http://money.cnn.com/2011/11/30/news/economy/fed_ecb_dollar_liquidity/index.htm?hpt=hp_t1
NEW YORK (CNNMoney) -- Europe's hurting for cash, and central banks around the world are stepping in to give it a boost.
The Federal Reserve, along with five other central banks, acted Wednesday to make it cheaper for banks around the world to borrow U.S. dollars.
The Fed -- along with central banks of the eurozone, England, Japan, Switzerland and Canada -- announced a coordinated plan to lower prices on dollar liquidity swaps beginning on Dec. 5, and extending these swap arrangements to Feb. 1, 2013.
A swap takes place when the Fed provides U.S. dollars to a foreign central bank in exchange for the equivalent amount of foreign currency from that central bank.
Overall, these efforts are meant to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity," the Federal Reserve said in a press release.
World stock markets surged on the news, pushing the Dow (INDU) back into positive territory for the year.
Velshi: Banks help Europe buy time
Together, the six central banks also created a temporary mechanism, making it easier for them to exchange their foreign currencies -- not just U.S. dollars. That tool gives any of these central banks easier access to euros, Japanese yen, British pounds, Swiss francs and Canadian dollars should they need those currencies to assist their region's banks in the event of a crisis.
These liquidity facilities could come in handy if Europe's debt crisis, for example, escalates to the point that foreign banks need the funds to continue normal business transactions.
"These swap lines are being implemented as a contingency measure, so that central banks can offer liquidity in foreign currencies if market conditions warrant such actions," the Federal Reserve said in a Q&A about the plan.
Since May, the cost for European banks to borrow dollars from other European banks has skyrocketed. Through central bank auctions announced in September, these banks can borrow dollars at reduced interest rates, for periods of three months.
This is meant to lower the cost of short-term borrowing for troubled European banks, as well as give them immediate access to dollars. Today's actions continue that plan and further reduce borrowing costs.
The European Central Bank is the one actually making the loans, so the Fed is not on the hook if a European bank fails, said Paul Ashworth, chief U.S. economist with Capital Economics.
China starts easing
In its statement Wednesday, the Fed stressed that the move is designed to offer help to foreign banks, and that U.S banks are not in need of liquidity, at least for now.
"U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets," the central bank said. "However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions."
Meanwhile, the People's Bank of China also announced a plan to increase liquidity Wednesday by lowering its reserve requirement ratio for financial institutions by half a percentage point. To top of page
Wednesday, November 30, 2011
Tuesday, November 29, 2011
Monday, November 28, 2011
Fiscal Policy 11-28-11
THE CAR ANALOGY
The economy is like a car
• You can drive 120mph but it is not sustainable
• Like extremely low unemployment
• You could drive a car at 20mph
• such at high unemployment
• But 70mph is sustainable and is what its designed for
• Such as full unemployment 4-6%
• The engine (technology) of gas milage (productivity)
How does the government stabilize the economy?
THe government has two different tools to use
0. Fiscal policy
1. Monetary policy
Fiscal policy is actions by congress to stabilize the economy
Monetary policy is actions by the federal reserve to stabilize the economy.
Two different types of fiscal policy
DISCRETIONARY FISCAL POLICY
• Congress creates a new bill that is designed to change Ad through government
spending or taxation
• Problem is time lags due to bureaucracy
• takes time for congress to act
• ex. In a recession congress increases spending
NON DISCRETIONARY FISCAL POLICY
• AKA. Automatic stabilizers
• Permanent spending taxation laws enacted to work counter cyclically to stabilize the
economy
• ex. Welfare, unemployment, min. wage etc.
• When there is high unemployment what are ways government can stimulate
economy?
CONTRACTIONARY FISCAL POLICY (THE BRAKE)
Laws that reduce inflation, decrease GDP
• Decrease government spending
• Tax increases
• Combinations of the two
EXPANSIONARY FISCAL POLICY (THE GAS)
LAWs that reduce unemployment and increase GDP (Close a recessionary Gap)
• Increased government spending
• decrease taxes on consumers
• combinations of the two
How much should the government spend?
THE MULTIPLIER EFFECT
Why do cities want the Superbowl in their stadium?
An initial change in spending will set off a spending chain that is magnified in the
economy.
Example?
Bobby spends $100 on Jason's product
• jason now has more income so he buys $100 of nancy's
• Nancy now has more income so she buys $100 of Tiffany's product
• The result is at least $300 increase in consumer spending
EFFECTS OF GOVERNMENT SPENDING
If the government spends $5million will AD increase by the same amount?
• No, AD will increase even more as spending becomes income for consumers.
• Consumers will take that money and spend thus increasing AD
How much will AD increase
• It depends on how much of the new income consumers save
• If they save a lot spending and AD will increase less
• If they save less, then spending and AD will increase a lot.
