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Mankiw 6e PowerPoints

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The Monetary System:
What It Is and How It Works
4
CHAPTER

CHAPTER 4 The Monetary System
Chapter 4 covers topics that many students will have seen in their introductory course, including: the functions, types, and measures of money; fractional reserve banking and the money multiplier; the Fed’s tools for controlling the money supply; and bank runs.

As a result, you might consider a homework or quiz to get students to review these basic concepts on their own so you can use class time for the more intermediate-level material. This material includes: a more sophisticated model of the money multiplier; bank leverage and capital requirements.

The material in this chapter lends itself well to current events analysis; if you can free up class time by having students review the basics on their own, you might consider devoting class time to the discussion of current Federal Reserve policy, recent problems in banking sector, or other topical issues.

IN THIS CHAPTER, YOU WILL LEARN:
The definition, functions, and types of money
How banks “create” money
What a central bank is and how it controls the money supply

CHAPTER 4 The Monetary System

Money: Definition
Money is the stock
of assets that can be readily used to make transactions.

CHAPTER 4 The Monetary System

Money: Functions
Medium of exchange
we use it to buy stuff
Store of value
transfers purchasing power from the present to the future
Unit of account
the common unit by which everyone measures prices and values

CHAPTER 4 The Monetary System

If your students have taken principles of economics, they will probably be familiar with the material on this slide.
It might be worthwhile, though, to take an extra moment to be sure that students understand that the definition of store of value (an item that transfers purchasing power from the present to the future) simply means that money retains its value over time, so you need not spend all your money as soon as you receive it. The idea should be familiar, even though Mankiw’s wording is a bit more sophisticated than most other texts.

Money: Types
1. Fiat money
has no intrinsic value
example: the paper currency we use
2. Commodity money
has intrinsic value
examples:
gold coins,
cigarettes in P.O.W. camps

CHAPTER 4 The Monetary System

Again, this material should be reviewed for most students.

Note: Many students have seen the film The Shawshank Redemption starring Tim Robbins and Morgan Freeman. Most of this film takes place in a prison. The prisoners have an informal “underground economy” in which cigarettes are used as money, even by prisoners who don’t smoke. Students who have seen the film will better understand “commodity money” if you mention this example. Also, the textbook (p. 83) has a case study on cigarettes being used as money in POW camps during WWII.

NOW YOU TRY
Discussion Question
Which of these are money?
a. Currency
b. Checks
c. Deposits in checking accounts
(“demand deposits”)
d. Credit cards
e. Certificates of deposit
(“time deposits”)

CHAPTER 4 The Monetary System
Answers:
a – yes
b – no, not the checks themselves, but the funds in checking accounts are money
c – yes (see b)
d – no, credit cards are a means of deferring payment
e – CDs are a store of value, and they are measured in money units. They are not readily spendable, though.

Suggestion: Ask students to determine, for each item listed, which of the functions of money it serves.

Two definitions
The money supply is the quantity of money available in the economy.
Monetary policy is the control over the money supply.

CHAPTER 4 The Monetary System

Again, this is mostly review.

The central bank and monetary control
Monetary policy is conducted by a country’s central bank.
The U.S.’s
central bank
is called the
Federal Reserve
(“the Fed”).
To control the money supply, the Fed uses
open market operations, the purchase and sale of government bonds.

The Federal Reserve Building Washington, DC

CHAPTER 4 The Monetary System

Again, this is mostly review.

Money supply measures, March 2015
11,846
M1 + small time deposits,
savings deposits,
money market mutual funds,
money market deposit accounts
M2
2,988
C + demand deposits,
travelers’ checks,
other checkable deposits
M1
1,279
Currency
C
amount
($ billions)
assets included
symbol

CHAPTER 4 The Monetary System

The most important thing that students should get from this slide is the following:
Each successive measure of the money supply is BIGGER and LESS LIQUID than the one it follows. I.e.,:
checking account deposits (in M1 but not C) are less liquid than currency.
money market deposit account and savings account balances (in M2 but not M1) are less liquid than demand deposits.

Whether you require your students to learn the definitions of every component of each monetary aggregate is up to you. Most professors agree that students should learn the definitions of M1, M2, demand deposits, and time deposits. Some professors feel that, since the quantity of information students can learn in a semester is finite, it is not worthwhile to require students to learn such terms as “repurchase agreements.” However, you might orally state the definitions of such terms to help students better understand the nature of the monetary aggregates.

