Presentation on theme: "FIN 30220: Macroeconomic Analysis"— Presentation transcript:
1FIN 30220: Macroeconomic Analysis Money, Output, and Prices
2Why does this piece of paper (cloth, actually)have value?
3Money was more valuable as the paper it was printed on! In the early 1920’s, Germany experienced a period where the monthly inflation rate was 29,500% per month! Prices doubled roughly every four days!!!Money was more valuable as the paper it was printed on!Using money to stoke a furnace!
4All time top inflation rates Hungary (1946)13,600,000,000,000,000 %/mo.Prices double every 15 hoursZimbabwe (2008)79,000,000,000 %/mo.Prices double every 24.7 hoursYugoslavia (1994)313,000,000 %/mo.Prices double every 34 hours
5What is Money?ANY commodity that satisfies three basic properties can be called moneyUnit of AccountStore of ValueMedium of exchange“I can’t define it, but I know it when I see it!”Throughout history, many different commodities have been used as money
6The earliest money was commodity money whose value comes from the commodity itself Cowrie ShellsCocoa BeansAnimal SkinsSaltTobacco LeavesPrecious Metals
7Coinage began with King Sadyattes of Lydia, most commonly dated to 630-620 BC. While remaining a topic of debate by some, this type is now commonly considered to be the first official coin, meeting all of the requirements laid out in the dictionary definition: it is the first coin to have certified markings which signify a specific exchange value and be issued by a governmental authority for use as money.
8The Chinese were also developing metal coins around 600BC
9…and time marches on…. Leonidas I Sparta C. 480BC Alexander the Great Julius CaesarRomansC. 120ADConstantine IByzantine EmpireC. 330ADCharlemagneFranksC. 800ADHenry VIIIEnglandC. 1520AD
10Can you guess who these people are? Cleopatra and Mark AntonyEgypt BCElizabeth Taylor and Richard Burton from the 1963 film “Cleopatra”
11The English Penny was introduced around 785AD by King Offa of Mercer The English Penny was introduced around 785AD by King Offa of Mercer. Originally, it was a coin of grams of pure silverThe penny was eventually standardized to 1/240 of a Tower pound (350g) of 92.5% silver (sterling silver)…this was later switched to 1/240 of a Troy pound (373g)Note: Avoirdupois LB = 453GFrom the time of King Offa, the penny was the only denomination of coin minted in England for 500 years, until the gold coinage issue of King Henry III around 1257 AD.
12Early on, the colonies (being British colonies) used British money Pound (20 shillings)Guineas or Sovereigns were gold coins with a value of one pound sterlingShilling (12 pence)All these coins are during the reign of Charles I (1625 – 1649). Inadequate supply of British money put commerce in jeopardy in the colonies.Pence (Penny)
13Taking matters into their own hand, Boston authorities allowed John Hull and Robert Sanderson to set up a mint in “Pine Tree” shillings were minted until 1674 when the mint was shut downAll the coins bear the date Why? Coinage was the sole prerogative of the king, but in 1652 there was no king (King Charles I had been beheaded three years earlier). They kept the date so they could deny any illegality if and when a monarchy was once again reestablished which it was in 1660.
14Spanish dollar = 8 Reals (.88 ounces of silver) Spain established a mint in what is now Mexico City in Spanish ships returning to Europe would stop off in the colonies to buy supplies. This made Spanish money widely available in the colonies.Spanish dollar = 8 Reals (.88 ounces of silver)Doubloon = 4 dollars (1/5 oz. of gold)2 Bits is still considered slang for a quarter!Spanish coins remained legal tender until the coinage act of 1857!
15The US mint began production in 1793 The Constitution (1787) gives the congress the right to “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures” (Section 8, Clause 5)On April 2, 1792 Congress passed the coinage act which created the mint.The Coinage Act of 1792 defined a US Dollar as ounces of pure gold or .86 ounces of pure silver (15:1 ratio) – same (almost) as the Spanish dollarThe US mint began production in 1793US coins made in 1792 were not minted for circulation and are EXTEMELY valuable. This 1792 penny sold for $603,750!