MARGINAL PROPENSITY TO CONSUME
Marginal Propensity to consume (MPC)
• How much people consumer rather than save
• It is always expressed as a fraction
MPC = Change in consumption
Change in income
MARGINAL PROPENSITY TO SAVE (MPS)
• How much people save rather then consume when there is a change in income
• It is also expressed as a fraction
MPS = Change in savings
Change in income
MPS = 1 - MPC
Why is this true?
Because people can either save or consume
HOW IS SPENDING MULTIPLIED?
Assume the MPC is .5 for everyone?
• Assume the Superbowl comes to town and there is an increase of $100 in ashley's
rester aunt
• Ashley now has $100 more income
• She now saves $50 and spends $50 at Karl's Salon
• Karl now has $50 more income
• $25 and spends $25 at Dans Fruit stand
• Dan now has $25 more income
• This continues until every penny is either saved or spend
**Total Change in GDP = multiplier x initial change in spending
CALCULATING THE SPENDING MULTIPLIER
If MPC is .5, how much is the multiplier?
spending multiplier
1
Or
1
MPS
1 - MPC
• if the multiplier is 4 how much will an initial increase of $5 in government spending
increase the GDP?
• How much will a decrease in $3 in spending decrease GDP?
Lets practice the spending multiplier
2. If MPC is .9 what is multiplier?
3. if MPC is .8 what is the multiplier?
4. If MPC is .5 and consumption increased $2 million, how much will GDP increase?
Conclusion: as the marginal propensity to consume falls, the multiplier effect is less.
WHAT ABOUT TAXING?
• The multiplier effect also applies when the government cuts or increases taxes
• But chaining taxes has less of an effect then government spending. Why?
EXPANSIONARY POLICY (CUTTING TAXES)
• Assume the MPC is .75 so the multiplier is 4 if the government cuts taxes by $4 million
how will consumer spending increase?
• When they get the tax cut, consumers will save $1 million and spending $3 million
• The $3 million amount will be magnified in the economy.
The economy is like a car
• You can drive 120mph but it is not sustainable
• Like extremely low unemployment
• You could drive a car at 20mph
• such at high unemployment
• But 70mph is sustainable and is what its designed for
• Such as full unemployment 4-6%
• The engine (technology) of gas milage (productivity)
How does the government stabilize the economy?
THe government has two different tools to use
0. Fiscal policy
1. Monetary policy
Fiscal policy is actions by congress to stabilize the economy
Monetary policy is actions by the federal reserve to stabilize the economy.
Two different types of fiscal policy
DISCRETIONARY FISCAL POLICY
• Congress creates a new bill that is designed to change Ad through government
spending or taxation
• Problem is time lags due to bureaucracy
• takes time for congress to act
• ex. In a recession congress increases spending
NON DISCRETIONARY FISCAL POLICY
• AKA. Automatic stabilizers
• Permanent spending taxation laws enacted to work counter cyclically to stabilize the
economy
• ex. Welfare, unemployment, min. wage etc.
• When there is high unemployment what are ways government can stimulate
economy?
CONTRACTIONARY FISCAL POLICY (THE BRAKE)
Laws that reduce inflation, decrease GDP
• Decrease government spending
• Tax increases
• Combinations of the two
EXPANSIONARY FISCAL POLICY (THE GAS)
LAWs that reduce unemployment and increase GDP (Close a recessionary Gap)
• Increased government spending
• decrease taxes on consumers
• combinations of the two
How much should the government spend?
THE MULTIPLIER EFFECT
Why do cities want the Superbowl in their stadium?
An initial change in spending will set off a spending chain that is magnified in the
economy.
Example?
Bobby spends $100 on Jason's product
• jason now has more income so he buys $100 of nancy's
• Nancy now has more income so she buys $100 of Tiffany's product
• The result is at least $300 increase in consumer spending
EFFECTS OF GOVERNMENT SPENDING
If the government spends $5million will AD increase by the same amount?
• No, AD will increase even more as spending becomes income for consumers.
• Consumers will take that money and spend thus increasing AD
How much will AD increase
• It depends on how much of the new income consumers save
• If they save a lot spending and AD will increase less
• If they save less, then spending and AD will increase a lot.
MARGINAL PROPENSITY TO CONSUME
Marginal Propensity to consume (MPC)
• How much people consumer rather than save
• It is always expressed as a fraction
MPC = Change in consumption
Change in income
MARGINAL PROPENSITY TO SAVE (MPS)
• How much people save rather then consume when there is a change in income
• It is also expressed as a fraction
MPS = Change in savings
Change in income
MPS = 1 - MPC
Why is this true?
Because people can either save or consume
HOW IS SPENDING MULTIPLIED?
Assume the MPC is .5 for everyone?