Source: Federal Reserve Board, H.6 release.
http://www.federalreserve.gov/releases/h6/current/h6.htm
Figures are seasonally adjusted.

Banks’ role in the monetary system
The money supply equals currency plus
demand (checking account) deposits:
M = C + D
Since the money supply includes demand deposits, the banking system plays an
important role.

CHAPTER 4 The Monetary System

A few preliminaries
Reserves (R ): the portion of deposits that banks have not lent.
A bank’s liabilities include deposits;
assets include reserves and outstanding loans.
100-percent-reserve banking: a system in which banks hold all deposits as reserves.
Fractional-reserve banking:
a system in which banks hold a fraction of their deposits as reserves.

CHAPTER 4 The Monetary System

It might be worthwhile at this point to explain why deposits are liabilities and why reserves and loans are assets.

Banks’ role in the monetary system
To understand the role of banks, we will consider three scenarios:
1. No banks
2. 100-percent-reserve banking
(banks hold all deposits as reserves)
3. Fractional-reserve banking
(banks hold a fraction of deposits as reserves, use the rest to make loans)
In each scenario, we assume C = $1,000.

CHAPTER 4 The Monetary System
Remind your students to keep in mind that M = C + D in all of the scenarios.

SCENARIO 1:
No banks
With no banks,
D = 0 and M = C = $1,000.

CHAPTER 4 The Monetary System

SCENARIO 2:
100-percent-reserve banking
After the deposit:
C = $0,
D = $1,000,
M = $1,000
LESSON:
100%-reserve banking has no impact on size of money supply.

FIRSTBANK’S
balance sheet
Assets
Liabilities
reserves $1,000
deposits $1,000
Initially C = $1000, D = $0, M = $1,000.
Now suppose households deposit the $1,000 at “Firstbank.”

CHAPTER 4 The Monetary System

FIRSTBANK’S
balance sheet
Assets
Liabilities
reserves $1,000
reserves $200
loans $800
SCENARIO 3:
Fractional-reserve banking
The money supply now equals $1,800:
Depositor has $1,000 in
demand deposits.
Borrower holds $800 in currency.
deposits $1,000
Suppose banks hold 20% of deposits in reserve, making loans with the rest.
Firstbank will make $800 in loans.
LESSON: In a fractional-reserve
banking system, banks create money.

CHAPTER 4 The Monetary System

SECONDBANK’S
balance sheet
Assets
Liabilities
reserves $800
loans $0
reserves $160
loans $640
SCENARIO 3:
Fractional-reserve banking
Secondbank will loan 80% of this deposit.
deposits $800
Suppose the borrower deposits the $800 in Secondbank.
Initially, Secondbank’s balance sheet is:

CHAPTER 4 The Monetary System

Maybe the borrower deposits the $800 in the bank. Or maybe the borrower uses the money to buy something from someone else, who then deposits it in the bank. In either case, the $800 finds its way back into the banking system.

SCENARIO 3:
Fractional-reserve banking

THIRDBANK’S
balance sheet
Assets
Liabilities
deposits $640
If this $640 is eventually deposited in Thirdbank,
Then Thirdbank will keep 20% of it in reserve
and loan the rest out:
reserves $640
loans $0
reserves $128
loans $512

CHAPTER 4 The Monetary System

Again, the person who borrowed the $640 will either deposit it in his/her own checking account or will use it to buy something from somebody who, in turn, deposits it in his/her checking account. In either case, the $640 winds up in a bank somewhere and that bank can then use it to make new loans.

Finding the total amount of money:
Original deposit = $1000
+ Firstbank lending = $ 800
+ Secondbank lending = $ 640
+ Thirdbank lending = $ 512
+ other lending…
Total money supply = (1/rr ) × $1,000
where rr = ratio of reserves to deposits
In our example, rr = 0.2, so M = $5,000

CHAPTER 4 The Monetary System

Money creation in the banking system
A fractional-reserve banking system creates money, but it doesn’t create wealth:
Bank loans give borrowers some new money
and an equal amount of new debt.

