The loanable funds market (3/23)

•The market where savers and borrowers exchange funds (QLF) at the real rate of interest (r%)

•The demand for loanable funds, or borrowing comes from households, firms, government and the foreign factor. The demand for loanable funds is in fact the supply of bonds. 

•The supply of loanable funds, or saving comes from households, firms, government and the foreign sector. The supply of loanable funds is also the demand for bonds. 

Change in demand for loanable fun

ds

•demand for loanable funds = borrowing (ie supplying bonds) 

•more borrowing = more demand for loanable funds (->)

•less borrowing = less demand for loanable funds (<-) 

Examples

•government deficit spending = more borrowing = more demand for loanable funds 

•less investment demand = less borrowing = less demand for loanable funds 

Changes in supply of loanable funds 

• supply of loanable funds = Saving (ie demand for bonds) 

• more saving = more supply of loanable funds (->) 

•less saving = less supply of loanable funds (<-) 

Examples 

• government budget surplus = more saving = more supply of loanable funds 

• decrease in consumers' MPS = less saving = less supply of loanable funds 

•When government does fiscal policy, it will affect the loanable funds market 

•changes in the real interest rate (r%) will affect gross private investment. 

(3/6) Creating a bank 

Transaction #2 

•Vault cash: cash held by the bank 

Transaction #3

•Commercial bank functions 

-accepting deposits 

-making loans 

Transaction #4 

•Depositing reserves in a federal reserve bank 

- required reserves

- reserve ratio 

Reserve ratio= commercial banks required reserves / commercial banks Checkable -deposit liabilities 

Excess reserves 

• actual reserves - required reserves 

•required reserves 

- checkable deposits x reserve ratio 

3/5)  The three types of multiple deposit expansion question 

Type 1: calculate the initial chance is excess reserves

-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 (ie. No fed involvement)

Type 4: calculate the change in demand deposits.  

Time value of money (3/4)

Is a dollar today worth more than a dollar tomorrow? 

Yes.

Why? 

Inflation and opportunity cost. 

This is the reason for charging and paying interest. 

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.

The simple interest formula 

• v= (1+r) ^n •p

The compound interest formula 

• v= (1+r/k)^nk•p

Monetary equation of exchange 

•MV=PQ

-M= money supply (M1 or M2) 

-V= money's velocity (M1 or M2) 

-P= price level (PL on the AS/AD diagram) 

-Q= real GDP (sometimes labeled Y on the AS/AD diagram) 

Functions of the FED 

•it issues paper currency 

•sets reserve requirement and holds reserves of banks 

•it lends money to banks and charged them to interest

•they are check clearing service for banks

•it acts as personal bank for the government 

•supervises member banks 

•controls the money supply in the economy 

Banks and the creation of money

How do banks "create" money?

By lending out deposits that are used multiple times. 

Where do the loans come from? 

From depositors who take cash and place it in their banks.

How are the amounts of potential loans calculated?

Using their bank balance sheet, or T-accounts that consist of assets and liabilities for banks.

Bank liabilities (he right side of the T account sheet)

#1 = demand deposits (DD) or checkable deposits

- cash deposits from the public

- they are liabilities because they belong to depositors 

#2 =owners equity (stock shares) 

-they are values of stocks held by the public ownership of bank shares. 

Key concept for AP concerning liabilities 

-if demand deposits come from someone's cash holdings, then the DD is already part of money supply.

- if the demand deposit comes from the purchase of bonds (by FED) then this creates new cash and therefore creates new money supply (M1)

Bank assets (left side of T account sheet) 

#1) required reserves (RR) 

- these are the percentages of demand deposits that must be held in the vault so that some depositors have access to their money. 

#2) excess reserves (ER) 

- these are the source of new loans. These amounts are applied to the monetary multiplier / reserve multiplier (DD=RR plus ER) 

#3) bank property holdings (buildings and fixtures) 

#4) securities (federal bonds) 

- these are 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) customer loans

-these can be amounts held by banks from precious transactions, owed to the bank by prior customers.

Money creation 

• banks want to create profit. They generate profit by lending the excess reserves and collecting interest. Since each loan will go out into customer's and business' accounts, more loans are created in decreasing amounts (because of reserve requirement) 

A rough estimate of the number of loan amounts created by any first loan is the "money multiplier" 

• The money multiplier - a.k.a Checkable Deposits Multiplier, Reserve multiplier, Loan multiplier 

Formula: 1 / the reserve requirement (ratio)

   - RR = 10% = 1/.1 = Monetary multiplier of 10

• Excess reserves are multiplied by the multiplier to create new loans for the entire banking system and this creates new Money Supply  

Unit 4 - Monetary Policy videos

Part 1

The money market is defined as having three types of money. Commodity money is a currency standing for one thing. Representative money can be explained by things such as gold and silver, which represents a commodity. The third is Fiat money, which is the type that our country now runs by. This is money not backed by metal, and must be accepted through transactions. 

