1. Money, Monetary Policy and Economic Stability
Unit 4
Money, Monetary Policy and Economic Stability

2. Money Before money, economies used a barter system
Unit IV Lesson 1
Before money, economies used a barter system
Problem – double coincidence of wants
Basic properties of any commodity used as money
Portability, uniformity, stability in value and acceptability

3. Unit IV Lesson 1
Functions of Money
Medium of Exchange function eliminates the need for the double coincidence of wants
The Store-of-value function permits money to be held for use at a later time
The Unit-of-Account, or Standard-of-Value function means there is an agreed-to measure for stating the prices of goods and services. This simplifies price comparisons.

4. Complete Activity 34 and review answers
Unit IV Lesson 1
Complete Activity 34 and review answers

5. Definitions of Money in the U.S.
Unit IV Lesson 1
Definitions of Money in the U.S. M1
Consists of currency, traveler’s checks, and checkable deposits M2
Includes M1 plus savings deposits, small time deposits, money market deposit accounts (MMDAs), noninstitutional money market mutual funds (MMMFs) and other deposits M3
Includes M2 plus large ($100,000 or more) time deposits

6. Complete Activity 35 and review answers
Unit IV Lesson 1
Complete Activity 35 and review answers

7. Equation of Exchange MV=PQ
Unit IV Lesson 2
Equation of Exchange MV=PQ
“M” – M1, stock of money
“V” – Income (GDP) velocity of circulation or average number of times $1 is spent on final goods and services in a particular time period
“P” – average price level of final goods and services in GDP, also known as the GDP deflator
“Q” – real output, the quantity of goods and services in GDP

8. Unit IV Lesson 2
Evidence shows that income velocity (V) is highly predictable with its value remaining in a very narrow range over a multiyear period
Thus, changes in the money supply (M) result in changes in Nominal GDP (PxQ)
Depending on the state of the economy, the changes in the money supply can result in changes in prices, in output only or in some combination of both

9. Complete Activity 36 and review answers
Unit IV Lesson 2
Complete Activity 36 and review answers

10. Financial Intermediaries
Unit IV Lesson 3
Financial Intermediaries
Bringing people who want to borrow funds together with people who want to lend funds
Examples: commercial banks, savings and loans associations, savings banks, credit unions & money market mutual fund companies
Functions:
liquidity creation, minimization of the cost of borrowing, minimization of the cost of monitoring borrowers and risk reduction through pooling

11. Fractional Reserve System of Banking
Unit IV Lesson 3
Fractional Reserve System of Banking
Banks – any depository institution whose deposits are a part of M1.
Banks must hold a specific percentage of deposits as reserves; this percentage is called the required reserve ratio
The deposit that is not part of required reserves is called excess reserves

12. Banks may loan excess reserves or buy government securities
Unit IV Lesson 3
Banks may loan excess reserves or buy government securities
A bank makes a loan by creating a a checkable deposit for the borrower; this results in an increase in the money supply

13. Money Expansion Multiplier
Unit IV Lesson 3
Money Expansion Multiplier
Exists because the reserves & deposits lost by one bank are received by another bank
It magnifies excess reserves into a larger creation of checkable-deposit money
Deposit expansion multiplier = ____1____
reserve requirement
Expansion of the money supply =
excess reserves x deposit expansion multiplier

14. Unit IV Lesson 3
Higher reserves = lower money expansion multipliers and a decrease in the money supply
Total increase in money supply may be less than predicted by the money expansion multiplier if
Borrowers do not spend all the money they borrow
Banks do not lend out all their excess reserves
People hold part of their money as cash

15. Complete Activity 37 and review answers
Unit IV Lesson 3
Complete Activity 37 and review answers

16. The Federal Reserve System
Unit IV Lesson 4
The Federal Reserve System
Has the responsibility to control the money supply to promote the economic goals of full employment, price stability and stable economic growth
Board of Governors
Central authority, 7 member board, serve 14 year terms
Chairman – Alan Greenspan
Federal Open Market Committee (FOMC)
7 members of the board and 5 of the presidents of the Federal Reserve Banks
Sets the Fed’s monetary policy and directs the purchase and sale of gov’t securities