CHAPTER 4 The Monetary System

Bank capital, leverage, and capital requirements
Bank capital: the resources a bank’s owners have put into the bank
A more realistic balance sheet:
Assets Liabilities and
Owners’ Equity
Reserves $200 Deposits $750
Loans 500 Debt 200
Securities 300 Capital
(owners’ equity) 50

CHAPTER 4 The Monetary System
This slide and the following three slides correspond to the subsection “Bank Capital, Leverage, and Capital Requirements” on pp. 90-91.

Bank capital, leverage, and capital requirements
Leverage: the use of borrowed money to supplement existing funds for purposes of investment
Leverage ratio = assets/capital
= $(200 + 500 + 300)/$50 = 20
Assets Liabilities and
Owners’ Equity
Reserves $200 Deposits $750
Loans 500 Debt 200
Securities 300 Capital
(owners’ equity) 50

CHAPTER 4 The Monetary System
Banks are highly leveraged.

Bank capital, leverage, and capital requirements
Being highly leveraged makes banks vulnerable.
Example: Suppose a recession causes our bank’s assets to fall by 5%, to $950.
Then, capital = assets – liabilities = 950 – 950 = 0
Assets Liabilities and
Owners’ Equity
Reserves $200 Deposits $750
Loans 500 Debt 200
Securities 300 Capital
(owners’ equity) 50

CHAPTER 4 The Monetary System
Because banks are highly leveraged, a small loss of assets could wipe out bank equity.

Bank capital, leverage, and capital requirements
Capital requirement:
minimum amount of capital mandated by regulators
intended to ensure banks will be able to pay off depositors
higher for banks that hold more risky assets
2008-2009 financial crisis:
Losses on mortgages shrank bank capital, slowed lending, exacerbated the recession.
Govt injected billions of dollars of capital into banks to ease the crisis and encourage more lending.

CHAPTER 4 The Monetary System

A model of the money supply
Monetary base, B = C + R
controlled by the central bank
Reserve-deposit ratio, rr = R/D
depends on regulations & bank policies
Currency-deposit ratio, cr = C/D
depends on households’ preferences
exogenous variables

CHAPTER 4 The Monetary System

Solving for the money supply:

where

CHAPTER 4 The Monetary System

The point of all this algebra is to express the money supply in terms of the three exogenous variables described on the preceding slide.

The money multiplier
If rr < 1, then m > 1
If monetary base changes by ΔB,
then ΔM = m × ΔB
m is the money multiplier,
the increase in the money supply resulting from a one-dollar increase
in the monetary base.

where

CHAPTER 4 The Monetary System

NOW YOU TRY
The money multiplier

Suppose households decide to hold more of their money as currency and less in the form of demand deposits.
Determine impact on money supply.
Explain the intuition for your result.

where

CHAPTER 4 The Monetary System

SOLUTION
The money multiplier

Impact of an increase in the currency-deposit ratio
Δcr > 0.
An increase in cr increases the denominator
of m proportionally more than the numerator.
So m falls, causing M to fall.
If households deposit less of their money,
then banks can’t make as many loans,
so the banking system won’t be able to
create as much money.