16U S P P 8 S Where does the dollar sign come from? Imagine a U and an S (for United States overlapping)PPSThe dollar was fashioned after the Spanish peseta - the P stands for Peseta, the “s” makes it plural (what if the P and S overlap), the line indicates an abbreviation8The back of a Spanish peseta had two columns (the pillars of Hercules) wrapped with a scroll that reads “plus ultra”- beyond the pillars, there are other lands. Could this be the origin of the dollar sign?
17The first circulated penny was released in 1793 All American coins must have “an impression emblematic of liberty and the word liberty as well as the year. On the reverse of copper coins was required the denomination.The first circulated penny was released in 1793The “Chain link penny” caused a lot of controversy..many believed that the chains represented slavery!The chain was immediately replaced with a victory wreath.Note that from 1793 to 1857, the cent was larger than a modern quarterHalf penny 1793
181794: US dollar (A gold dollar was released in 1849) On the reverse of gold and silver coins will be an eagle and “United states of America” . Denominations didn’t begin showing up on silver coins until 1804Half dime introduced in 1794The dime was first issued in 1796Quarter: 17961794: US dollar (A gold dollar was released in 1849)1794: US Half dollarProduction of silver coins ceased in 1964
19On the reverse of gold and silver coins will be an eagle an “United states of America” . Denominations didn’t begin showing up on gold coins until 18071796: Quarter Eagle ($2.50)US Half eagle ($5)US eagle ($10)US double eagle ($20)Production of gold coins ceased in 1934
201909: Lincoln appeared on the cent to commemorate the 100 anniversary of his birth 1932, George Washington appears on the quarter1938: Jefferson appears on the nickel1946: FDR appears on the dime due to his big support for the march of dimes1964: JFK appears on the half dollar
21Women finally made it onto US coins! Susan B. Anthony was the first non-mythical woman to appear on a US coin in 1978Sacagawea followed in Susan’s footsteps in 2000Currently, the US mint produces between 4B and 10B coins annually. As a self funded agency, the mint generated 3.89B dollars of revenues in 2010.The US mint has facilities in Washington DC, Philadelphia, West Point, Denver , San Francisco, and the bullion depository at Fort Knox.
23Paper money first makes an appearance in China around 900AD Due to a severe copper shortage, the Chinese begin issuing paper currency. Frequent reissues fuel inflation
24Each of the colonies issued currency Each of the colonies issued currency. Most of these were “bills of credit”
25Beginning in 1775, the Continental congress issued currency to finance the revolutionary war. Continentals were bills of credit – not backed by gold or silver. Easily counterfeited, the notes quickly devalued, giving rise to the phrase “not worth a continental!”
26Bank of North America (1782 – 1786) The founding fathers feared fiat money (for good reason with the failure of the continental). In fact, the constitution forbids states from issuing paper fiat money.A private business chartered by the confederation congress. Was the first IPO in the United States and the first Private Commercial bank. Later re-chartered as the Bank of Pennsylvania. Eventually acquired by Wells FargoBank of North America (1782 – 1786)
27The founding fathers feared fiat money (for good reason with the failure of the continental). In fact, the constitution forbids states from issuing paper fiat money.The First bank of the US was chartered in While officially a private bank, the US government controlled 25%. The charter was not renewed in 1811.The Second Bank of the US was chartered in Its charter renewal was vetoed by Andrew Jackson in 1836The second bank of the US existed for five more years until going bankrupt in 1841
28Prior to 1838, a bank charter could be obtained only by a specific legislative act. However laws passes by various states after 1838 allowed the automatic chartering of banks by the states without any special legislative consent.From 1840 – 1863 all banking business was done by state banks
29Anyone who satisfied the chartering requirements could become a bank and issue currency! 1837 – 1863 over 8,000 “brands of currency issued by banks, state governments, private individuals, and private companies
30The US began issuing United States Notes in 1862 after passing the legal tender act. US Notes were not backed by gold, but were “legal tender for all debts public and private”US Notes were nicknamed “greenbacks”US notes were last placed into circulation in 1971
31The National Banking Act of 1863 allowed Nationally chartered banks to distribute bank notes (deemed legal tender) backed by US TreasuriesNational banknotes were printed by the US TreasuryState bank notes were subject to very high taxes and soon disappeared
32The Federal Reserve was created in 1913 to as a solution to bank panics (particularly, the banking panic of 1907)
33Salmon P. Chase - $10,000 (Treasury Secretary under Lincoln) William McKinley - $500Grover Cleveland- $1,000Salmon P. Chase - $10,000 (Treasury Secretary under Lincoln)James Madison- $5,000Denominations of $500, $1,000, $5,000, and $10,000 were no longer printed after 1946 for fear of German counterfeiting!!