17. Tools of the Fed Open-Market Operations
Unit IV Lesson 4
Tools of the Fed
Open-Market Operations
The buying of bonds or securities from (increase money supply), or the selling of bonds to (decrease the money supply), commercial banks and the public
Fed’s most important instrument for influencing the money supply

18. Reserve Ratio The Discount Rate Unit IV Lesson 4
Raising the reserve ratio = decrease in money supply
Lowering the reserve ratio = increases the money supply
The Discount Rate
Interest Rate charged on short-term loans from the Fed to commercial banks
Lower discount rate = increase in money supply
Higher discount rate = decrease in the money supply

19. Complete Activity 38 and review answers
Unit IV Lesson 4
Complete Activity 38 and review answers

20. The Money Market The Demand for Money
Unit IV Lesson 5
The Money Market
The Demand for Money
Transactions demand – the demand for money to make purchases of goods & services
Precautionary (liquidity)demand – the demand for money to serve as protection against unexpected need
Speculative demand – the demand for money because it serves as a store of wealth
How much of your wealth do you want to hold as money & how much do you want to hold as interest-bearing assets?

21. Explain and Illustrate Visual 4.1
Unit IV Lesson 5
Explain and Illustrate Visual 4.1

22. Explain and Illustrate Visual 4.2
Unit IV Lesson 5
Explain and Illustrate Visual 4.2

23. Explain and Illustrate Visual 4.3
Unit IV Lesson 5
Explain and Illustrate Visual 4.3

24. Complete Activity 39 and review answers
Unit IV Lesson 5
Complete Activity 39 and review answers

25. Explain and Illustrate Visual 4.4
Unit IV Lesson 5
Explain and Illustrate Visual 4.4

26. Understand? Fed purchases Treasury securities Money supply increases
Unit IV Lesson 5
Understand?
Fed purchases Treasury securities
Money supply increases
Interest rate decreases
Investment increase (& interest-sensitive components of consumption spending increase)
Aggregate Demand increases
Output increases and the Price Level increases

27. Fed sells Treasury securities Money supply decreases
Unit IV Lesson 5
Fed sells Treasury securities
Money supply decreases
Interest rate increases
Investment decreases (& interest-sensitive components of consumption spending decrease)
Aggregate Demand decreases
Output decreases and the Price Level decreases

28. Complete Activity 40 and review answers
Unit IV Lesson 5
Complete Activity 40 and review answers

29. Interest Rates and Monetary Policy in the Short Run & the Long Run
Unit IV Lesson 6
Interest Rates and Monetary Policy in the Short Run & the Long Run
Nominal interest rate
Rate that appears on the financial pages of newspapers & ads for financial institutions
Not adjusted for inflation
Real interest rate
Increase in purchasing power the lender wants to receive to forego consumption now for consumption in the future
Adjusted for inflation
Real interest rate = Nominal interest rate – inflation rate “Fisher Equation”

30. Two Relationships between the real and nominal interest rates
Unit IV Lesson 6
Two Relationships between the real and nominal interest rates
Ex ante real interest rate (expected interest rate)
equals the nominal interest rate minus the expected inflation rate
Ex poste real interest rate (real interest rate actually received)
Equals the nominal interest rate minus the actual rate of inflation

31. Equation of exchange MV=PQ
Unit IV Lesson 6
Equation of exchange MV=PQ
Looking at this equation, we see that changes in the money supply – holding velocity & real output constant – lead to changes in the price level
These changes in the price level change the nominal interest rate once they are anticipated

32. Complete Activity 41 and review answers
Unit IV Lesson 6
Complete Activity 41 and review answers

33. Complete Activity 42 and review answers
Unit IV Lesson 6
Complete Activity 42 and review answers

34. REVIEW FOR UNIT IV EXAM