Unit 4: Single Bank vs. Banking System

Unit 4: Single Bank vs. Banking System

When a customer deposits cash or withdrawals cash from their demand deposit account, it has no effect on money supply. It only changes: 

1. The composition of $
2. Excess reserves
3. Required reserves
4. Single Bank

• loan from your excess reserves. (ER)

Banking system 

• Money increases by the multiple in the change of ER. ER * multiplier.

FED

• When the FED buys or sells bonds, ER is created. # bought/sold * multiplier

Countercyclical Policies: Keynesian Fiscal Policy vs. Monetary Policy

In the early 21st century, here in the USA: 
An efficient, "full employment" economy will probably have: 

1. An annual unemployment rate of 4-5%.
2. An annual inflation rate of 2-3%.

If the economy goes into recession: 
3. The real GDP will decrease for at least 6 months.
4. The real unemployment rate will go to 6% or more.
5. The inflation rate will probably go to 2% or less.

If congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:
6. The policy will try to improve C, or G (parts of AD0 
7.Congress will out federal taxes.
8. Congress will increase job and spending programs.
9. The federal budget will probably create a deficit.
10. Due to changes in Money Demand, interest rates will increase.

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:
11. The policy will target improvements in IG (part of AD)
12. The Fed will target a lower federal fund rate.
13. The Fed can lower the discount rate.
14. The Fed can buy bonds (Open Market Operations).
15. The Fed can lower the reserve requirement, but probably wont because it is too complex for the banks. 
16. These Fed policies will lower the interest rates through changes in the Money Supply.
17. These options should increase Ig.


If the economy suffers from too much demand-pull inflation or cost-push inflation, then18. The unemployment rate will go to 4% or less.
19. The inflation rate will probably go to 4% or more.
If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then:
20. The policy will try to decrease C, or G (parts of AD)
21. Congress will increase federal taxes. 
22. Congress will decrease job and spending programs.
23. The federal budget will probably create a surplus.
24. Due to the changes in Money Demand, interest rates will decrease.

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:25. The policy will target decreases in IG (part of AD).
26. The Fed will target a higher federal fund rate.
27. The Fed can increase discount rate.
28. The Fed can sell bonds (Open Market Operations).
29. The Fed can raise the reserve requirement, but probably wont because it is too complex for the banks. 
30. These Fed policies will raise the interest rates through changes in Money Supply.
31. These options should decrease Ig.

The Components & Definitions

March 11, 2016

Liabilities: 

1. Cash Deposits from the public = DD
2. Owner's equity or stock shares = Values of the bank stocks as held by the public

Assets:

1. Required Reserves = The percentage of DD in the Vault = RR
2. Excess Reserves = The remaining % of DD, used for loans = ER
3. Property = Usually a statement of the bank's property values
4. Securities or Bonds = Previously purchased bonds held by the bank as investments.
5. Loans = Previously loaned funds now owed back to the bank.

Assets: 

1. Required Reserves
2. Excess Reserves
3. Property
4. Securities

Liabilities:

1. Demand Deposits
2. Owner's Equity

Remember: DD = RR + ER
Bonds can move two ways: 

1. The Fed sells to the banks and increases the amount.
2. The Fed buys from the banks and decreases the amount.

Banks and The Creation of Money

How do banks create money?

• By lending out deposits/money.

Where do the loans come from?

• From depositors who take cash and place it in accounts at the bank.

How are the amounts of potential loans calculated? 

• By using a T-account that consists of assets and liabilities.

Bank Liabilities (the right side of the T Account Sheet):

• #1 Demand Deposits (DD)/Checkable Deposits (CD); Theses are 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; The values of stocks held by the public ownership of bank shares.

Key concept for AP concerning Liabilities: 

• If the DD comes in from someone's cash holdings, then that DD is already part of the $ supply.
• If the DD comes in from the purchase of bonds (by the Fed) then it creates new cash and therefore creates new $ supply.