34The largest denomination ever printed was a $100,000 gold certificate The largest denomination ever printed was a $100,000 gold certificate. It was never circulated, but was used for inter-bank transfers
35The beginning of the end: 1934 During the great depression, US citizens were converting paper currency into gold in large quantities. The government didn’t have enough gold to back up the currency, so FDR passed an executive order that made it illegal for US citizens to hold gold.Only foreign central banks could convert paper dollars into goldThis coin sold at auction in 1996 for $7.5M!!
36FDR put the Great Seal on US Currency in 1935 Old Version (prior to 1935)New version (began in 1935)Secretary of Agriculture (and later, vice president) Henry Wallace saw the Latin phrase “Novus Ordo Seclorum” which means a new order of the ages and thought it meant “The new deal of the ages” both were freemasons and saw the symbol above the pyramid as the “all seeing eye” – the Masonic symbol for the great architect of the universe.
37In God We Trust was adopted officially as the motto of the United States in 1956 as an alternative or replacement to E Pluribus Unum.In god we trust has appeared sporadically on coins since 1864In God we trust has appeared on currency since 1957Some atheists have been known to mark out the motto with a custom made stamp
38On August 15, 1971, Nixon closes the gold window and the US dollar ceases to be convertible into gold by anyone. This marks the beginning of a truly anchorless system
39The U.S. Department of the Treasury first issued paper currency of the United States in 1862 as a result of a shortage of coins and the need to finance the Civil War.Today, the BEP has facilities in Washington DC and Fort Worth TexasCurrently, the BEP produces around 38 million notes per day with a face value of approximately $500M (mostly to replace worn out currency)Average Lifetime$ months$ Years$ Years$ Years$ Years$ YearsThe average cost of a note is 9.1 cents
40The BEP has had a contract with the Crane paper company to supply the paper for our currency since 1879.The “paper” is 75% cotton and 25% linen with blue and red silk threads running through it Have you ever wondered how many times you could fold a piece of currency before it would tear? About 4,000 double folds (first forward and then backwards) are required before a note will tear.All bills, regardless of denomination, utilize green on the backs. Faces use black ink, color shifting ink, and metallic ink. Inks are formulated and blended by the BEPUS currency utilizes a combination of offset and Intaglio printing. In Intaglio printing, images are engraved on plates. Ink is applied to the plate and then pressed into the paper under great pressure.
41Federal Reserve District Seal: A (1) = Boston, B (2) = New York, C (3) = Philadelphia, D (4) = Cleveland, E (5) = Richmond, F (6) = Atlanta, G (7) = Chicago, H (8) = St. Louis, I (9) = Minneapolis, J (10) = Kansas City, K (11) = Dallas, L (12) = San FranciscoSeal of the US TreasuryFederal Reserve District NumberSeries DateSignature of the Secretary of the TreasurySignature of the Treasurer of the US (Note: Every Treasurer of the US has been a woman since 1949 under Truman)
42Each printing plate has 32 objects Each printing plate has 32 objects. The plate, therefore, is divided into 32 locations…One press run will be 200,000 sheets. The serial numbers are applied use skip numbering. The numbers are placed so that when the sheets are stacked and cut, the stacks of bills will be sequential.A1E1A3E3B1F1B3F3C1G1C3G3D1H1H3A2E2A4E4B2F2B4F4C2G2C4G4D2H2D4H4This would be the serial number locations for the first page of the first run of 200,000 sheets.A1E1B1F1C1G1D1H1After the first run of 200,000, the process is repeated starting withAfter 15 runs of 200,000 (1 cycle) we are at serial number At this point, we go back to
43Given the numbering system, each serial number is guaranteed to come from one particular plate location. This gives currency an anti counterfeiting device…This letter identifies the number of “cycles”: Y = 25Serial numberPlate positionFederal Reserve DistrictPlate serial number
45See it now?Did you know that the owl is a Masonic symbol of wisdom?
