Macroeconomics Exam 2
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Anything that serves as a medium of exchange
Medium of Exchange
Anything that is widely accepted as a means of payment`
Keynesian's belief for the functions of money
- Medium of exchange
- A unit of account
- A store of value
- Standard of deferred payment (visa)
- Liquidity (more "money like")
Occurs when goods are exchanged directly for other goods
Unit of Account
A consistent means of measuring the value of things
Store of value
An item which holds value over time
- Balances in checking accounts. A form of money that has no intrinsic value. They can be converted to currency, but typically just serve as a medium of exchange
- Examples: Demand deposits (typical non-interest bearing checking accounts) or other checkable deposits (checking accounts that are interest baring, but you must have total access to this account without penalty)
The total quantity of money in the economy at any one time
The 2 different ways Keynesian's look at money
- M1- only includes those things that are 100% liquid (holds value)
- M2- includes everything in M1 and things that are considered "near money"(things that aren't 100% liquid, but are pretty close)
Examples of M1
- Checkable Deposits
- Currency in Circulation
- Traveler's Checks
Currency in Circulation
- Money is considered "in circulation" when it leaves the "hands of the banking center"
- When the reserve prints money and it is in a vault then it is just considered currency.
- The Fed makes no attempt to control this because if people want more currency than the banks will notify the federal reserve. They are more interested in regulating checkable deposits.
Vault Cash (Till Money)
The dollars sitting on the other side of the teller's window
How can a $3 trillion money system supply an $18 trillion economy?
- Involves velocity of money
- Velocity represents how many times in a year a dollar turns over.
- M1 turns over about 6 times a year.
Examples of M2
- Money Market Deposit Accounts (MMDA)
- Savings accounts
- Small Time Deposit (CDs)
- Money Market Mutual Fund (MMMF)
Money Market Deposit Accounts (MMDA)
A checking account where you only have limited check writing privileges before penalty. Typically there is a minimum amount you must keep in the account for interest. This doesn't hold value because the more you use it, the more penalties you receive.
Why are savings accounts considered M2?
- Money is placed into these accounts and you receive some interest, but you can't actually take a savings account and pay for something.
- You have to transfer money into a checking account to use it
Small Time Deposits (CD)
- A deposit is considered small if it is under $100,000.
- Certificate of Deposits are M2 because the bank expects you to keep the money in the CD for the entire time frame. If you withdraw early, then there can be a penalty.
Money Market Mutual Fund (MMMF)
- A mutual fund that can only invest in money market instruments. They won't rise or fall very much since it is such a short investment and are considered very safe
- Mutual funds are where small savers can pool their money together so they can buy things that they can't individually.
Difference between Money Market Instruments and Capital Market Instruments
- Money Market instruments are those that have a maturity of 1 year or less. The biggest are treasury bills
- Capital Market instruments are financial instruments that have an original maturity of over a year such as stocks or treasury notes/bonds.
John Maynard Keynes
- Came up with Keynesian Economics because he didn't believe that classical economics holds true all the time.
- The hole is that "all money is invested" because if you hold onto your liquid money then you don't give it to a financial institution who would invest your savings.
Liquidity Preference theory
At a time like the great depression, people will want to hold onto their money because it is the only thing that is guaranteed. Just holding onto the money will give you a 4% interest automatically rather than the .5% the bank may give you.
As a Keynesian, should the government fundamentally shift the economy in a better direction?
- Yes they should. In the equation GDP= C+I+G+(X-M) we can fundamentally shift one of these components which will help the economy better than just waiting it out.
- The government has a necessary role in controlling our economy.
- They also want to promote spending because saving is a leakage.
- GDP= C+I+G+(X-M)
- GDP= C+S+T
- I,G, and X are injections and S, T, and M are leakages.
- I- investment spending
- X- exports
- M- imports
Which fiscal policies can the government directly control? (essay?)
- Government expenditures and the Taxation Policy
- In a Recessionary Gap (actual GDP < F.E.L), we would increase government spending and decrease taxes. Inevitably the size of the government's debt will go up.
- Keynesian says that it may take years to see the benefits, but the added economic growth of this will start paying for itself.
Two terms that apply specifically to disposable income
- Average Propensity to Consume
- Average Propensity to Save.
- When you add the two together you get 1 whole or 100%.
- We have a negative APS which means we spend more then we earn. Related to dissaving which is when you spend more than you earn and then dip into some money you put away.
Income Approach of GDP spending
- GDP= Ct+1+St+1+Tt+1Time lag between when production is occurring and when income is received.
- When you receive your pay check, taxes (t) are immediately taken out. (S)avings and (C)onsumption occur in the future
- Changes in GDP tend to cause further change in GDP due to an induced change in consumption.
