Unit IV

3 Uses of Money

• medium of exchange
• unit of account
• store of value

Types of Money

• Representative Money- paper money backed by a tangible product
• Commodity Money- gold and silver coins
• Fiat Money- it is money b/c the government says it is 

Characteristics of Money 

• Durability - how long is money good for 
• Portability - can carry it anywhere
• Divisibility - can be broken into smaller units
• Scarcity
• Acceptability

M1 Money

• consists of currency in circulation (paper and coins, travelers check)
• Checkable deposits- checking accounts, demand deposits 
• Account for 75% of $ in circulation

M2 Money 

• savings accounts
• money- market accounts
• accounts held by banks outside the U.S

Assets= Liabilities + Net Worth 
Reserve Ratio: commercial banks required reserves/ commercial banks check able deposit liabilities

3 Important Issues

• Excess Reserves = actual reserves - required reserves
• lending ability
• asset or liability to which bank
• M1 money as well
• money market account- accounts interests; large money account
• Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money
• Monetary Multiplier = 1 / (required reserve ratio)
• Maximum check able deposit creation = excess reserves x monetary multiplier

Reserve Requirement

• The Fed. requires banks to always have some money readily available to meet consumers demand for cash
• The amount set by the Fed.  is the Required Reserve Ratio 
• The required reserve ratio is the % of demand deposits that must not be loaned out 
• Typical Reserve Ratio = 10%

Monetary policy

• Controlled by the federal reserve bank (fed)
• Influencing the economy through changes in reserves which influences the money supply and available credit

4 options

1.       Reserve requirement – percent that is set by the fed of the minimum reserve that the bank must keep

2.       Discount rate – rate of interest that the fed charges for overnight loans to banks  

3.       Federal fund rate – rate that FDIC members charge each other for loans

a.       Decrease = expansionary monetary policy

b.      Increase = contractionary monetary policy

4.       OMO(open market operation)- buy or sell securities (bonds)

a.       Fed buys bonds = expand money supply

b.      Fed sells bonds = decrease money supply

Prime rate – interest rate that banks charge their most credit worthy borrowers 

	Expansionary (easy money)	Contractionary (tight money)
OMO	Buy bonds	Sell bonds
Discount rate	Decrease	Increase
Federal fund	Decrease	Increase
Required reserve	Decrease	Increase

Easy money - dollar depreciates

Tight money - high interest rate 

Single bank- amount of money single bank can create (loan out) = ER

Ar - Rr = Er

Banking system - can create money by a multiple of its initial ER

Deposit multiplier = 1/rr

New money system - deposit multiplier X initial ER

If initial deposit is not new money, the total change in the MS is only the money created by the banking system

Money Market 

Loanable Funds