CHAPTER 4 The Monetary System
Note: An increase in cr raises both the numerator and denominator of the expression for m. But since rr < 1, the denominator is smaller than the numerator, so a given increase in cr will increase the denominator proportionally more than the numerator, causing a decrease in m. If your students know calculus, they can use the quotient rule to see that (dm/dcr) < 0. The instruments of monetary policy The Fed can change the monetary base using: open market operations (the Fed’s preferred method of monetary control) To increase the base, the Fed could buy government bonds, paying with new dollars. the discount rate: the interest rate the Fed charges on loans to banks To increase the base, the Fed could lower the discount rate, encouraging banks to borrow more reserves. CHAPTER 4 The Monetary System The instruments of monetary policy The Fed can change the reserve-deposit ratio using: reserve requirements: Fed regulations that impose a minimum reserve-deposit ratio To reduce the reserve-deposit ratio, the Fed could reduce reserve requirements. interest on reserves: the Fed pays interest on bank reserves deposited with the Fed To reduce the reserve-deposit ratio, the Fed could pay a lower interest rate on reserves. CHAPTER 4 The Monetary System Why the Fed can’t precisely control M Households can change cr, causing m and M to change. Banks often hold excess reserves (reserves above the reserve requirement). If banks change their excess reserves, then rr, m, and M change. where CHAPTER 4 The Monetary System CASE STUDY: Quantitative Easing Monetary base From 8/2008 to 8/2011, the monetary base tripled, but M1 grew only about 40%. CHAPTER 4 The Monetary System Figure 4-1 on p. 97. This slide and the next correspond to the case study “Quantitative Easing and the Exploding Monetary Base” on pp. 97-98. 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1971.58333333332 1971.66666666665 1971.74999999999 1971.83333333332 1971.91666666665 1971.99999999999 1972.08333333332 1972.16666666665 1972.24999999999 1972.33333333332 1972.41666666665 1972.49999999998 1972.58333333332 1972.66666666665 1972.74999999998 1972.83333333332 1972.91666666665 1972.99999999998 1973.08333333332 1973.16666666665 1973.24999999998 1973.33333333332 1973.41666666665 1973.49999999998 1973.58333333332 1973.66666666665 1973.74999999998 1973.83333333332 1973.91666666665 1973.99999999998 1974.08333333332 1974.16666666665 1974.24999999998 1974.33333333332 1974.41666666665 1974.49999999998 1974.58333333332 1974.66666666665 1974.74999999998 1974.83333333332 1974.91666666665 1974.99999999998 1975.08333333332 1975.16666666665 1975.24999999998 1975.33333333332 1975.41666666665 1975.49999999998 1975.58333333332 1975.66666666665 1975.74999999998 1975.83333333332 1975.91666666665 1975.99999999998 1976.08333333332 1976.16666666665 1976.24999999998 1976.33333333331 1976.41666666665 1976.49999999998 1976.58333333331 1976.66666666665 1976.74999999998 1976.83333333331 1976.91666666665 1976.99999999998 1977.08333333331 1977.16666666665 1977.24999999998 1977.33333333331 1977.41666666665 1977.49999999998 1977.58333333331 1977.66666666665 1977.74999999998 1977.83333333331 1977.91666666665 1977.99999999998 1978.08333333331 1978.16666666665 1978.24999999998 1978.33333333331 1978.41666666665 1978.49999999998 1978.58333333331 1978.66666666665 1978.74999999998 1978.83333333331 1978.91666666665 1978.99999999998 1979.08333333331 1979.16666666665 1979.24999999998 1979.33333333331 1979.41666666665 1979.49999999998 1979.58333333331 1979.66666666665 1979.74999999998 1979.83333333331 1979.91666666664 1979.99999999998 1980.08333333331 1980.16666666664 1980.24999999998 1980.33333333331 1980.41666666664 1980.49999999998 1980.58333333331 1980.66666666664 1980.74999999998 1980.83333333331 1980.91666666664 1980.99999999998 1981.08333333331 1981.16666666664 1981.24999999998 1981.33333333331 1981.41666666664 1981.49999999998 1981.58333333331 1981.66666666664 