46Some argue that when looked at even closer, it’s a spider, not an owl.
47Federal Reserve System (2006) The narrowest definition of money would be the Monetary Base (also called M0, Inside Money, or High Power Money). The monetary base is a direct liability of the Federal Reserve – that is, cash!Federal Reserve System (2006)In MillionsAssetsLiabilities$11,036 (Gold)$793,705 (Currency in Circulation)$792,581 (US Bonds)$12,346 (Reserve Deposits)$64 (Loans)$15,275 (US Treasury Deposits)$78,968 (Other)$61,323 (Other)Total: $882,649Total: $882,649ReservesMonetary Base = Cash in Circulation + Vault Cash + Reserve Deposits
48Quantitative easing program Needless to say, we are living in interesting times. This can be seen in the Fed’s balance sheetsFederal Reserve System (2006)Federal Reserve System (2013)In MillionsIn MillionsAssetsLiabilitiesAssetsLiabilities$11,041 (Gold)$11,036 (Gold)$793,705 (Currency in Circulation)$1,218,754 (Currency in Circ.)$2,117,750 (US Bonds)$792,581 (US Bonds)$12,346 (Reserve Deposits)$2,434,944 (Reserve Deposits)$212 (Loans)$64 (Loans)$15,275 (US Treasury Deposits)$206 (US Treasury Deposits)$1,757,096 (Other)$78,968 (Other)$61,323 (Other)$232,195 (Other)Total: $882,649Total: $882,649Total: $3,886,099Total: $3,886,099Quantitative easing programQE1 (Nov. 2008): $2.1T in Bank Debt, Mortgage Backed Securities and TreasuriesQE2 (Nov. 2010): $600B in Treasury SecuritiesQE3 (Sept. 2012): $40B per month (increased to $85B/mo. In Dec. 2012)
49Quantitative easingQE1QE2QE3$4TBillions of dollars$2.7T$1.7T
50Quantitative easingQE1QE2QE3$4TBillions of dollars$2.3T$1.3T
51Monetary BaseNormal Annual Growth: 7% per year2006 – 2013 Growth: 21% per yearCurrency in CirculationNormal Annual Growth: 7% per year2006 – 2013 Growth: 6% per yearThe lack of inflation from QE is largely because the cash injected isn’t circulating!
52M1 = Currency in Circulation + Checkable Deposits Billions of Dollars$1.7T$1.3T
53M2 = M1 + Savings Deposits + MMM Funds + Small Time Deposits Billions of Dollars$7.7T$3T$600B$500B
54Money in the United States “Quantitative Easing”M2 ($11.8T)M0 ($4T)M1 ($2.9T)
55By purchasing and/or selling securities, the Fed can directly control the quantity of M0. Suppose that the Federal Reserve wants to increase the Monetary Base.The Fed credits the reserve account of the dealer’s bankFederal ReserveDealers Sell bonds to the FedBond DealerThis is called an open market purchase
56Suppose that the Federal Reserve purchases a $10,000 Treasury Suppose that the Federal Reserve purchases a $10,000 Treasury. It pays for it by crediting the bond dealer’s bank account at Citibank.AssetsLiabilities+ $10,000 (Treasuries)+ $10,000 (Reserve Deposits)Citigroup’s reserve accountCitigroup’s balance sheet is affected as follow:AssetsLiabilities+ $10,000 (Reserves Deposits)+ $10,000 (Deposits)Bond dealer’s checking account
57The federal reserve requires that 5% of transaction deposits must be kept on reserve with the federal reserve. The remainder, the bank is free to lend out.AssetsLiabilities+ $500 (Required Reserves)+ $10,000 (Deposits)+ $9,500 (Excess Reserves)Suppose that Citibank makes a $9,500 car loanAssetsLiabilities+ $500 (Required Reserves)+ $10,000 (Deposits)+ $9,500 (Excess Reserves)+ $9,500 (Line of Credit)+ $9,500 (Car Loan)
58Eventually, the $9,500 will end up in the bank account of the car dealership. At that point, Citibank covers the credit line by a transfers a $9,500 credit into Bank of America’s accountAssetsLiabilities+ $500 (Required Reserves)+ $10,000 (Deposits)+ $9,500 (Car Loan)Now, Bank of America has $9,500 in new reserves, 5% must be kept at the Fed, the rest can be lent out.AssetsLiabilities+ $475 ( Required Reserves)+ $9,500 (Deposits)+ $9,025 (Excess Reserves)Car dealer’s checking account
