Copyright South-Western, a division of Thomson, Inc. Slide 1 MONEY AND INTEREST The Money Supply Money Creation and Circulation Interest and Interest Rates 3

Copyright South-Western, a division of Thomson, Inc. Slide 2 Lesson 3.1 THE MONEY SUPPLY Define money supply, and explain how it is measured Describe two types of money, and explain the fractional-reserve system GOALS

Copyright South-Western, a division of Thomson, Inc. Slide 3 WHAT IS THE MONEY SUPPLY? The money supply is defined as the liquid assets held by banks and individuals. The flow of money—and the amount of it flowing—has a direct effect on how the economy performs.

Copyright South-Western, a division of Thomson, Inc. Slide 4 EXPANDING THE MONEY SUPPLY Extra money in the economy can cause inflation Demand for goods and services increase Supply decreases, causing prices to rise

Copyright South-Western, a division of Thomson, Inc. Slide 5 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 A certificate of deposit that matures next June Your savings account Less Liquid More Liquid

Copyright South-Western, a division of Thomson, Inc. Slide 6 AGGREGATE MEASURES OF THE MONEY SUPPLY M1 M1 Money that can be spent immediately M2 M2 All the money in M1 plus short-term investments M3 M3 All the money in M1 and M2 plus large deposits MZM MZM Money at zero maturity

Copyright South-Western, a division of Thomson, Inc. Slide 7 THE NATURE OF MONEY Two types of money Commodity money is based on some item of value, for example, gold or precious stones. Fiat money is money that is deemed legal tender by the government, and it is not based on or convertible into a commodity. The fractional-reserve system

Copyright South-Western, a division of Thomson, Inc. Slide 8 Lesson 3.2 MONEY CREATION AND CIRCULATION Describe how money is created by bank activities Explain how money circulates in the United States GOALS

Copyright South-Western, a division of Thomson, Inc. Slide 9 HOW MONEY IS CREATED Printing currency and creating money are two different things. Money is actually created by the interaction of the demand for it, banks’ use of it, and the Federal Reserve’s supply and control of it.

Copyright South-Western, a division of Thomson, Inc. Slide 10 DEPOSITS AND RESERVES Primary reserves Secondary reserves

Copyright South-Western, a division of Thomson, Inc. Slide 11 THE MULTIPLIER EFFECT Money on deposit, minus the reserve requirement, can be loaned to customers. When it is, it creates new deposits, which also go out to customers as loans and create more deposits, thus expanding the amount of money in the system.

Copyright South-Western, a division of Thomson, Inc. Slide 12 HOW MONEY CIRCULATES Transfers and circulation The Fed and fiat money Money as an IOU

Copyright South-Western, a division of Thomson, Inc. Slide 13 Lesson 3.3 INTEREST AND INTEREST RATES List factors that affect interest rates Explain which factors the Federal Reserve affects GOALS

Copyright South-Western, a division of Thomson, Inc. Slide 14 INTEREST RATES AND BUSINESS The money supply and the economy are linked closely to interest rates. Generally, when rates are high, money is said to be “tight” and business tends to slow because it costs more to acquire capital. When rates drop, more credit is accessible, and the economy tends to gather speed.

Copyright South-Western, a division of Thomson, Inc. Slide 15 FACTORS AFFECTING INTEREST RATES The federal funds rate is the amount of interest charged for short-term, interbank loans. The discount rate is the interest rate that the Federal Reserve sets and charges for loans to member banks. The prime rate is the rate that banks charge their best and most reliable customers.

Copyright South-Western, a division of Thomson, Inc. Slide 16 MONETARY POLICY AND INTEREST RATES The Federal Reserve sets the discount rate. The Federal Reserve only influences the federal funds rate.