Different types of financial assets
something used to facilitate the exchange of goods and services
shares in the ownership of a business
a certificate of debt issued by a business or a government
money is measured in liquidity. M1 is the highest liquidity (coins, cash, cd)
open market operations
fiat money: something that serves as money but has no other important uses
1. Change the required reserve ratio
2. Change the discount rate
3. Change the federal funds rate
4. Open-market purchase of government bonds by the central bank
Increase in gov. spending leads to more income = more consumption
Tax reductions lead to more consumption.
More consumption leads to more investments by firms.
Firms can produce more, which leads to greater investments.
- examples above are expansionary fiscal policy
- the opposite (raise taxes + lower gov spending) is contractionary fiscal policy
- these things shift aggregate demand
Federal Reserve Board (Board of Governors)
-independent regulatory agency
-#1 Goal: control the money supply
there are 7 board members who all serve 14 year terms
-US central bank
-also, to stabilize the banking system
they are chosen by the president
-created by the Federal Reserve Act of 1913
The Federal Open Market Committee aids the Board of Governors in conducting Monetary Policy .
buying and selling bonds
AD + AS Graph
P0 shows the market in equilibrium. P2 shows a shift in AD, creating a recessionary gap.
Shifters of AD + AS
Actions of the government
What does the money supply mean?
The money supply is the money in the economy at M1.
In a money market graph, why is the Money Supply curve vertical?
Money supply is independent of interest rates because it is determined by monetary policy actions of the Fed
What are the shifters of money supply?
1. setting reserve requirements, 2. setting federal funds rate, 3. setting discount rates, 4. open market operations
How do banks create money?
After banks receive deposits from their customers, they put away enough to meet required reserves.
The rest of the money in their excess reserves, they can loan out.
That loan gets spent in the economy.
This means they created money because they have the same money in one person's savings that they loaned out, and that went into the economy.
Required reserves is the percentage of a deposit a bank is required to keep (cannot be loaned out).
Why is money demanded in an economy?
1. to perserve wealth in liquid form and 2. to use in transactions the market
What does the demand curve look like?
Lower interest rates lead to a higher demand for money. The curve is downward sloping.
What are the shifters of money demand?
1. Technology, 2. Real GDP, 3. Institutions, 4. Price Level (TRIP)
Shifters of Money Supply (extended)
The Discount Rate
Rate the Fed charges banks to take out overnight loans from them.
Federal Funds Rate
Rate banks charge other banks to take out overnight loans
Open Market Operations
The Fed buying and selling bonds
Big Money=Buy; Small Money=Sell
Formulas to Know
Quantity Theory of Money
MV = PQ
Quantity theory of money shows that the money supply (M) will affect the price level (P) and/or the real output if the velocity of money (V) is fixed in the short run.
shows inverse relationship between inflation and unemployment
if you want to lower inflation, unemployment will rise