09 • When the general public deposits currency in a bank the • bank’s assets and liabilities both increase. • bank assets increase, but the liabilities remain the same. • bank liabilities increase, but the assets remain the same. The University of Akron

  20. Worksheet 09 • The maximum additional loans a bank can make is the value of its • total reserves. • required reserves. • excess reserves. The University of Akron

  21. Worksheet 09 • Banks create money when they, • sell government securities. • make additional loans. • accept currency from the general public. The University of Akron

  22. Worksheet 09 • When a bank buys a government security, its excess reserves • increase. • decrease. • are unchanged. The University of Akron

  23. Worksheet 09 • When a bank’s customer sells a government security and pays for it by check, the bank’s excess reserves • increase. • decrease. • are unchanged. The University of Akron

  24. Worksheet 09 • If the Fed lowers the required reserve ratio, the quantity of money will • not change. • decrease as banks make more loans. • increase as banks make more loans. The University of Akron

  25. Worksheet 09 • Barter – • Electronic check – • Liquidity – Function Function Characteristic The University of Akron

  26. Worksheet 09 • Monetary base– • Savings and loan association– FED Types of financial institution The University of Akron

  27. 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% The University of Akron

  28. 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 The University of Akron

  29. Worksheet 09 The University of Akron

  30. Decision Tree Student questions Money concepts Worksheet 09 The financial (monetary) system Money creation Stage 1 (WS 10) Summary Questions Extensions

  31. The monetary system What do households do with saving? • Hide under the mattress • Buy high value, durable precious goods (gold, silver, jewels, art, etc.) • Store in financial assets (saving accounts, money markets, bonds, etc.) The University of Akron

  32. The monetary system The role of Financial Intermediaries Functions • Create liquidity • Lower costs • Pool risks • Facilitate transactions • Make payments The University of Akron

  33. The monetary system Financial Intermediaries create liquidity when they borrow short and loan long • Expain The University of Akron

  34. The monetary system How do Financial Intermediaries Lower costs? • They reduce the search costs in the market • They increase available alternatives The University of Akron

  35. 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 University of Akron

  36. 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 University of Akron

  37. 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 University of Akron

  38. The monetary system The monetary system • The Federal Reserve System • http://www.federalreserveeducation.org/ • Commercial banks • Thrift institutions • Money market funds The University of Akron

  39. The monetary system Do we need to describe the FED? • Board of Governors • FOMC • Chairman • Regional Federal Reserve Branches The University of Akron

  40. The monetary system Do we need to describe the FED’s policy tools? • Required reserve ratio • Discount rate • Open market operations • Announcement today on interest target The University of Akron

  41. The monetary system Impact of FED tools • Required reserve ratio • Changes amount of reserves needed • Discount rate • Changes the cost of borrowing from FED • Open market operations • Changes the banks’ reserves The University of Akron

  42. Decision Tree Student questions Money concepts Worksheet 09 The financial (monetary) system Money creation Stage 1 (WS 10) Summary Questions Extensions

  43. Money Creation – the start Assume there are 12 banks with identical beginning balance sheets. Each has assets and liabilities as follows: The University of Akron

  44. 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 A A L A L A A The University of Akron

  45. 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? The University of Akron

  46. Stage 1 - Money Creation The University of Akron

  47. Stage 1 - Money Creation • The value of total reserves held by your bank is • The actual reserve ratio is • The value of the bank’s required reserves is • Your bank’s in excess reserves are $5,000,000 5/50 = 10% $5,000,000 $0 The University of Akron

  48. Stage 1 - Money Creation 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 The University of Akron

  49. Stage 1 - Money Creation The University of Akron

  50. Stage 2 - Money Creation Assume that I deposit $1 million in one bank. • If I choose your bank, determine what changes would occur in your balance sheet The University of Akron

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