• Assume the Superbowl comes to town and there is an increase of $100 in ashley's
rester aunt
• Ashley now has $100 more income
• She now saves $50 and spends $50 at Karl's Salon
• Karl now has $50 more income
• $25 and spends $25 at Dans Fruit stand
• Dan now has $25 more income
• This continues until every penny is either saved or spend
**Total Change in GDP = multiplier x initial change in spending
CALCULATING THE SPENDING MULTIPLIER
If MPC is .5, how much is the multiplier?
spending multiplier
1
Or
1
MPS
1 - MPC
• if the multiplier is 4 how much will an initial increase of $5 in government spending
increase the GDP?
• How much will a decrease in $3 in spending decrease GDP?
Lets practice the spending multiplier
2. If MPC is .9 what is multiplier?
3. if MPC is .8 what is the multiplier?
4. If MPC is .5 and consumption increased $2 million, how much will GDP increase?
Conclusion: as the marginal propensity to consume falls, the multiplier effect is less.
WHAT ABOUT TAXING?
• The multiplier effect also applies when the government cuts or increases taxes
• But chaining taxes has less of an effect then government spending. Why?
EXPANSIONARY POLICY (CUTTING TAXES)
• Assume the MPC is .75 so the multiplier is 4 if the government cuts taxes by $4 million
how will consumer spending increase?
• When they get the tax cut, consumers will save $1 million and spending $3 million
• The $3 million amount will be magnified in the economy.
Tuesday, November 22, 2011
World record Broken by Emily Krenek and Taylor Lahey!
The Belton High School World Record Club made history today by eclipsing a Guiness World Record. Belton High School seniors Emily Krenek and Taylor Lahey completed the "Fastest Time to Duct Tape a Person to a Wall" challenge in 51.4657 seconds.
Here's the link to the YouTube video: http://youtu.be/ULV5joDtpmA
The criteria for breaking the record is as follows:
• Only 1 person taping
• Person being taped must weigh over 110 pounds
• Person being taped has to remain attached to the wall for at least 1 minute.
Taylor was able to tape Emily to the wall in 51.4657 seconds and she remained there for 2 mimutes and 25 seconds. They were assisted in their attempt by: Randy Hale, Hadley Young, Levi Jordan, Kaylee Krenek, and Shannon Rice. Elizabeth McMurtry, Matt Blackburn, and I are the Club Sponsors.
These students are also looking at breaking a handful of other records throughout their senior year. Their next target is the World's Largest Knockout Basketball Game. They are looking to challenge this record at some point before or after the Christmas Break.
If you see any of these students, please congratulate them on their achievement.
Thursday, November 17, 2011
Phillips Curve PPT on Google Docs
https://docs.google.com/present/edit?id=0AbxQN7GyomHPZGNzdHpkY3FfMjA4ZHM2ano5Z3c
Wednesday, November 16, 2011
Today's Powerpoint-AG S&D/Fiscal Policy
https://docs.google.com/present/edit?id=0AbxQN7GyomHPZGNzdHpkY3FfMTMxY2R3dmJzZDk
Monday, November 14, 2011
Thursday, November 3, 2011
11-3-11
• Savers and borrowers care about the real interest rate because tat is what they earn or pay interest after inflation.
• Real interest rate = interest rate - expected inflation
• If expected inflation is 0%; then real rate = nominal rate.
• But its also true that if expected inflation is constant and any change in the nominal rate will be reflected in an identical change in the real rate.
• This is why the graphs in the text are labeled "nominal interest rate for a given expected future inflation rate"
EQUILIBRIUM IN THE LOANABLE FUNDS MARKET
• Demand is downward sloping for one very intuitive reason.
• Firms borrow tot pay for capital investment projects.
• If the project has an expected rate of return that exceeds the real interest rate, the investment will be profitable, and the funds will be demanded.
• Rate of return (%) =
(100(Revenue form project) - (cost of project))-(cost of project)
• As the real rate falls more projects become profitable, so the quantity of funds demanded will increase.
• Supply is upward sloping
• Savers can lend their money to borrowers but in doing so must forgo consumption
• In order to compensate for the forgone consumption, savers must receive interest income and as the real interest rate rises, the opportunity to earn more income rises so more dollars will be saved.
• As the real Rate rises, the quantity of funds supplied will increase.
• Changes in Perceived business opportunities
- A change in the beliefs about the rate of return on investment spending can
increase or reduce the amount of desired spending at any given interest rate.
• Changes in the Government's Borrowing.
• Changes in the government's borrowing
- Budget deficits are major sources of the demand for loanable funds
- Treasury must borrow funds and acquire more debt. This increases the demand
for lovable funds in the market.
- In a budget surplus, less debt would be acquired and the demand for loanable
funds would decrease.