1981.74999999998 1981.83333333331 1981.91666666664 1981.99999999998 1982.08333333331 1982.16666666664 1982.24999999998 1982.33333333331 1982.41666666664 1982.49999999998 1982.58333333331 1982.66666666664 1982.74999999998 1982.83333333331 1982.91666666664 1982.99999999998 1983.08333333331 1983.16666666664 1983.24999999998 1983.33333333331 1983.41666666664 1983.49999999997 1983.58333333331 1983.66666666664 1983.74999999997 1983.83333333331 1983.91666666664 1983.99999999997 1984.08333333331 1984.16666666664 1984.24999999997 1984.33333333331 1984.41666666664 1984.49999999997 1984.58333333331 1984.66666666664 1984.74999999997 1984.83333333331 1984.91666666664 1984.99999999997 1985.08333333331 1985.16666666664 1985.24999999997 1985.33333333331 1985.41666666664 1985.49999999997 1985.58333333331 1985.66666666664 1985.74999999997 1985.83333333331 1985.91666666664 1985.99999999997 1986.08333333331 1986.16666666664 1986.24999999997 1986.33333333331 1986.41666666664 1986.49999999997 1986.58333333331 1986.66666666664 1986.74999999997 1986.83333333331 1986.91666666664 1986.99999999997 1987.08333333331 1987.16666666664 1987.24999999997 1987.3333333333 1987.41666666664 1987.49999999997 1987.5833333333 1987.66666666664 1987.74999999997 1987.8333333333 1987.91666666664 1987.99999999997 1988.0833333333 1988.16666666664 1988.24999999997 1988.3333333333 1988.41666666664 1988.49999999997 1988.5833333333 1988.66666666664 1988.74999999997 1988.8333333333 1988.91666666664 1988.99999999997 1989.0833333333 1989.16666666664 1989.24999999997 1989.3333333333 1989.41666666664 1989.49999999997 1989.5833333333 1989.66666666664 1989.74999999997 1989.8333333333 1989.91666666664 1989.99999999997 1990.0833333333 1990.16666666664 1990.24999999997 1990.3333333333 1990.41666666664 1990.49999999997 1990.5833333333 1990.66666666664 1990.74999999997 1990.8333333333 1990.91666666663 1990.99999999997 1991.0833333333 1991.16666666663 1991.24999999997 1991.3333333333 1991.41666666663 1991.49999999997 1991.5833333333 1991.66666666663 1991.74999999997 1991.8333333333 1991.91666666663 1991. 99999999997 1992.0833333333 1992.16666666663 1992.24999999997 1992.3333333333 1992.41666666663 1992.49999999997 1992.5833333333 1992.66666666663 1992.74999999997 1992.8333333333 1992.91666666663 1992.99999999997 1993.0833333333 1993.16666666663 1993.24999999997 1993.3333333333 1993.41666666663 1993.49999999997 1993.5833333333 1993.66666666663 1993.74999999997 1993.8333333333 1993.91666666663 1993.99999999997 1994.0833333333 1994.16666666663 1994.24999999997 1994.3333333333 1994.41666666663 1994.49999999996 1994.5833333333 1994.66666666663 1994.74999999996 1994.8333333333 1994.91666666663 1994.99999999996 1995.0833333333 1995.16666666663 1995.24999999996 1995.3333333333 1995.41666666663 1995.49999999996 1995.5833333333 1995.66666666663 1995.74999999996 1995.8333333333 1995.91666666663 1995.99999999996 1996.0833333333 1996.16666666663 1996.24999999996 1996.3333333333 1996.41666666663 1996.49999999996 1996.5833333333 1996.66666666663 1996.74999999996 1996.8333333333 1996.91666666663 1996.99999999996 1997.0833333333 1997.16666666663 1997.24999999996 1997.3333333333 1997.41666666663 1997.49999999996 1997.5833333333 1997.66666666663 1997.74999999996 1997.8333333333 1997.91666666663 1997.99999999996 1998.0833333333 1998.16666666663 1998.24999999996 1998.33333333329 1998.41666666663 1998.49999999996 1998.58333333329 1998.66666666663 1998.74999999996 1998.83333333329 1998.91666666663 1998.99999999996 1999.08333333329 1999.16666666663 1999.24999999996 1999.33333333329 1999.41666666663 1999.49999999996 1999.58333333329 1999.66666666663 1999.74999999996 1999.83333333329 1999.91666666663 1999.99999999996 2000.08333333329 2000.16666666663 2000.24999999996 2000.33333333329 2000.41666666663 2000.49999999996 2000.58333333329 2000.66666666663 2000.74999999996 2000.83333333329 2000.91666666663 2000.99999999996 2001.08333333329 2001.16666666663 2001.24999999996 2001.33333333329 2001.41666666663 