Money, Monetary Policy, and Fiscal Policy

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Money, Monetary Policy, and Fiscal Policy

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Who Am I?

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Who Am I?

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Who Am I?

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Who Am I?

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Who Am I?

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Money Money Anything that is generally accepted as final payment for goods and services Money is NOT the same as wealth or income Wealth is the total collection of assets that store value Income is a flow of earnings per unit of time

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MoneyThe Barter System: goods and services are traded directly. There is no money exchanged. Problems: Before trade could occur, each trader had to have something the other wanted. Some goods cannot be split. If 1 goat is worth five chickens, how do you exchange if you only want 1 chicken?

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MoneyExample: A heart surgeon might accept only certain goods but not others because he doesn’t like broccoli. To get the surgery, a pineapple grower must find a broccoli farmer that likes pineapples.

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MoneyMoney serves these three purposes Medium of exchange It can be used to purchase goods and services Unit of Account It can be used to compare the value of different goods and services Store of Value It can be held to buy something in the future

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Money SupplyMeasuring the Money Supply M1 (high liquidity) Currency, Checking, travelers checks M2 (moderate liquidity) M1 plus: Savings and investment funds (money market, mutual funds, ATM accessed savings) that allow investors to make easy transfers and withdrawals M3 (Low liquidity) M2 plus: Time deposits over $100,000 (CDs, etc.)

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MoneyWhat is the difference between credit cards and debit cards? Are credit cards money? A credit card is NOT money. It is a short-term loan (usually with a higher than normal interest rate). Ex: You buy a shirt with a credit card, VISA pays the store, you pay VISA the price of the shirt plus interest and fees.

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MoneyEx: You buy a shirt with a credit card, VISA pays the store, you pay VISA the price of the shirt plus interest and fees. Total credit cards in circulation in U.S: 576.4 million Average number of credit cards per cardholders: 3.5 Average credit card debt per household : $15,788

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MoneyCommodity money Gold, silver, copper, etc. Representative money The gold standard, there must be gold backing all of the money in an economy Fiat money Fiat money is not worth anything by itself, it is only worth something because the government says so and we agree.

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Money SupplyThere is no gold standard. Money is just an I.O.U. from the government “for all debts, public and private.” What makes money effective? Generally Accepted - Buyers and sellers have confidence that it IS legal tender. Scarce - Money must not be easily reproduced. Portable and Dividable - Money must be easily transported and divided.

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Monetary PolicyThe Federal Reserve System Created in 1914 in response the many previous bank failures The Fed Board of Governors 7 members appointed by the Pres. And confirmed by the Senate 12 regional Fed Reserve Banks

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Monetary policyThe Tools of Monetary Policy Changes in the Discount Rate When the fed lowers the discount rate, banks are encouraged to make more loans and the money supply increases When the fed raises the discount rate, banks are encouraged to make fewer loans and the money supply decreases

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Monetary policyThe Tools of Monetary Policy 2. Open Market Operations When the Fed buys or sells U.S. securities to influence the money supply Fed buys, bank deposits increase, banks have more money to lend, and the money supply increases Fed sells, bank deposits decrease, banks have less money to lend, and the money supply decreases

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Monetary policyThe Tools of Monetary Policy 3. Changes in the reserve requirement The reserve requirement is the minimum percentage that banks must keep to back up checking-type accounts Lowering the reserve requirement will increase money supply Raising the reserve requirement will decrease money supply

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Monetary PolicyExample: Assume the reserve ratio in the US is 10% You deposit $1000 in the bank The bank must hold $100 (required reserves) The bank lends $900 out to Bob (excess reserves) Bob deposits the $900 in his bank Bob’s bank must hold $90. It loans out $810 to Jill Jill deposits $810 in her bank SO FAR, the initial deposit of $1000 caused the CREATION of another $1710 (Bob’s $900 + Jill’s $810) Money Multiplier = 1/Reserve Ratio A reserve ratio of 10% has a money multiplier of 10 A $2 billion increase to money supply will actually increase the money supply by 20 billion

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Monetary Policy The Feds other responsibilities: The Fed works as a clearing house for all checks The Fed is also known as the lender of last resort In cases of emergency the Fed will come to the aid of ailing banks The Fed also performs stress tests on member banks.

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Fiscal PolicyFiscal Policy Changes in federal government spending of tax revenues designed to promote full employment, price stability, and reasonable rates of economic growth

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Fiscal PolicyExpansionary Fiscal Policy Increase in government spending and / or a decrease in taxes designed to increase aggregate demand in the economy. The intent is to increase GDP and decrease unemployment

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Fiscal PolicyContractionary Fiscal Policy A decrease in gov. spending and / or an increase in taxes designed to decrease aggregate demand in the economy. The intent is to control inflation

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Fiscal PolicyKeynesian approach Demand-side economics Focuses on changing aggregate demand in order to promote full employment Keynes argued that government stimulus could jolt the economy out of a severe recession or depression

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Fiscal PolicySupply-Side Fiscal Policy The idea that fiscal policy might directly affect aggregate supply. For example, a corporate tax cut may give businesses incentive to expand or invest in capital goods with the money saved.

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Last Updated: 8th March 2018

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