• Changes in private savings behavior
- If households decide to consume more and save less, The supply of loanable funds will shift to the left,
• Changes in capital inflows
- If a nation is perceived to have a stable government, a strong economy and is a
good place to save money, foreign money will flow into that nation's financial
markets, increasing the supply of loanable funds.
INFLATION AND INTEREST RATES
• Anything that shifts either the supply of loanable funds curve or the demand for the loanable funds curve, changes the interest rate.
• We have seen in previous modules that unexpected inflation creates winners and losers, particularly in borrowers and lenders.
• Economists are going to capture the effects of inflation on borrowers and lenders by distinguishing between the nominal interest rate and the real interest rate where the difference is as follows
Real interest rate = Nominal interest rate - Inflation rate
• For borrowers, the true cost of borrowing is the real interest rate, not the nominal interest rate.
• For lenders, the true payoff to lending is the real interest rate, not the nominal interest rate.
• Real interest rate = interest rate - expected inflation
• If expected inflation is 0%; then real rate = nominal rate.
• But its also true that if expected inflation is constant and any change in the nominal rate will be reflected in an identical change in the real rate.
• This is why the graphs in the text are labeled "nominal interest rate for a given expected future inflation rate"
EQUILIBRIUM IN THE LOANABLE FUNDS MARKET
• Demand is downward sloping for one very intuitive reason.
• Firms borrow tot pay for capital investment projects.
• If the project has an expected rate of return that exceeds the real interest rate, the investment will be profitable, and the funds will be demanded.
• Rate of return (%) =
(100(Revenue form project) - (cost of project))-(cost of project)
• As the real rate falls more projects become profitable, so the quantity of funds demanded will increase.
• Supply is upward sloping
• Savers can lend their money to borrowers but in doing so must forgo consumption
• In order to compensate for the forgone consumption, savers must receive interest income and as the real interest rate rises, the opportunity to earn more income rises so more dollars will be saved.
• As the real Rate rises, the quantity of funds supplied will increase.
• Changes in Perceived business opportunities
- A change in the beliefs about the rate of return on investment spending can
increase or reduce the amount of desired spending at any given interest rate.
• Changes in the Government's Borrowing.
• Changes in the government's borrowing
- Budget deficits are major sources of the demand for loanable funds
- Treasury must borrow funds and acquire more debt. This increases the demand
for lovable funds in the market.
- In a budget surplus, less debt would be acquired and the demand for loanable
funds would decrease.
• Changes in private savings behavior
- If households decide to consume more and save less, The supply of loanable funds will shift to the left,
• Changes in capital inflows
- If a nation is perceived to have a stable government, a strong economy and is a
good place to save money, foreign money will flow into that nation's financial
markets, increasing the supply of loanable funds.
INFLATION AND INTEREST RATES
• Anything that shifts either the supply of loanable funds curve or the demand for the loanable funds curve, changes the interest rate.
• We have seen in previous modules that unexpected inflation creates winners and losers, particularly in borrowers and lenders.
• Economists are going to capture the effects of inflation on borrowers and lenders by distinguishing between the nominal interest rate and the real interest rate where the difference is as follows
Real interest rate = Nominal interest rate - Inflation rate
• For borrowers, the true cost of borrowing is the real interest rate, not the nominal interest rate.
• For lenders, the true payoff to lending is the real interest rate, not the nominal interest rate.
Wednesday, November 2, 2011
November 1, 2011 Modules 22-25
MODULE 22-29 Notes
OBJECTIVES
• You will learn the following
- Relationship between savings and investment spending
- Purpose of the four principal types of financial assets
•Stocks
•Bonds
•Loans
•Bank deposits
- How investors achieve diversity
MATCHING UP SAVINGS AND INVESTMENTS
• Physical capital
- Factories, shopping malls, large pieces of machinery, etc.
• Usually paid for by borrowing
• Where does this funding come from?
• Savings = Spending
- Savings - investments spending identity
• In a simple economy (No government intervention)
- All money spent by a person or firm ends up pockets of others as income
• Total income = Total spending = C + I
• So... C + S = C + I
Lets add Government activity
• The government spends on goods services, and transfers and collects tax revenues
• If the budget is balanced...
- Tax revenue = Government spending + transfer payment
- Budget balance (BB) = Tax revenue - G - Transfers
- If BB is > 0, there is a surplus and government is saving money
- If BB is < 0, there is a deficit and the government is borrowing money.
THE FINANCIAL SYSTEM
• Financial markets is where households invest their current savings and their current savings and their accumulated savings (WEALTH) by purchasing financial assets
• FINANCIAL ASSET
- Paper claim that entitles the buyer to the future income from the seller.
THREE TASKS OF THE FINANCIAL SYSTEM
0. Reducing transaction cost
1. Reducing risk
- Financial Risk
- Diversification
3. Providing Liquidity
- Liquid assets
- Illiquid Assets
WHAT IS MONEY?