2001.49999999996 2001.58333333329 2001.66666666663 2001.74999999996 2001.83333333329 2001.91666666662 2001.99999999996 2002.08333333329 2002.16666666662 2002.24999999996 2002.33333333329 2002.41666666662 2002.49999999996 2002.58333333329 2002.66666666662 2002.74999999996 2002.83333333329 2002.91666666662 2002.99999999996 2003.08333333329 2003.16666666662 2003.24999999996 2003.33333333329 2003.41666666662 2003.49999999996 2003.58333333329 2003.66666666662 2003.74999999996 2003.83333333329 2003.91666666662 2003.99999999996 2004.08333333329 2004.16666666662 2004.24999999996 2004.33333333329 2004.41666666662 2004.49999999996 2004.58333333329 2004.66666666662 2004.74999999996 2004.83333333329 2004.91666666662 2004.99999999996 2005.08333333329 2005.16666666662 2005.24999999996 2005.33333333329 2005.41666666662 2005.49999999995 2005.58333333329 2005.66666666662 2005.74999999995 2005.83333333329 2005.91666666662 2005.99999999995 2006.08333333329 2006.16666666662 2006.24999999995 2006.33333333329 2006.41666666662 2006.49999999995 2006.58333333329 2006.66666666662 2006.74999999995 2006.83333333329 2006.91666666662 2006.99999999995 2007.08333333329 2007.16666666662 2007.24999999995 2007.33333333329 2007.41666666662 2007.49999999995 2007.58333333329 2007.66666666662 2007.74999999995 2007.83333333329 2007.91666666662 2007.99999999995 2008.08333333329 2008.16666666662 2008.24999999995 2008.33333333329 2008.41666666662 2008.49999999995 2008.58333333329 2008.66666666662 2008.74999999995 2008.83333333329 2008.91666666662 2008.99999999995 2009.08333333329 2009.16666666662 2009.24999999995 2009.33333333328 2009.41666666662 2009.49999999995 2009.58333333328 2009.66666666662 2009.74999999995 2009.83333333328 2009.91666666662 2009.99999999995 2010.08333333328 2010.16666666662 2010.24999999995 2010.33333333328 2010.41666666662 2010.49999999995 2010.58333333328 2010.66666666662 2010.74999999995 2010.83333333328 2010.91666666662 2010.99999999995 2011.08333333328 2011.16666666662 2011.24999999995 2011.33333333328 2011.41666666662 2011.49999999995 2011.58333333328 2011.66666666662 2011.74999999995 2011.83333333328 2011.91666666662 2011.99999999995 2012.08333333328 2012.16666666662 2012.24999999995 2012.33333333328 2012.41666666662 2012.499999999 95 2012.58333333328 2012.66666666662 2012.74999999995 2012.83333333328 2012.91666666661 2012.99999999995 2013.08333333332 2013.16666666666 2013.25 2013.33333333334 2013.41666666668 2013.50000000002 2013.58333333336 2013.6666666667 2013.75000000004 2013.83333333338 2013.91666666672 2014.00000000006 2014.0833333334 2014.16666666674 2014.25000000008 2014.33333333342 2014.41666666676 2014.5000000001 2014.58333333344 2014.66666666678 2014.75000000012 2014.83333333346 2014.9166666668 37.313 37.297 37.487 37.418 37.399 37.467 37.429 37.421 37.57 37.506 37.724 37.8 37.757 37.726 37.745 37.859 37.708 37.784 37.851 37.766 37.819 37.785 37.722 37.843 37.782 37.883 38.076 38.17 38.365 38.558 38.519 38.646 38.507 38.542 38.628 38.713 38.756 38.895 38.896 39.009 39.089 39.062 39.137 39.23 39.155 39.108 39.039 39.07 39.155 39.043 39.019 39.042 39.103 39.11 39.2 39.275 39.415 39.499 39.604 39.561 39.66 39.758 39.724 39.711 39.718 39.865 39.881 40.119 40.266 40.503 40.658 40.758 40.903 40.91 41.088 41.295 41.424 41.512 41.627 41.74 41.728 41.945 42.112 42.282 42.386 42.583 42.781 42.952 43.185 43.303 43.615 43.691 43.908 44.027 44.252 44.721 44.74 44.823 45.123 45.28 45.484 45.806 45.921 46.21 46.52 46.678 46.906 47.039 47.211 47.514 47.692 47.867 47.988 48.238 48.464 48.71 48.925 49.36 49.576 49.944 50.127 50.392 50.599 50.924 51.128 51.229 51.585 51.526 51.785 51.811 51.992 52.188 52.465 52.759 53.261 53.248 53.489 53.803 54.061 54.274 54.679 55.03 55.27 55.543 55.837 56.096 56.487 56.69 56.898 57.339 57.612 58.024 58.319 58.707 59.098 59.428 59.751 59.953 60.017 60.03 60.484 60.649 60.498 61.004 61.126 61.362 61.865 62.029 62.218 62.405 62.53 63.059 63.458 63.724 64.074 64.539 65.164 65.466 65.743 66.215 66.652 