FRQ Video Assignment

April 3, 2017

Loanable Funds Market

The Loanable Funds Market

• An interest rate of 50%
• BAD for BORROWERS
• GOOD for SELLERS
• The loanable funds market is the private sector supply and demand of loans 
• Brings together those that want to lend money (savers) and those who want to borrow (firms with investment spending projects) 

Shows the Effect on Real Interest Rate

• Demand: Inverse relationship between real interest rate and quantity loans demanded
• Supply: Direct relationship between real interest rate and quantity loans supplied
• NOT the same as the money market
• Supply is not vertical 

Prime Rate

• The interest rate that banks charge their most credit worth customers 

March 31, 2017

3 Tools of Monetary Policy 

3 Tools of Monetary Policy

1. Reserve Requirement
2. Open Market Operations (OMO)
3. Discount Rate

Reserve Requirement

• The FED sets the amount that banks must hold
• Bank deposits when someone (public or private) deposits money in the bank
• Banks keep some of the money in reserves and loans out their excess reserves
• The loan eventually becomes despots for another bank that will loan out their excess reserves
• The reserve requirement (reserve ratio) is the percent of deposits that the bank cannot loan out
• If there is a recession, the bank should:
• Decrease RR
• Banks hold less money and have more excess reserves
• Banks create more money by loaning out excess
• Money supply increases, Interest Rates Fall, Aggregate Demand Increases
• If there is an inflation, the bank should
• Increase RR
• Banks hold more money and have less ER
• Banks create less money
• Money Supply decreases, Interest Rates increase, Aggregate Demand decreases

Open Market Operations

• When the FED buys or sells government bonds (securities) 
• Most important/widely used monetary policy
• If the FED buys bonds ---> takes bonds out of economy and replaces them with money 

If the bank buys bonds, the money supply increases

If the bank sells bonds, the money supply decreases

• Effect is enhanced by multiplier, but if banks don't loan it out or people store it, it becomes effective.

The Discount Rate

• The interest rate that the FED charges commercial banks for short term loans

The Federal Fund Rate

• The interest rate that banks charge one another for overnight loans

March 24, 2017

Money Creation Formula

• A single bank can create $ by the amount of its excess reserves
• The banking system as a whole can create $ by a multiple of the excess reserves

*MM x ER = Expansion of Money

*Money Multiplier = 1/RR

New vs. Existing $

• If the initial deposit in a bank comes from the Fed, or bank purchase of a bond or other money out of circulation (buried treasure), the deposit immediately increases money supply
• The deposit then leads to further expansion of the money supply through the money creation process

*Total change in MS if initial deposit is new $ = Deposit + $ created by banking system

• If a deposit in a bank is existing $ (already counted in M1; ex: currency or checks), depositing the amount does not change the MS immediately because it is already counted.
• Existing currency deposited into checking account changes only the composition of the money supply from coins/paper $ to checking account deposits

*Total Change in the MS if deposit is existing $ = Banking System Created Money Only 

March 23, 2017

• Demand Deposits
• Created through the Fractional Reserve System
• Fractional Reserve System
• The process in which banks hold a small portion of their deposits in reserves and they loan out the excess.
• Required Reserves
• Cash that banks keep on hand
• Total Reserves (TR) or Actual Reserves (AR)

*Required Reserves (RR) + Excess Reserves (ER)

March 22, 2017

The Money Market

• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded (vise versa):
• When interest rates rise, the quantity demanded of money falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.
• When interest rates fall, quantity demanded increases. No incentive to convert cash into interest earning assets.

Money Demand Shifters

1. Change in the Price Level
2. Change in Income
3. Change in Taxation that affects investment

March 22, 2017

Stocks and Bonds

Stocks:

• You Own 

Bonds: Loans, or IOU's, that represent debt that the government or a corporation must repay to an investor

• You Loan
• Bond holder has no ownership of the company
• If a corporation issues and then sells a bond:
• Liability for corporation
• Asset for the buyer
• If that corporation issues a 10k bond with a 10 year term and a 5% interest:
• Nominal Interest Rate @ time of issue: 5%
• Nominal Interest Rate falls to 3% bond increases
• Nominal Interest Rate rises to 8% bond decreases

Stockowners can earn a profit in 2 ways:

• Dividends: Portions of a corporation's profits; paid out to stockholders 
• Higher corporate profit, the higher the dividend
• Capital Gain: Earned when a stockholder sells stock for more than he or she paid for it.
• A stockholder that sells stock at a lower price then the purchase price suffers capital loss. 

Federal Reserve System:

• "The FED" or "Central Bank"
• Stabilize the economy and maximum employment