59The initial bond purchase creates a “ripple effect” through the banking system AssetsLiabilitiesChange in MB = $10,000+ $10,000 (Treasuries)+ $10,000 (Reserve Deposits)AssetsLiabilities+ $500 (Required Reserves)+ $10,000 (Deposits)+ $9,500 (Car Loan)Change in M1=$19,500AssetsLiabilities+ $475 ( Required Reserves)+ $9,500 (Deposits)+ $9,025 (Excess Reserves)
60This process will continue as payments get passed from bank to bank. $ Change in M1= (mm)$ Change in MBCash1 +Depositsmm =CashReserves+DepositsDepositsReservesCashIn our example,= 5%= 0%DepositsDeposits1$ Change in M1 =$10,000 = $200,000.05
61Currently in the US….Currency in Circulation = $1.3TReserves = $2.3TCheckable Deposits = $1.7T
62Think of money demand as a portfolio allocation problem Think of money demand as a portfolio allocation problem. You have a fixed amount of income and you are allocating it over several assets.More Liquid Lower ReturnLess Liquid Higher ReturnIncome$5,000/monthCash $400Checking Account$2,000Savings Account$600Stock/Bonds $2,000M1M2
63Money DemandSuppose that you are planning on spending $120 over the coming month. You currently have all your money in a savings account earning interest. To buy things you will need cash.As long as your money is in a savings account it is counted as M2, but not M1The cash you withdraw is included in M1
64Suppose you go to the bank three times per month (every 10 days) Suppose you go to the bank three times per month (every 10 days). You withdraw $40 each time. More generally, if you make plan on Spending PY dollars per month. If you make N trips to the ATMATM WithdrawalsCash Balance Hits Zero
65Average Cash Balances (Money Demand) Real Money DemandWhat determines N?
66The objective here is to choose the number of times you go to the bank to get money There are two costs associated with money:If you make very few trips to the bank (N is small), you will need to withdraw more cash – having more cash entails more lost interestIf you make a lot of trips to the bank, you will withdraw less each time (less interest cost), but you will pay more in transaction costs
67Take the derivative with respect to ‘N’ Solve for N
68Money DemandThis is the optimal behavior (i.e. trips to the ATM per month)As the interest rate goes up, you hold less cash. Therefore, you make more trips to the bankAs ATM fees rise, you make less trips to the bank, but withdraw more each time
69Money Demand Real Income Nominal Interest Rate Transaction Costs Real Money Demand
70Generally Speaking…. “is a function of…” Real Income (+) Transactions Costs (Cost of obtaining money) (+)Nominal Interest Rate (-)Real Money DemandRemember,
71A common form of money demand can be written as follows: Constant between 0 and 1Real money demand is equal to a fraction (k is between zero and one) of real income. That fraction depends on interest rates (-) and transaction costs (+)
72The Quantity Theory of Money Money SupplyNominal IncomeVelocity – Measures the number of times a dollar changes handsNote: We could rewrite this as percentage changes…
73The Quantity Theory of Money and Money Demand When money demand drops– velocity increases.
74In 1995, we saw a dramatic change in household portfolio decisions…why? M1 Money Demand falls dramatically starting in 1995M1 Demand Rises fromTrend
75As interest rates rose, households switched out of checking accounts and into savings accounts….technology (online banking, ATMs, etc. made this transition easier)Falling demand for M2Rising Demand for M2
76When the money market is in equilibrium, real money supplied equals real money demanded. Nominal Money Supply(determined by the Fed)real interest ratePrice Levelreal output (determined in the labor market)Transactions costsExpected inflationDetermined in capital marketsreal money
77Suppose that the Fed increases the money supply by 10% (assume inflation expectations are zero) Recall, nothing has changed in the real economyAt the existing interest rate, there is excess supply of money. Now what?