• Money
- Something that you can turn into a good or service
• Three roles of money
- Medium of exchange
• Gimmie a dollar for a pack of gum
- Store of value
• Retains its value over short periods of time
- Unit of account
• A way of evaluating the "measurements" of goods and services
MEDIUM OF EXCHANGE
• Your employer exchanges dollars for an hour of your labor
• Your exchange those dollars for a grocers pound of apples
• The grocer exchanges those dollars for an orchards apples crop, and on and on
STORE OF VALUE
• So long as prices are not rapidly increasing, money is a decent way to store value. You can put money under your mattress or in a checking account and still useful, with essentially the same value a week or month later
• If i were the town cheese maker, I must quickly get rid of my cheese because if I wait long, moldy cheese loses value quickly.
UNIT OF ACCOUNT
• Units of currency (Dollars, Euro yen...) Measures the relative worth of goods and services just as inches and meters measure distance
• In the barter system all goods are measured in terms of other goods
• Prices in a barter economy: A Ib of cheese dozen eggs = beer or something
• With money the value of cheese and all other goods and services is measured in terms of a monetary unit.
TYPES OF MONEY
• Commodity money
- Something used as money, normally gold of silver, that has intrinsic value to
others
• Commodity backed money
- Medium of exchange with no intrinsic value guaranteed by a promise that it
could be converted into valuable goods on demand
• Fiat money
- Money whose value derives entirely from its official status as a means of
exchange.
MEASURES THE MONEY SUPPLY
• How much money is out there?
• Two different measures on the amount of money supply. M1 and M2
- M1 = Currency and coin in circulation+checking deposits+Travelers checks
- M2 = M1 + Savings accounts + Short term CD, money market accounts.
Notes 11-1-11
BANKING AND MONEY CREATION AND THE FEDERAL RESERVE
MODULE 25
MONETARY ROLE OF BANKS
• More than half of the M1 is currency
• The rest is in demand deposits
- How do you figure M1
• If a large part of (about half) of the money supply is accounted for by checking deposits into banks, the banks must pay a crucial role in the supply of money in the economy.
M1 = currency + coin + traveler's checks + Checking deposits
WHAT BANKS DO
• Banks offer a safe place for depositors to put money and they offer lending services to borrowers who need money.
• A saver is paid interest on his or her savings, and a borrower is charged interest on his or her borrowing.
• Another way of thinking about it is that banks take liquid assets (Savings) to finance the investment of illiquid assets (Homes and capital equipment).
BANK RUNS
• Depositors put their money in banks to earn interest and to keep it safe. But when the public begins to fear that the bank itself might fold, or if they fear for the stability for the entire financial system, they may want to withdraw their money.
• If everyone goes to the bank to withdraw their deposits, it creates a bank run.
• The bank keeps only a small percentage of the total deposits on reserve, so a bank run can lead to a self-fulfilling prophesy of the bank's failure.
• This can be very damaging to communities and it can spread across the economy
• This is one of the primary reasons for regulating banks.
BANK REGULATIONS
2. Deposit insurance(FDIC)
3. Capital requirements
4. Reserve Requirements
5. Discount window
DEPOSIT INSURANCE
• The US Government created the FEDERAL DEPOSIT INSURANCE Corporation. The FDIC provides DEPOSIT INSURANCE, a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account. Currently the FDIC guarantees the first $250,000 of each account.
CAPITAL REQUIREMENTS
• To reduce the incentive for excessive risk-taking, regulators require that the owners of banks hold substantially more assets then the value of bank deposits
• That way, the bank will still have assets longer than its deposits even if some of its loans go bad, and losses will accrue against the bank owners' assets not the government
• Bank's capital = assets - liabilities
• For example, main Street Bank has capital of $200,000, equal to 9% of the total value of its assets. In proactive, banks' capital is required to equal at least 7% of the value of their assets.
RESERVE REQUIREMENT
• The Federal Reserve establishes the required reserve ratio for banks. This policy insures that the banks will have a certain fraction of all deposits on hand in the even that customers wish to withdraw money.
• In the unites States the required reserve ratio for checkable bank deposits is 10%
THE DISCOUNT WINDOW
• The Federal Reserve stands ready to loan money to banks in an arrangement known as the DISCOUNT WINDOW.
• This helps a bank that finds itself in a short-term punch because many depositors might be withdrawing their cash in a short period of time.
MODULE 26
History and structure of the Federal Reserve System
FEDERAL RESERVE
• The Federal Reserve is a central bank--An institution that oversees and regulates the banking system, and controls the monetary base.
• The creation of the federal Reserve System in 1913 marked the beginning of the modern era of American Banking
• Though banks were federally regulated since 1964, there were still fundamental problems delivering money from large banks in big cities to smaller banks in rural communities. If a rural bank in Indiana was low on reserves, the bank may fail before money could be delivered to the bank. This bank failure could spark run on several banks, devastating local communities.
