Unit IV - Creation of money

• How do banks "create" money?
• By lending out deposits.
• 
• Where do the loans come from? 
• Depositors who take cash and place it in their banks.
• How are the amounts of potential loans calculated?
• By using the balance sheet or T account which consists of liabilities and assets.
• Bank Liabilities (right side of T Account)
1. Demand Deposits (DD) or Checkable Deposits (CD)
• Cash deposits from the public.
• They are a liability because they belong to the depositors and can be withdrawn by the depositors.
2. Owner's Equity
• Values of stock held by the public ownership of bank shares.
• Bank Assets (left side of T Account)
1. The required reserves (RR): A % of DD that must be held in the vault so that some depositors may have access to their money.
2. ER (Excess Reserves): Source of new loans
• DD = RR + ER
3. Property: Bank's holdings
4. Securities (Bonds): Purchased by the bank or new bonds sold to the bank by the Federal Reserve. 
• These bonds can be purchased from the bank turned into cash that immediately becomes available as excess reserves. 
5. Loans: Money creation using excess reserves.
• Key Concept for AP concerning Liabilities
• If the DD comes in from someone's cash holdings, then that DD is already part of the money supply. 
• If the DD comes in from the purchase of bonds (by the FED), then this creates new cash and therefore creates new money supply. 
• Monetary Multiplier: 1 / RR 
• The Monetary Multiplier is multiplied by Excess Reserves to get the change in money supply.

Unit IV - Monetary Policy

1. Reserve Requirement
• Only small % of your bank is safe.
• ER is loaned out - "Fractional Reserve Banking"
• FED sets the ER. 
• When FED increases MS, it increases the amount of money held in bank deposits. 
• Decrease RR
• Banks have less money and more ER.
• Banks create more money by loaning out excess reserves.
• Money supply increases, interest rate decreases, and AD increases.
• Increase RR
• Banks hold more money and less ER.
• Banks create less money.
• Money supply decreases, interest rate increases, and AD decreases. 
2. Discount Rate
• Interest rate that the FED charges commercial banks.
• To increase money supply, FED should lower discount rate (Easy Money policy)
• To decrease money supply, FED should increase discount rate (Tight Money policy)
• 
3. Open Market Operations
• The FED buys/sells government bonds (securities).
• To increase MS, FED should buy government securities.
• To decrease MS, FED should decrease government securities.

• Expansionary (Easy Money)
• OMO: Buy bonds
• Discount Rate: Decrease
• Reserve Requirement: Decrease
• Loans decrease, AD increases, GDP increases, MS increases, and interest rate decreases.
• Contractionary (Tight Money)
• OMO: Sell bonds
• Discount Rate: Increase
• Reserve Requirement: Increase
• Loans decrease, AD decreases, GDP decreases, MS decreases, and interest rate increases.
• Federal Fund Rate: Where FDIC member banks loan each other overnight funds.
• Prime Rate: Interest rate that banks give to their most credit-worthy customers. 

Unit IV - Time Value

• 
• Is a dollar today worth more than a dollar tomorrow?
• Yes
• Why? Opportunity cost and inflation
• This is the reason for charging and paying interest.
• Simple Interest Formula
• V = ((1 + r) ^ n) * p 
• V = future value of $
• P = present value of $
• r = real interest rate (nominal - inflation) expressed as a decimal
• n = year
• k = # of times interest is credited per year.
• Compound Interest Formula: V = (1 + r/k)^ nk
• When interest rates increase, the quantity demanded of money decrease.
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded. 

• Money Demand Shifters
1. Change in price level
2. Change in income
3. Changes in taxation that affect investment
• Increase money > decreases interest rate > increases investment > increases AD 

• Financial Assets vs. Financial Liabilities
• Asset: Something you own.
• Liability: Something you owe.

• Stocks vs. Bonds
• Stocks: A share of a company you buy.
• Bonds: Lend money to government so they pay you back with interest. 

• Bank: A financial intermediary
• Uses liquid assets (i.e. bank deposits)
• Process is known as Fractional Reserve Banking.
• A system in which depository institutions hold liquid assets less than the amount of deposits. 
• Can take the form of:
• Currency in bank vaults
• Bank Reserves: deposits held at the federal reserve. 
• T-Account (Balance Sheet)
• Statement of assets and liabilities. 

• Reserve Requirement: FED requires bank to always have some money readily available to met consumers' demand for cash.
• Ratio: Amount set by the FED.
• % of DD that must not be loaned out.
• Typically is 10%.
• 3 Types of Multiple Deposit Expansion
• Type 1: Calculate initial change in excess reserves.
• Type 2: Calculate change in loans in banking.
• Type 3: Calculate change in the money supply.
• Sometimes type 2 and type 3 will have the same result. 

Unit IV - Money

• Uses of Money
• Medium of Exchange: barter and trade
• Unit of Account
• Establishes economic value
• Store of Value: Money holds its value over a period of time
• Types of Money
•  Commodity money: gets value from type of material from which it is made
• Gold and Silver Coin
• Representative money: paper money backed by something tangible, giving it value
• Fiat money: money because the government says so.

• Characteristics of money
• Divisible
• Can be broken down
• Portable
• Uniform
• Scarce
• Durable

• Money Supply
• M1 Money - 75% of all money and most liquid (easy to convert)
• Currency (cash and coins) 
• Checkable Deposists (Demand deposits) - not as liquid as TC
• Travelers Check - worth 20$ - very liquid
•  M2 Money - not as liquid as M1 Money
• M1 money
• Savings Account
• Deposits held by banks outside of US
• M3 Money
• M2 money
• Certificate of Deposits (CD's)

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