1. Money, Money Supply, Bank Accounting, & Fiscal and Monetary Policy
Review Day #3: Block May 3rd or 4th
Unit-4 Macro Review
Money, Money Supply, Bank Accounting, &
Fiscal and Monetary Policy

2. Fed vs. Government The Federal Reserve creates money
By buying bonds in open market operations
Too much money can lead to inflation
The Government creates debt
By borrowing money for deficit spending
Too much debt can lead to crowding out
Loanable Funds = Gov’t
Money Market = Fed

3. Money Market Use for Gov’t Debt Use for Monetary Policy
Model of Saver & Borrowers
Supply = National Savings
Demand = Investment (I) (borrowers for capital goods => leads to innovation
Crowding Out: Gov’t borrows too much => real interest rates rise = Business Investment falls (I ↓)
Use for Monetary Policy
MS is is fixed by Fed
MD = Desire to “hold money” [transaction demand)
Fed buys/sell bonds to shift MS => this changes short term interest rates (federal funds rate)
MD rarely shifts

4. MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓
2 Types of Monetary Policy
Expansionary
Contractionary
Currently 1.50%
Currently 0.75% target
Contractionary Policy
=> ↑ reserve requirement, ↑ discount rate & Sell Bonds
MS1 MD
Nominal
Interest
Rate
Qty of $
MS2
LRAS1
Price
Level
Real
GDP
AD1
SRAS1
Affects AD
AD2 P1 Y1 Y* E1 i2 E2 Q2 P2 E2
MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓ i1 E1 Q1

5. MONEY Commodity money Fiat money Types of Money (Std. of value)
Measuring Money Supply
M most liquid (cash, checking deposits, travelers checks, etc…)
M slightly less liquid (M1 + savings acct., money markets,…)
M3 = least liquid (M2 + large time deposits (over $100,000) )

6. Banks Create Money by lending
Fractional Reserve Banking System
Banks Create Money by lending
Example:
$100 Deposit
10% Reserve Ratio
1st Bank Balance Sheet
This loan causes
money creation
Excess Reserves can
be lent out by bank .

7. Money Multiplier = 1/R 10 * $90 = $900 increase Money Supply
Reserve Requirement = 10%
Money Multiplier = 1/10% = 10
Money Supply Change = Money Multiplier X 1st Loan
10 * $90 = $900 increase Money Supply

8. Practice Test
16 Practice Multiple Choice

9. Quantity Theory of Money
Monetarists economists believe that money is neutral!
That is changes in Money Supply (MS) have no affect on real GDP in long run
Qty Theory of Money Equation
Velocity of money is relatively constant
Real GDP is fixed in short run
↑ MS only will ↑Price Level

10. 2011 Practice Free Response

11. DEMAND FOR MONEY Demand for money is downward sloping Money Market MS
The Money Market is not the Loanable Funds market!
(It is a much broader market)
Money Market
Nominal
Interest
Rate MS
Demand for Money:
Transactions Demand
Precautionary Demand
Speculative Demand MD
Qty $
Price Level changes shifts Demand Curve for Money
↑ Px level shifts MD right
↓Px level shifts MD left