END OF THE NATIONAL BANKING SYSTEM
• In 1913 the national banking system was eliminated and the Federal Reserve System was created as a way to compel all deposit--taking institutions to hold adequate reserves and to open their accounts to inspection of regulators
• The panic of 1907 convinced many that the time for centralized control of bank reserves had come.
• In additions, the Federal Reserve was given the sole right to us sue currency in order to make the money supply sufficiently responsive to satisfy economic conditions around the country.
• The creation of the Fed didn't stop bank runs and didn't stop the Great Depression. A series of economic downturns and damaging bank and instigated new laws from Congress that attempted to stabilize the banking industry and provide safeguards for the public and their deposits.
• However when the Great Depression became a distant became a distant memory and bank runs became much less common, Congress let some of the regulations of the 1930's lapse
• Some of these legal lapses created problems of the 1980s and in 2008.
OBJECTIVES
• You will learn the following
- Relationship between savings and investment spending
- Purpose of the four principal types of financial assets
•Stocks
•Bonds
•Loans
•Bank deposits
- How investors achieve diversity
MATCHING UP SAVINGS AND INVESTMENTS
• Physical capital
- Factories, shopping malls, large pieces of machinery, etc.
• Usually paid for by borrowing
• Where does this funding come from?
• Savings = Spending
- Savings - investments spending identity
• In a simple economy (No government intervention)
- All money spent by a person or firm ends up pockets of others as income
• Total income = Total spending = C + I
• So... C + S = C + I
Lets add Government activity
• The government spends on goods services, and transfers and collects tax revenues
• If the budget is balanced...
- Tax revenue = Government spending + transfer payment
- Budget balance (BB) = Tax revenue - G - Transfers
- If BB is > 0, there is a surplus and government is saving money
- If BB is < 0, there is a deficit and the government is borrowing money.
THE FINANCIAL SYSTEM
• Financial markets is where households invest their current savings and their current savings and their accumulated savings (WEALTH) by purchasing financial assets
• FINANCIAL ASSET
- Paper claim that entitles the buyer to the future income from the seller.
THREE TASKS OF THE FINANCIAL SYSTEM
0. Reducing transaction cost
1. Reducing risk
- Financial Risk
- Diversification
3. Providing Liquidity
- Liquid assets
- Illiquid Assets
WHAT IS MONEY?
• Money
- Something that you can turn into a good or service
• Three roles of money
- Medium of exchange
• Gimmie a dollar for a pack of gum
- Store of value
• Retains its value over short periods of time
- Unit of account
• A way of evaluating the "measurements" of goods and services
MEDIUM OF EXCHANGE
• Your employer exchanges dollars for an hour of your labor
• Your exchange those dollars for a grocers pound of apples
• The grocer exchanges those dollars for an orchards apples crop, and on and on
STORE OF VALUE
• So long as prices are not rapidly increasing, money is a decent way to store value. You can put money under your mattress or in a checking account and still useful, with essentially the same value a week or month later
• If i were the town cheese maker, I must quickly get rid of my cheese because if I wait long, moldy cheese loses value quickly.
UNIT OF ACCOUNT
• Units of currency (Dollars, Euro yen...) Measures the relative worth of goods and services just as inches and meters measure distance
• In the barter system all goods are measured in terms of other goods
• Prices in a barter economy: A Ib of cheese dozen eggs = beer or something
• With money the value of cheese and all other goods and services is measured in terms of a monetary unit.
TYPES OF MONEY
• Commodity money
- Something used as money, normally gold of silver, that has intrinsic value to
others
• Commodity backed money
- Medium of exchange with no intrinsic value guaranteed by a promise that it
could be converted into valuable goods on demand
• Fiat money
- Money whose value derives entirely from its official status as a means of
exchange.
MEASURES THE MONEY SUPPLY
• How much money is out there?
• Two different measures on the amount of money supply. M1 and M2
- M1 = Currency and coin in circulation+checking deposits+Travelers checks
- M2 = M1 + Savings accounts + Short term CD, money market accounts.
Notes 11-1-11
BANKING AND MONEY CREATION AND THE FEDERAL RESERVE
MODULE 25
MONETARY ROLE OF BANKS
• More than half of the M1 is currency
• The rest is in demand deposits
- How do you figure M1
• If a large part of (about half) of the money supply is accounted for by checking deposits into banks, the banks must pay a crucial role in the supply of money in the economy.
M1 = currency + coin + traveler's checks + Checking deposits
WHAT BANKS DO
• Banks offer a safe place for depositors to put money and they offer lending services to borrowers who need money.
• A saver is paid interest on his or her savings, and a borrower is charged interest on his or her borrowing.
