Monetary Policy/ omo's

Monetary Policy

• Open Market Operations (OMO): When the Fed buys or sells bonds. 
• Discount Rate: FDIC member banks and other eligible institution may borrow short term loans from the Fed (bank borrow from the Fed)
• Federal Funds Rate: FDIC member banks loan each other overnight funds. (banks borrow from other banks)
• Reserve Requirement: The required amount a bank must keep on hand by law
• In a recession
• Open Market Operations: The Fed buys bonds (Increase Reserve)
• Discount Rate: Decrease
• Reserve Requirement: Decrease
• Federal Funds Rate: Decrease
• Money Supply: Increase
• In an inflation

• Open Market Operations: The Fed sells bonds (Decrease Reserve)
• Discount Rate: Increase
• Reserve Requirement: Increase
• Federal Fund Rate: Increase
• Money Supply: Decrease

The loanable funds market

Loanable Funds Market

• The market savers and borrowers exchange funds (QLF) at the real rate of interest (r%)
• Demand for loanable funds or borrowing comes from households, firms, government, and foreign sector
• Demand for the loanable fund is in fact supply of bonds
• Supply of loanable fund or saving comes from the household, firms, government, and foreign sector
• Supply of loanable fund is also demand for bonds

Changes in Demand for Loanable Funds

• Demand for loanable fund = borrowing (i.e. supplying bonds)
• More borrowing = more demand for the loanable fund (shift to the right)
• Less borrowing = less demand for the loanable fund (shift to the left)
• Examples:
• Government deficit spending = more borrowing = more demand for loanable fund = DLF shift to the right = real interest rate (r%) increase
• Less investment = less borrowing = less demand for loanable fund = DLF shift to the left = real interest rate (r%) decrease 

Changes in Supply of Loanable Funds

• Supply of loanable funds = saving (i.e. demand for bonds)
• More saving = more supply of loanable fund (shift to the right)
• Less saving = less supply of loanable fund (Shift to the left)
• Examples:
• Government budget surplus = more saving = more supply of loanable fund = SLF shift to the right = r% decrease
• A decrease in consumers' MPS = less saving = less supply of loanable fund = SLF shift to the left = r% increase

The money market

Money Market

• A market where Fed and users of money interact this determining the nominal interest rate (i%)
• Money demand (AD) comes from households, firms, government and the foreign sector
• Money supply (MS) is determined only by the Federal Reserve

Money Demand

• Transaction Demand: Demand for money as a medium of exchange (independent of the interest rate)
• Asset Demand: Demand for money as a store of value (dependent on the interest rate)
• Total Money Demand: MD is downward sloping because, at high-interest rates, people are less inclined to hold money and more inclined to hold stocks and bonds
• At lower interest rates, people sacrifice less when they hold money

Money Supply

• Determined by Federal Reserve because the Fed has monopoly control over the supply of money

Money

Types of Multiple Deposit Expansion Question

Type 1: Calculate the initial change in ER

-aka. the amount a single bank can loan from the initial deposit

Type 2: Calculate the change in loans in the banking system

Type 3: Calculate the change in the money supply

-Sometimes Type 2 and Type 3 will have the same result (i.e. no Fed involvement)

Type 4: Calculate the change in DD

Functions of the FED

1. It issues paper currency
2. Sets RR and holds reserves of banks
3. It lends money to banks and charges them interest
4. They are a check clearing service for banks
5. It acts as a personal bank for the government
6. Supervises member banks
7. Controls the money supply in the economy

Uses of Money

1. Medium of Exchange
• Serves to trade one product to another
2. Unit of Account
• Establishes economic growth
3. Store of Value
• Money holds it's valued over a period, whereas products may not

Types of Money

1. Representative Money
• Paper money is backed by something tangible that gives its value.
• Example: IOU
2. Commodity Money
• Gets its a value from the type of material from which it's made
• Example: Gold, silver
3. Fiat Money
• Money because the government says so

Characteristics of Money

1. Durability
2. Portability
3. Divisibility
4. Acceptability
5. Uniformity
6. Scarcity
7. Limited supply

Money Supply

• M1
• Currency(coins of cash)
• Checkable Deposits -> Demand Deposits -> Checking accounts
• Traveler's checks

Liquidity- easily to convert to cash

• M2
• Consists of M1 money +
• Savings accounts +
• Money market accounts

-Not as liquid

-Saving

• M3
• M2 + Certificates of deposit

Time Value of Money

v = future value of $

p = present value of $

r = real interest rate (nominal rate - inflation rate) expressed as a decimal

n = years

k = number of times interest is credited per year Simple Interest Formula: v = (1+r)^n * p

The Compound Interest Formula: v = (1+r/k)^nk *p

Balance/Business Sheet

-Summarizes the financial position of the bank at a certain time

-The value of assets must equal liabilities.

Assets (Left side)

• Required Reserves (RR)
• Excess Reserves (ER)
• Bonds
• Loans
• Property

Liabilities (Right side)

• Demand Deposits
• Owner's Equity
• Net worth

Owner's Equity- 

Based on how much you invested into stock

Net Worth- What you've earned

Money Creation

-Putting new money into circulation

2 Ways

1. When the Fed buys bonds from the public or from a financial institution (OMO, Open Market Operation)
2. When the banks make loans to the public

-The money supply is increased when banks make loans.

-The more loans banks make, the more money there is in circulation.

-A bank can loan any amount that is in excess of its required reserves.

-The banking system can create loans in multiples of an original loan

-Reserves of total reserves are the number of deposits that a bank has accepted but not loaned out.

-Required Reserves- are the amount a bank must keep on hand by law

-The RRR(Required Reserve Ratio) determines this amount

-Banks make money off interest.

Balance of payment Unit 7

Balance of Payments

• The measure of money inflows and outflows between the US and the rest of the world (ROW)
• Inflows are credits
• Outflows are debits
• Balance of Payments is divided into 3 accounts 
• Current account
• Capital / financial Account
• Balance of Payments
• The measure of money inflows and outflows between the US and the rest of the world (ROW)
• Inflows are credits
• Outflows are debits
• Balance of Payments is divided into 3 accounts 
• Current account
• Capital / financial Account
• Official Reserves Account
Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of goods/services - imports of goods/services
• Exports create a credit to the balance of payment
• Imports create a debit to the balance of payment

• Net Foreign Income
• (Income earned by U.S. owned foreign assets) - (Income paid to foreign U.S. assets)
• Example: Interest payments on U.S. owned Brazillian bonds - Interest payment on German-owned U.S. treasury bonds
• New Transfers (tend to be unilateral)
• Foreign Aid is a debit to the current account
• Example: Mexican migrant workers send money to family in Mexico
• Relationship Between Current and Capital Account
• Zero each other out
• The current account has a negative balance (deficit) then capital account have a positive balance (surplus)
• Official Reserves
• Foreign currency holdings of the US Federal Reserve System
• When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments
• When there is a balance of payments deficit, the Fed depletes its reserve of foreign currency and credits the balance of payments
• The Official Reserves zero out the balance of payment