67.259 67.657 67.938 68.574 68.972 69.533 69.89 70.388 70.488 70.889 71.023 71.548 72.325 72.529 72.951 73.345 73.903 74.291 74.847 75.154 75.935 76.45 77.044 77.932 78.261 79.095 79.638 79.957 80.382 81.463 81.581 82.017 82.657 82.956 83.477 84.282 85.016 85.389 86.46 87.077 87.645 88.329 88.66 89.357 89.947 90.584 91.442 91.047 92.024 92.522 92.725 92.701 94.533 94.297 94.71 95.224 95.332 96.17 96.743 96.296 97.394 98.253 98.848 99.362 99.995 100.099 100.935 101.347 101.812 102.678 102.95 103.827 104.246 105.145 105.912 106.376 106.999 108.215 108.949 109.444 110.383 110.98 112.061 112.896 114.053 114.495 115.321 116.465 117.484 118.336 118.7 119.661 120.706 121.34 121.816 122.568 122.828 123.489 124.248 124.787 125.714 126.749 127.707 128.679 129.984 130.386 131.347 132.113 133.086 134.115 134.248 134.692 135.718 136.828 138.195 139.363 140.501 141.763 141.483 140.88 142.389 143.278 144.653 145.223 145.37 146.519 147.104 147.54 147.647 148.72 150.002 150.825 151.882 152.092 153.415 154.545 155.472 156.2 157.422 158.832 160.469 161.788 163.019 163.623 165.966 167.892 169.626 171.143 172.337 173.782 175.233 176.357 178.345 179.565 180.178 182.203 182.993 184.717 186.015 187.117 188.185 189.155 189.457 190.575 190.615 192.062 192.726 193.789 194.955 196.346 197.045 198.914 200.987 202.507 204.311 206.303 207.45 208.18 211.081 210.474 211.126 213.741 215.304 217.379 219.483 221.32 223.441 224.95 226.622 229.329 232.33 233.828 236.149 235.28 237.849 241.161 240.355 241.027 243.026 243.743 247.094 247.581 248.728 250.899 251.462 251.793 256.234 256.663 258.629 261.196 261.709 262.919 264.159 265.708 266.117 267.336 265.972 268.271999999999 269.287 269.808 270.697 271.982999999999 271.913999999999 272.604 274.222 275.032 276.953 278.593999999999 279.376 281.84 285.183 286.237999999999 289.273 290.586 293.961 297.191 298.746 300.742 304.07 306.308 309.768 312.609 313.545 315.559 316.904 319.196 320.501 322.32 324.084 326.8 330.553 331.412 333.980999999999 337.468 340.151 343.243 344.452 347.575 351.806 356.183 359.975 363.722 365.544 368.084 371.288999999999 373.391 376.826 380.84 384.829 387.72 391.204 396.451 400.929 402.665 405.32 409.033 413.183 415.647 418.864 420.63 423.468 427.290999999999 428.248 430.035999999999 432.825 434.593999999999 434.788 437.432999999999 438.535999999999 442.55 445.737999999999 448.642 448.699 449.192 450.953 451.922 453.234 453.333 455.109 456.905 455.39 459.73 460.271999999999 462.093999999999 464.418 467.196 469.842 472.09 473.725999999999 475.518 479.042 480.873 483.285 485.066 488.015 489.756 490.994999999999 494.528 497.406 499.075 502.162 506.079 509.573 512.028 513.839 517.004 519.258 519.727999999999 522.705 523.199 526.6 531.330999999999 536.004 538.87 541.643 547.143 551.626 555.875 558.940999999999 565.079 567.567999999999 569.079 572.503 580.197 589.803 604.237 628.121 618.602999999999 602.285 600.018 601.789 604.232999999999 605.473 606.452999999999 605.650999999999 606.409 610.39 611.281 612.766 616.736 619.424999999999 622.211 625.428 630.351999999999 632.623 638.38 645.827999999999 671.482999999999 663.791 661.227 665.58 673.731 681.875 685.136999999999 688.997 692.751 697.001 700.996 702.800999999999 704.272 710.71 712.616 71 4.044 719.607999999999 728.909 732.451999999999 736.658 738.857999999999 739.911999999999 741.59 745.66 745.831999999999 753.928 754.984 752.953999999999 756.816999999999 763.239 764.399 768.073 770.181 775.415 780.955999999999 781.815999999999 786.286 792.21 793.875 787.955999999999 793.809999999999 800.419 800.906999999999 802.322999999999 800.431999999999 804.944999999999 806.598 808.057999999999 812.420999999999 816.724 817.467999999999 815.431999999999 825.165999999999 832.406999999999 834.04 835.320999999999 836.965999999999 836.885 834.993 834.639 83 4.22 837.891999999999 840.317999999999 837.701 843.491 847.251 848.166999999999 848.942999999999 849.593 851.146999999999 851.842999999999 853.389 851.444999999999 856.401999999999 857.424 