• Another way of thinking about it is that banks take liquid assets (Savings) to finance the investment of illiquid assets (Homes and capital equipment).
BANK RUNS
• Depositors put their money in banks to earn interest and to keep it safe. But when the public begins to fear that the bank itself might fold, or if they fear for the stability for the entire financial system, they may want to withdraw their money.
• If everyone goes to the bank to withdraw their deposits, it creates a bank run.
• The bank keeps only a small percentage of the total deposits on reserve, so a bank run can lead to a self-fulfilling prophesy of the bank's failure.
• This can be very damaging to communities and it can spread across the economy
• This is one of the primary reasons for regulating banks.
BANK REGULATIONS
2. Deposit insurance(FDIC)
3. Capital requirements
4. Reserve Requirements
5. Discount window
DEPOSIT INSURANCE
• The US Government created the FEDERAL DEPOSIT INSURANCE Corporation. The FDIC provides DEPOSIT INSURANCE, a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account. Currently the FDIC guarantees the first $250,000 of each account.
CAPITAL REQUIREMENTS
• To reduce the incentive for excessive risk-taking, regulators require that the owners of banks hold substantially more assets then the value of bank deposits
• That way, the bank will still have assets longer than its deposits even if some of its loans go bad, and losses will accrue against the bank owners' assets not the government
• Bank's capital = assets - liabilities
• For example, main Street Bank has capital of $200,000, equal to 9% of the total value of its assets. In proactive, banks' capital is required to equal at least 7% of the value of their assets.
RESERVE REQUIREMENT
• The Federal Reserve establishes the required reserve ratio for banks. This policy insures that the banks will have a certain fraction of all deposits on hand in the even that customers wish to withdraw money.
• In the unites States the required reserve ratio for checkable bank deposits is 10%
THE DISCOUNT WINDOW
• The Federal Reserve stands ready to loan money to banks in an arrangement known as the DISCOUNT WINDOW.
• This helps a bank that finds itself in a short-term punch because many depositors might be withdrawing their cash in a short period of time.
MODULE 26
History and structure of the Federal Reserve System
FEDERAL RESERVE
• The Federal Reserve is a central bank--An institution that oversees and regulates the banking system, and controls the monetary base.
• The creation of the federal Reserve System in 1913 marked the beginning of the modern era of American Banking
• Though banks were federally regulated since 1964, there were still fundamental problems delivering money from large banks in big cities to smaller banks in rural communities. If a rural bank in Indiana was low on reserves, the bank may fail before money could be delivered to the bank. This bank failure could spark run on several banks, devastating local communities.
END OF THE NATIONAL BANKING SYSTEM
• In 1913 the national banking system was eliminated and the Federal Reserve System was created as a way to compel all deposit--taking institutions to hold adequate reserves and to open their accounts to inspection of regulators
• The panic of 1907 convinced many that the time for centralized control of bank reserves had come.
• In additions, the Federal Reserve was given the sole right to us sue currency in order to make the money supply sufficiently responsive to satisfy economic conditions around the country.
• The creation of the Fed didn't stop bank runs and didn't stop the Great Depression. A series of economic downturns and damaging bank and instigated new laws from Congress that attempted to stabilize the banking industry and provide safeguards for the public and their deposits.
• However when the Great Depression became a distant became a distant memory and bank runs became much less common, Congress let some of the regulations of the 1930's lapse
• Some of these legal lapses created problems of the 1980s and in 2008.
November 2, 2011 Modules 28 & 29
MODULE 28 and 29 Notes
OPPORTUNITY COST OF HOLDING MONEY
• What is the O.C of holding money?
- You gain the convenience of being able to spend it easily
- You lose the ability to earn interest on it.
• The higher the short-term interest rate, the higher the opportunity cost of holding money. The lower the short-term interest, the lower the opportunity cost.
• Since we Demand money to make purchases in the short term, the opportunity cost of holding money is the short-term interest rate.
• We assume that in a short period of time, there will be virtually no inflation, so the nominal interest rate is equal to the real interest rate
• When the interest rate rises, the opportunity cost of holding money rises, so the quantity of money demanded will fall
• The money demand curve is downward sloping.
SHIFTS OF THE MONEY DEMAND CURVE
• Just like there are external factors that shift the demand curve for pomegranates, there are external factors that shift the demand for money
• The most important factors causing the money demand curve to shift are changes in the aggregate demand curve to shift are changes in REAL GDP, changes in Banking Technology and banking institutions.
CHANGES IN AGGREGATE PRICE LEVEL
• All else equal, higher prices will increase the demand for money (A rightward shift in the MD curve) and lower prices reduces the demand for money (A leftward shift of the MD Curve)
• We can actually be more specific than this: other things equal, the demand for money is proportional to the price level. That is, if the aggregate price level rises by 20% the quantity of money demanded at any given interest rate also rises by 20%
• Why? Because if the price of everything rise by 20% that it takes 20% more money to buy the same basket of goods and serves.
