1. Unit 4- Financial Sector

2. Barter Inefficient Prevents economic growth
Double coincidence of wants

3. Time Value of Money Money and Interest Rates
PV=FV/(1+r)n
FV = PV (1+r)n
13% interest rate
I give you $100 today
I give you $100 on March 17, 2017
*No calculators on the AP exam, so…

4. Types of Money
Commodity money- money itself serves a purpose (i.e. tulip bulbs, salt, tobacco)
Commodity-Backed money- money’s value is backed by a commodity (gold, silver)
*Fiat money- value based solely on acceptance of value and government backing

5. Functions of Money Medium of Exchange
Unit of Account (Standard of Value)
Store of Value

6. Fed Tools Open Market Operations- buy/sell bonds
Discount Rate- rate Fed charges banks
Reserve Requirement/Required Reserve Ratio

7. What should the Fed do? During a recessionary period? List 3
During an inflationary period? List 3

8. What should the Fed do? During a recessionary period?
Expansionary Monetary Policy
During an expansionary period?
Contractionary Monetary Policy

9. Money Market

10. Open Market Operations
Buy
Bonds
Sell
Bonds

11. Money Multiplier Simple Deposit Multiplier = 1 /Required Reserve Ratio

12. Money Multiplier New Deposits Open Market Operations (buying bonds)
Apply multiplier after subtracting required reserves
Example: Bob finds $100 under his mattress and deposits it
10% RR
Bank can loan $90
$90 x 10 = $900 increase in money supply
Open Market Operations (buying bonds)
Apply multiplier to full amount
Example: Fed buys $100 in bonds from the open market
$100 x 10 = $1000 increase in money supply
*What if the RR is 20%?????

13. Money Supply Measures based on Liquidity
Monetary Base =
M0 =
M1=
M2=

14. Money Supply Expansion
Expansion = Multiplier X Excess Reserves

15. Money Multiplier New Deposits Open Market Operations (buying bonds)
Apply multiplier after subtracting required reserves
Example: Bob finds $100 under his mattress and deposits it
10% RR
Bank can loan $90
$90 x 10 = $900 increase in money supply
Open Market Operations (buying bonds)
Apply multiplier to full amount
Example: Fed buys $100 in bonds from the open market
$100 x 10 = $1000 increase in money supply
*What if the RR is 20%?????

16. How Bankers Keep Books
Banks keep balance sheets
Assets = liabilities + net worth (Equity)
Assets include:
Reserves
Loans
Liabilities include:
Deposits owed to customers.

17. Money Market

18. Money Market
Q of money is fixed at any given point in time
MS = M1

19. Money Market i = nominal interest rate
Money Market graphs short term interest rates

20. Money Market Nominal Interest rate is the Federal Funds Rate
FFR = rate banks charge each other for overnight loans

21. Money Market MD= Q of money demanded at various interest rates
Q of money demanded = amount of wealth held as money over other assets

22. Money Market
What is the opportunity cost of holding money?

23. Money Market
Change in “i“ causes movement along the curve

24. Money Market
Increase Price Level will shift MD to the right

25. Fed Tools Open Market Operations- buy/sell bonds
Discount Rate- rate Fed charges banks
Reserve Requirement/Required Reserve Ratio

26. What should the Fed do? During a recessionary period? List 3
During an inflationary period? List 3

27. What should the Fed do? During a recessionary period?
Expansionary Monetary Policy
During an expansionary period?
Contractionary Monetary Policy

29. FIGURE 28-1 Bank Failures in the United States, 1915-2000
2,200
FDIC established
2,000
1,800
200
1,600
160
1,400
Number of Bank Failures
120
Number of Bank Failures
1,200 80
1,000 40
800
1935
1945
1955
1965
1975
1985
'95
'00
600
Great Depression begins
400
200
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
'95
'00
Year
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

31. The Banking System Bank Regulation Deposit Insurance Bank Supervision
The Federal Deposit Insurance Corporation insures people’s deposits at banks.
Bank Supervision
Ensures banks take only sensible, defensible risks
Controls the money supply
Reserve Requirements
Helps control the money supply

32. Just what is a bond? Issued by a government or business to raise $
Bond purchaser is the lender
Purchaser receives regular interest payments
Interest rate is called coupon rate
Purchaser is paid the principle at maturity
Longer the term, higher the interest
Bonds can be traded before maturity
Privately issued bonds have higher coupon rates- more risk
US government bonds have “zero” risk

33. Stock v. Bonds Stock = owner Bond = lender
Riskier company = higher coupon rate

34. Trading Existing Bonds
If interest rates go up?
If interest rates go down?
Premium
Discount

35. How Bankers Keep Books
Banks keep balance sheets
Assets = liabilities + net worth (Equity)
Assets include:
Reserves
Loans
Securities (bonds)
Other holdings
Liabilities include:
Deposits owed to customers.

36. Balance Sheets- Important Points
1. Deposits and withdraws do not INITIALLY change M1
2. Required Reserves only apply to demand (checkable) deposits

37. Balance Sheets- Important Points
If a bank falls below reserve requirement:
-call in loans
-borrow from another bank (federal funds rate)
-borrow from the Fed (discount rate)

38. Balance Sheets- Important Points
-Reserve Requirement = 10%
-Required Reserve Ratio = .1

39. Fed Policy Recessionary Gap Inflationary Gap Expansionary policy
Buy bonds
Increase Money Supply
“easy money”
Interest rates down
Quantity of Investment Increase
AD Increase (speed up)
Price Level Increase
Inflationary Gap
Contractionary policy
Sell bonds
Decrease Money Supply
“tight money”
Interest rates up
Quantity of Investment Decrease
AD decrease (slows)
Price Level Decrease

41. Crowding Out
Government deficit spending causes real interest rates to rise (loanable funds)
Quantity of Investment Spending Decreases
May partially or fully restrict AD increase from increase in “G” with decrease in “I”

43. Demand for Money
Transaction Demand- function?
Asset Demand- function?

44. Demand for Money Transaction Demand- money for spending
Increase in PL will cause rightward shift

45. Demand for Money Financial Assets- stocks, bonds, loans, deposits
Asset Demand- inverse relationship to interest rates

46. Monetarism Money Supply is chief determinant of economic growth
MV = PQ

47. MV = PQ Equation of exchange M= money supply V= velocity of money
P= price level
Q= quantity of goods and services produced
PQ =

48. Quantity Theory of Money
MV=PQ
Change in M will cause proportional change in P
Classical View

49. MV = PQ

50. Investment Demand

51. Investment Demand Investment leads to capital formation
This changes future capital stock
This influences growth rate
In LR, increased investment
spending will increase LRAS