- In GDP= C+S+T, divide everything by change in GDP so you get 1= MPC + MPS + MRT (marginal rate of taxes).
- We are most interested in MPC because one persons spending is another's income
Government expenditure multiplier
- Mg= 1/(1-MPC)
- A keynesian would say to tackle those with a high MPC because over time they will have a greater impact in GDP
Essay (in a recessionary gap)
- Keynesian says to cut government expenditures. For example, if the government cuts taxes then disposable income goes up and gross income remains the same. You would use the increase in income to consume more things.
- Changing taxes alone is less effective than reducing government expenditures because no additional income is made.
Paradox of thrift
- The dangers associated with saving
- Says that by attempting to save more, we save less. If we are in a recession and people start to become more cautious then we spend less causing business's to spend less and in turn the employment level and income will go down
Changes in consumption (c) tends to cause an induced change in investment expenditures (I) and percentage-wise the change in I exceeds the change in C.
Federal Reserve System
- The "banker's bank"
- Helps banks from closing by...
- Ensuring the smooth flow of cash
- Storing and making money available for banks
- Allows you to be confident in your bank
- Give banks an annual "check up" to make sure they are in "good health"
is when people literally run to the bank to pull our their cash because they heard it was going under.
- Places you can deposit money and take loans.
- Commercial Banks, Credit Unions, Savings and Loans Associations, Mutual Savings Banks
Only allowed certain groups deposit such as a Teacher's Credit unions, but today they just act like smaller commercial banks
Savings and Loans Associations
Historically they were financial institutions, but their job was to only deal with mortgages to encourage home ownership
Mutual Savings Banks
Means that your depositors are also small owners, whenever they deposit something, they become partial owners
Assets of Commercial banks
- Assets are where the commercial banks has a claim against someone else
- Loans are a primary asset
- Investments are another major asset
- We are most interested in the Total Reserve Account- this is the equivalent to a checking account at the Federal Reserve System. This means that the Reserve gives a small interest for some of the funds in the Total Reserve Account.
Liabilities of Commercial Banks
- Liabilities are claims that others have against banks.
- Checkable deposits. all of the accounts we have at their bank
Types of Reserves
- Currency Reserve (Vault Cash/Till Money)
- Reserve against a Deficit Clearing Balance
- Legal (required) Reserves
- If banks need more money then they will request some from the Federal Reserve.
- If they have an excess of money then they will ship it back.
Reserve Against a Deficit Clearing Balance
- The amount by which the claims of all other commercial banks against a given commercial banks exceeds the claims of that given Commercial Bank against all other Commercial Banks.
- A Deficit Clearing Balance is like a banks "bounced check."
- Example: Claims of Delaware County Bank agianst another bank of $500 million. Claims of Other Banks against D.C.B of $600 million. The Deficit is -$100
- Reserves a bank must have based on their liability position.
- Example: Assets- Total Reserve $125, Required Reserves $50, and Excess Reserves $75.
Potential Money Multiplier
- Mp= 1/(reserve required
- By manipulating the money reserve, they can manipulate the amount of money banks create.
Primary Tools available to the Fed
- Changing the Reserve Requirement. During inflation, too much money chasing too few goods is bad so we want excess reserves to go down.
- Changing the Discount Rate. The Federal Reserve is the Banker's Banks. The rate the Federal Reserve charges for those who want to borrow from it. Typically are overnight loans and are made so banks can meet their required reserve
- Open Market Operations. The Fed buys/sells treasury securities on secondary markets. When you re-trade stocks.
- ONLY FOR RECESSION- Quantitative Easing (QE) Deals with buying back long term treasury securities. This reduces long term interest rates.
Federal Funds Market
Where banks give overnight loans to other banks. The Federal Funds Rate is the rate that one bank charges another bank for a loan.
Secondary Tools available to the Fed
- Jawboning/Moral Suasion- Just talking; saying the right words knowing that financial institutions will react.
- Changing Margin Requirements- the margin requirement is set by the Federal Reserve System. It is basically the "down payment" on a stock from a Brokerage house. You only pay like 10% and the house would loan you the rest. If the stock falls then you have to pay more and more to make up the difference.
Inflationary Gap (Essay)
- Primary Tools:
- Increase Reserve Requirement- giving banks less money to loan
- Increase Discount Rate- the only way this changes anything is if you deal with a bank that is borrowing from the Fed.
- Sell U.S treasury securities, so they don't inject more money into the economy.
- Secondary Tools:
- Talk up interest rates without actually making it happen
- Increase the margin requirement that way if you buy a margin account you have to have more money up front.
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