CHANGES IN REAL GDP
• As the economy gets stronger, real incomes and Real GDP Rise.
• The larger the quantity of goods and services we buy, the larger the quantity of money we will want to hold at any given interest rate.
• So an increase in real GDP--The total quantity of goods and services produced and sold in the economy--shifts the money demand curve downward
CHANGES IN TECHNOLOGY
• Changes in technology can affect the demand for money.
• In general, advances in information technology have tended to reduce the demand for money by making it easier for the public to make purchases without holding significant sums for money.
• If there was an ATM machine on every corner in every retail store and restaurant, there would be little need to hold money in your pocket.
CHANGES IN INSTITUTIONS
• Regulations that make it more attractive to keep money in banks will reduce the demand for money.
• If a nation's political and banking systems became dangerously unstable, it might increase the demand for money because people would rather hoard their money than store it in institutions that might be falling apart.
• The model of liquidity preference describes equilibrium in the money market. This model is a good foundation for learning a similar market in loanable funds that is also useful in describing how interest rates are determined and the impact of monetary policy
MODULE 29
MARKET FOR LOANABLE FUNDS
• It is through the financial markets by which the funds of the savers are borrowed by investors
• Economists use the model of a market for loanable funds to explain these interactions and determine the equilibrium real interest rate.
EQUILIBRIUM INTEREST RATE
• Economists work with a simplified model in which there is only one market where there is just one market which brings together those who want to lend money (savers) and those who want to borrow (Firms with investment spending projects)
• The hypothetical market is known as the loanable funds market. The price that is determined in the loanable funds market is the interest rate, denoted by 'r'.
OPPORTUNITY COST OF HOLDING MONEY
• What is the O.C of holding money?
- You gain the convenience of being able to spend it easily
- You lose the ability to earn interest on it.
• The higher the short-term interest rate, the higher the opportunity cost of holding money. The lower the short-term interest, the lower the opportunity cost.
• Since we Demand money to make purchases in the short term, the opportunity cost of holding money is the short-term interest rate.
• We assume that in a short period of time, there will be virtually no inflation, so the nominal interest rate is equal to the real interest rate
• When the interest rate rises, the opportunity cost of holding money rises, so the quantity of money demanded will fall
• The money demand curve is downward sloping.
SHIFTS OF THE MONEY DEMAND CURVE
• Just like there are external factors that shift the demand curve for pomegranates, there are external factors that shift the demand for money
• The most important factors causing the money demand curve to shift are changes in the aggregate demand curve to shift are changes in REAL GDP, changes in Banking Technology and banking institutions.
CHANGES IN AGGREGATE PRICE LEVEL
• All else equal, higher prices will increase the demand for money (A rightward shift in the MD curve) and lower prices reduces the demand for money (A leftward shift of the MD Curve)
• We can actually be more specific than this: other things equal, the demand for money is proportional to the price level. That is, if the aggregate price level rises by 20% the quantity of money demanded at any given interest rate also rises by 20%
• Why? Because if the price of everything rise by 20% that it takes 20% more money to buy the same basket of goods and serves.
CHANGES IN REAL GDP
• As the economy gets stronger, real incomes and Real GDP Rise.
• The larger the quantity of goods and services we buy, the larger the quantity of money we will want to hold at any given interest rate.
• So an increase in real GDP--The total quantity of goods and services produced and sold in the economy--shifts the money demand curve downward
CHANGES IN TECHNOLOGY
• Changes in technology can affect the demand for money.
• In general, advances in information technology have tended to reduce the demand for money by making it easier for the public to make purchases without holding significant sums for money.
• If there was an ATM machine on every corner in every retail store and restaurant, there would be little need to hold money in your pocket.
CHANGES IN INSTITUTIONS
• Regulations that make it more attractive to keep money in banks will reduce the demand for money.
• If a nation's political and banking systems became dangerously unstable, it might increase the demand for money because people would rather hoard their money than store it in institutions that might be falling apart.
• The model of liquidity preference describes equilibrium in the money market. This model is a good foundation for learning a similar market in loanable funds that is also useful in describing how interest rates are determined and the impact of monetary policy
MODULE 29
MARKET FOR LOANABLE FUNDS
• It is through the financial markets by which the funds of the savers are borrowed by investors
• Economists use the model of a market for loanable funds to explain these interactions and determine the equilibrium real interest rate.
EQUILIBRIUM INTEREST RATE
• Economists work with a simplified model in which there is only one market where there is just one market which brings together those who want to lend money (savers) and those who want to borrow (Firms with investment spending projects)
• The hypothetical market is known as the loanable funds market. The price that is determined in the loanable funds market is the interest rate, denoted by 'r'.
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