Money as an asset The Money Market The Money Multiplier Monetary Policy

 1. Medium of exchange – usable for buying and selling goods  2. Unit of account - dollar value of goods and services  3. store of value - transfer of purchasing power from the present to future

 At the core of monetary policy is the regulation of the money supply.  M1 – currency, checkable deposits  M2 – Near money (savings, small time deposits, MMMF)  Federal Reserve Notes are token money (fiat)  Checkable deposits are large component  Currency held by the FED, thrift, banks are excluded

 Money helps satisfy wants and is also an asset  Transaction Demand – As nominal GDP rises, people demand more money to buy goods and services  If nominal GDP is $1000 and each dollar is spend an average of four times each year, money demand for transactions would be $1000/4 = $250.  What happens if nominal GDP raises to $1200

 Asset Demand – Money can be held as an asset at very little risk.  Total Demand – Plotted against the nominal interest rate, the transaction demand for money is a constant MD t.

 John Maynard Keynes – Theory of Liquidity Preference  How is the Money Market Different from the Market for Loanable Funds? (extremely important to know the difference  Breadth of scope  Different Philosophies (Classical vs. Keynesian)  Graphing: “ Loanable funds are REAL-ly fun ”

 When we talk about monetary policy we are really talking about money supply policy.  Increase/Decrease in the money supply  How does this work?  Tips:  Increase - lowers interest rates as surplus money moves into the bond market, increasing bond prices  Decrease - increases interest rates as a shortage of money creates a sell-off of bonds, decreasing the bond prices

 best way to see money creation is to create a t- account or balance sheet (assets and liabilities of the bank)  Asset – anything owned by the bank or owed to the bank; cash on reserve is an asset as well as loans made to citizens  Liability – anything owned by depositors or lenders to the bank; checking deposits or loans made to the bank

 measures the maximum amount of new checking deposits that can be created by a single dollar of excess reserves  idea and math is identical to the spending multiplier  M = 1/(reserve ratio) = 1/rr (=1/.10 = 10 in our example)

 3 tools  Open Market Operations  Discount Rate  Reserve Ratio  Expansionary Policy  Longer path to impact than fiscal policy  Contractionary Policy

 Open Market Operations – (Federal Open Market Committee) can buy and sell securities on the open market  “ B ” uying “ B ” onds = “ B ” igger “ B ” ucks  “ S ” elling “ B ” onds = “ S ” maller “ B ” ucks  Federal Funds Rate

 Discount rates act like the real interest rates  Rates change in lockstep with the federal funds rate

 Rarely used  Lowering the reserve ratio increases excess reserves in commercial banks and expands the money supply  Increasing the reserve ratio decreases excess reserves in commercial banks and contracts the money supply  (pull in Table 16.1)

 Monetary policy DOES NOT affect government spending!  In a deep recessionary gap  expansionary monetary policy used to assist expansionary fiscal policy - risk inflation burst  In a mild recessionary gap  contractionary monetary policy could be used to offset expansionary fiscal policy - risk rising interest rates  In an inflationary gap  contractionary monetary policy could be used to assist contractionary fiscal policy - risk rising unemployment

 increasing the money supply has no effect on real GDP; but only serves to increase the price level.  MV = PQ or V = PQ/M