Bank Assets (the left side of the T Account Sheet):

• #1 Required Reserves (RR); The percentages of demand deposits that must be held in the vault so that some depositors have access to their money.
• It is usually anywhere from 5%, 10%, or 20%.
• #2 Excess Reserves (ER); Source for new loans
• #3 Property
• #4 Securities (Bonds); bonds that are purchased by the bank.
• #5 Loans; This can be amounts held by banks from previous transactions owed to the bank by prior costumers.

Money Creation (Using Excess Reserves)

• Banks want to create profit --> (lending)

The Monetary Multiplier (also known as):

• Loan Multiplier
• Reserve Multiplier
• Checkable Deposits Multiplier

The formula is simple: 1 divided by the reserve requirement (ratio)
Excess Reserves are multiplied by the multiplier 

• To create new loans for the entire banking system, and this creates new $ supply.

FISCAL POLICY (Recession)

• Congress will cut taxes or increase government spending.
• Consumption and government spending will increase.
• Aggregate demand will increase.
• GDP will increase, BUT a deficit occurs.
• Supply of loanable funds decreases.
• i increases
• IG decrease.

INTERNATIONAL TRADE 

• D$ increases
• Appreciate
• Exports Dec.
• Xn Dec.
• AD Dec.
• GDP Dec.

MONETARY POLICY (Recession)

The FED will:

1. Buy Bonds
2. Lower the Reserve Requirement
3. Lower the Discount Rate
4. Lower the Federal Fund Rate

Money supply increases
Interest will increase
Ig increases
AD increases GDP increases

INTERNATIONAL TRADE 

• D$ dec.
• Depreciate
• Exports inc.
• Xn inc.
• AD inc.
• GDP inc.

Unit 4: Crowding Out

What is it?

• A critique fall of Keynesian policies that are applied to fight a recession. (An expansionary policy)

Why does it happen?

• The policy of cutting taxes and raising spending will create a budget deficit.

So?

• The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)

This money comes from? 

• Mostly from US citizens and companies and investment firms.

Therefore?

• Money that could be spent on consumption or used for Private Savings is now being used to buy bonds.

On the Money Market?

• This will cause the $ demand curve to shift outward. Remember this is a Fiscal event!

On the Loanable Funds Market? 

• This will cause the supply curve to shift inward because we are not saving money privately anymore.

Also, on the Loanable Funds?

• This can cause the demand curve to shift outward because the private and public demand for $ increases.

On both graphs?

• The nominal and real interest rate will increase.

Therefore, on the investment D graph

• The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive ? 

• Yes

Why do it? 

• Fiscal Policy supporters (Keynesians) insist that gains in consumption (C) and spending (G) will outweigh any loss in the future IG.

Why?

• C and G are greater than IG and they are short run improvements. IG is longer run and Keynesians don't worry about that. In the long run we are all dead.

Anymore?

• Yes, this is summarized on the Aggregate Model. The AD will move outward due to the increases in C and G and the "maybe" move inward due to a loss ofIG, but not as much as the increase. Therefore the economy improves.

What is it?

• A critique fall of Keynesian policies that are applied to fight a recession. (An expansionary policy)

Why does it happen?

• The policy of cutting taxes and raising spending will create a budget deficit.

So?

• The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)

This money comes from? 

• Mostly from US citizens and companies and investment firms.

Therefore?

• Money that could be spent on consumption or used for Private Savings is now being used to buy bonds.

On the Money Market?

• This will cause the $ demand curve to shift outward. Remember this is a Fiscal event!

On the Loanable Funds Market? 

• This will cause the supply curve to shift inward because we are not saving money privately anymore.

Also, on the Loanable Funds?

• This can cause the demand curve to shift outward because the private and public demand for $ increases.

On both graphs?

• The nominal and real interest rate will increase.

Therefore, on the investment D graph

• The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive ? 

• Yes

Why do it? 

• Fiscal Policy supporters (Keynesians) insist that gains in consumption (C) and spending (G) will outweigh any loss in the future IG.

Why?

• C and G are greater than IG and they are short run improvements. IG is longer run and Keynesians don't worry about that. In the long run we are all dead.

Anymore?

• Yes, this is summarized on the Aggregate Model. The AD will move outward due to the increases in C and G and the "maybe" move inward due to a loss ofIG, but not as much as the increase. Therefore the economy improves.