847.360999999999 851.359999999999 857.096 860.651999999999 855.641999999999 860.669 863.88 871.63 872.291 936.485 1142.181 1480.767 1669.264 1730.163 1590.16 1668.485 1787.706 1799.221 1704.005 1693.74 1728.125 1819.743 1975.364 2044.667 2017.288 2010.088 2150.911 2106.512 2044.292 2034.486 2023.997 2015.197 2014.65 1981.159 1998.537 1991.144 2009.295 2057.137 2243.572 2428.216 2531.668 2590.336 2671.446 2703.445 2680.325 2656.502 2678.391 2622.98 2603.486 2647.505 2733.081 2684.203 2673.666 2634.893 2644.747 2669.164 2669.39 2616.238 2648.761 2665.101 2656.879 2748.98 2874.405 2973.347 3045.674 3139.116 3222.287 3310.26 3419.555 3508.965 3630.629 3702.083 3685.298 3733.498 3869.437 3925.669 3965.001 3932.332 3970.779 4008.88 4096.954 4072.022 4041.273 3847.937 3898.404 billions of dollars CASE STUDY: Quantitative Easing Quantitative easing: the Fed bought long-term govt bonds instead of T-bills to reduce long-term rates. The Fed also bought mortgage-backed securities to help the housing market. But after losses on bad loans, banks tightened lending standards and increased excess reserves, causing money multiplier to fall. If banks start lending more as economy recovers, rapid money growth may cause inflation. To prevent, the Fed is considering various “exit strategies.” CHAPTER 4 The Monetary System See Case Study on pp. 97-98. CASE STUDY: Bank failures in the 1930s From 1929 to 1933: over 9,000 banks closed money supply fell 28% This drop in the money supply may not have caused The Great Depression, but certainly contributed to its severity. CHAPTER 4 The Monetary System CASE STUDY: Bank failures in the 1930s Loss of confidence in banks: increases cr, reduces m Banks became more cautious: increases rr, reduces m where CHAPTER 4 The Monetary System CASE STUDY: Bank failures in the 1930s March 1933 % change 0.41 0.21 2.3 141.2 50.0 –37.8 0.17 cr 0.14 rr 3.7 m 2.9 5.5 8.4 –9.4 41.0 18.3 3.2 R 3.9 C 7.1 B 13.5 5.5 19.0 –40.3 41.0 –28.3% 22.6 D 3.9 C 26.5 M August 1929 CHAPTER 4 The Monetary System Table 4-2, p. 99. Source: Adapted from Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867-1960 (Princeton, NJ: Princeton University Press, 1963), Appendix A. I have added an extra column with the percent changes to the table. I have animated the table so that the rows appear in three groups. First group: M, C, and D, because M = C + D Second group: B, C, and R, because B = C + R Third group: m and its components, rr and cr The base rises, yet the money multiplier falls so much that the money supply falls. Could this happen again? Many policies have been implemented since the 1930s to prevent such widespread bank failures. E.g., Federal Deposit Insurance, to prevent bank runs and large swings in the currency-deposit ratio. CHAPTER 4 The Monetary System CHAPTER SUMMARY Money Definition: the stock of assets used for transactions Functions: medium of exchange, store of value, unit of account Types: commodity money (has intrinsic value), fiat money (no intrinsic value) Money supply controlled by central bank CHAPTER 4 The Monetary System CHAPTER SUMMARY Fractional reserve banking creates money because each dollar of reserves generates many dollars of demand deposits. The money supply depends on the: monetary base currency-deposit ratio reserve ratio The Fed can control the money supply with: open market operations the reserve requirement the discount rate interest on reserves CHAPTER 4 The Monetary System CHAPTER SUMMARY Bank capital, leverage, capital requirements Bank capital is the owners’ equity in the bank. Because banks are highly leveraged, a small decline in the value of bank assets can have a huge impact on bank capital. Bank regulators require that banks hold sufficient capital to ensure that depositors can be repaid. CHAPTER 4 The Monetary System U.S. Currency MCD =+ CD B B + =´ mB =´ CD CR + = + 1 cr crrr + = + CD m B + = ( ) ( ) ( ) ( ) CDDD CDRD + = + 1 cr m crrr + = + , MmB =´ /docProps/thumbnail.jpeg