78The price level increases by an equal 10% The price level increases by an equal 10%. The price increase returns real money to its original level (Money is neutral)No adjustment in the other two markets is necessary
79Again, the real economy is unaffected and “money is neutral” This one time increase in the money supply creates no inflation…just a one time adjustment in pricesM10%0% Growth0% GrowthTimeP10%0% Growth0% GrowthTimeAgain, the real economy is unaffected and “money is neutral”
80Suppose that prior to the 10% increase in the money supply, there was $100M in circulation. Further, assume that there is only one good in the economy – beer – six packs of beer initially cost $10.Prior to the increase in money supply:six packs of beerAfter the increase in money supply:six packs of beerNo net gain/loss, right? However, there is something going on here!
81Remember, the government must use the newly printed currency to buy something in order to send it into circulation. In this example, the only thing available to buy is beer (Party at Janet’s house!!!).Janet uses the $10M in newly created money to buy 1M beers!If there is zero net gain, or loss, then this 1M gain in beers by the government must be offset somewhere!Once prices rise, anyone holding money sees a drop in their purchasing power!!!Really, we can think of an increase in the money supply as an invisible tax – the inflation tax!
82Now, prices increase by more than 10% Now, lets repeat the example, but now assume that the money supply increase alters households expectations. Suppose households believe that the fed will increase the money supply by 10% every year10%5%Determined in capital marketsNow, prices increase by more than 10%
83The rise in inflation expectations creates an “overreaction” in prices due to the drop in money demandM0% Growth10% GrowthTimeP20%0% Growth10% GrowthTime
84Lets make this example a little more specific Lets make this example a little more specific. Suppose that prior to the 10% increase in the money supply, there was $100M in circulation. Further, assume that there is only one good in the economy – beer – six packs of beer initially cost $10.Prior to the increase in money supply:six packs of beerAfter the increase in money supply:six packs of beerNow we have a very real loss…who pays here? Surely not the government!
85Remember, the government must use the newly printed currency to buy something in order to send it into circulation. In this example, the only thing available to buy is beer (Party at Janet’s house!!!).Janet uses the $10M in newly created money to buy 1M beers!If there is zero net gain, or loss, then this 1M gain in beers by the government must be offset somewhere!Now, the households loss is bigger than the governments gain!Essentially, the loss is coming from the fact that people are spending too much time trying to avoid holding money and too little time making beer!!
86Money, Prices, and the Business Cycle…. A temporary, productivity shock raises real wages and lowers real interest ratesPrice needs to decline so that the real supply of money equals the new demand at the new interest rateThe increase in real output should increase money demandNew equilibrium interest rate
87Money, Prices, and the Business Cycle…. A permanent, productivity shock raises real wages and raises real interest ratesAn interest rate in this range would require a price increaseNo price change necessaryAn interest rate in this range would require a price decrease
88Money, Prices and the business cycle Given the mechanics of the money market, what relationships would we expect to see between money supply, prices and output?Just the facts ma’am.OutputMoneyPrices- or +More Likely
89The Price level vs. GDP% Deviation from TrendCorrelation = -.21
90M1 Money Supply vs. GDP% Deviation from TrendCorrelation = -.02
91M2 Money Supply vs. GDP % Deviation from Trend Correlation = .25 This is a problem
92Our model would also predict a zero correlation between the money supply and the real interest rate Real Interest Rate vs. M1% Deviation from TrendCorrelation = -.09
93Real Interest Rate vs. M2 % Deviation from Trend This is a problem Correlation = -.20This is a problem
94Recall the quantity theory Determined in capital marketsOr, in percentagesInflationSo, money has no impact on any real variables, but money controls nominal prices. The growth of money influences the inflation rate and (given a real return), inflation determines the nominal interest rate
95Example: Oil Price Shocks in the 1970’s 1979 Iranian Revolution(Temporary Shock)Dollars per Barrel1973 Arab Oil Embargo(Permanent Shock)
96The resulting decline in investment lowers the real interest rate In prior analyses, we already determined that both events looked like permanent productivity declines…Price needs to increase so that the real supply of money equals the new demand at the new interest rateThe decrease in real output should lower money demandNew equilibrium interest rateThe resulting decline in investment lowers the real interest rate
97Price Level (% Dev. From trend) CPI (1972 – 1982)Price Level (% Dev. From trend)1973 Arab Oil Embargo1979 Iranian Revolution