The three functions of money are that it is a medium of exchange, a store of value, and a unit of account. 

Part 2 

The money market is represented as a money market graph, which we can show that if we increase demand, we raise interest rates. So, if we raise demand, we increase the pressure on interest rates. Supply is set by the fed, so when the demand increased, the quantity in money does not. If the money supply shifts to the right, the interest rates are stable. 

Part 3

The Fed's tools of monetary policy are expressed in this segment video through contractionary and expansionary policy. Expansionary can be expressed as easy money, and in this, the RR is decreased as well as the discount rate. They also choose to buy bonds to increase there money supply. This is the opposite in contractionary policy, which is also known as tight money, because the RR increases as well as the discount rate. They choose to sell bonds to decrease this money supply.

RR can be defined as the percentage of a bank's total deposits that must be kept as vault cash or on reserve with the Federal branch. Lowered RR becomes excess reserves.

The discount rate is the rate at which banks borrow money from the Fed.

Part 4

The Loanable Funds Market can be defined as the money available in banks for people to borrow.

The Supply loanable funds comes from the amount of money that people have in banks. They are dependent on savings. So, the more money people save, the more money people will have to make loans. 

In a deficit, the government demands money to spend.

2 ways to demonstrate a change in Loanable Funds 

1) Increase in demand of loanable funds.

2) Decrease supply 

Part 5

The money creation process is defined by how banks create money by making loans. If a banks holds excess reserves, it reduces total money supply. The potential total increase is defined by the Initial Loan x Money Multiplier. 

Part 6

In the money market graph, we can see that the Money supply is controlled by the fed, therefore it is at a set amount. In loanable funds, the equilibrium rate and quantity stay the same. If there is deficit spending, the Money market has the government borrowing money from the people. There is an increase in demand as well as Interest rates. The Fisher Effect is represented, as it is the increase in interest rate, and it must have the same increase in price level. 

Money    (3/3)

3 uses 

1) as a medium of exchange. Using it to determine value. 

2) unit of account. Using it to compare prices. 

3) as store of value. Where you put your money.

3 types

1) Commodity - it has value within itself

      •salt 

      •olive oil

      •gold 

2) Representative- represents something of value.

Ex) IOU 

3) Fiat- it is money because the government says so. Consists of paper currency and coins. 

Currency is money buy not all money is currency. 

6 characteristics

1) Durability- how long it lasts 

2) Portability- you can put it anywhere on your body and take it anywhere.

3) Divisibility - a dollar can be broken down

4) Uniformity- money is the same anywhere you go 

5) Limited supply 

6) Acceptability 

Money supply

The total value of financial assets available in the US economy.

M1 Money

Involves 

•liquid assets - easily converted to cash 

    - coins 

    - currency 

    - checkable deposits or demand        deposits 

    - traveler's checks 

M2 Money

Includes

• M1 money 

• savings account

• money market account 

3 purposes of financial institutions 

1) to store money

2) to save money

3) loan money  

    • for credit cards 

    • for mortgages 

4 ways to save

1) through savings account 

2) through checking account 

3) through market money account 

4) through a certificate of deposit (CD)

Loans

Banks operate on a fractional reserve system. They keep a fraction of the funds and they loan out the rest. 

Interest rates

• principal

The amount of money borrowed

• interest 

   

   - simple interest - paid on the principle 

I=P•R•T / 100

T= I•100 / P•R

P= I•100 / R•T

R= I•100 / P•T

P= Principle

I= Simple interest 

R= Interest rate 

T= Time 

   - compound interest - paid on the principle plus the accumulated interest 

Types of financial institutions 

1) commercial bank 

2) savings and loans institutions 

3) mutual savings banks 

4) credit unions 

5) finance companies 

Investment

Redirecting resources. Consume now for the future. 

Financial assets 

•claims on property and income of borrower 

Financial intermediary 

• institution that channel funds from savers to borrowers 

3 purposes 

1) to share risk 

    -Diversification - spreading out investments to reduce risk. 

2) to provide information 

3) liquidity 

    - returns 

    - the money an investor receives above and beyond the sum of money that was initially invested. 

The higher the risk, the higher the return. 

Bonds you loan

Stocks you own 

Bonds 

Are loans or IOUs that represent debt, that the government or a corporation must repay to an investor. Generally low risk investments

3 components 

1) coupon rate - the interest rate that a bond issuer will pay to a bond holder 

2) maturity - the time at which payment to a bond holder is due. 

3)  par value - the amount that an investor pays to purchase a bond. 

Yield 

The annual rate of return on a bond if the bond were held to maturity. 

  

Unit 3

Aggregate(TOTAL) Demand (AD)

•Shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase price level

Aggregate Demand  (2/11)

•The relationship between the price level and the level of REAL GDP is inverse 

-Three reasons AD is downward sloping

•Real Balances Effect

- When the price level is high households and businesses cannot afford to purchase as much output 

- When the price level is low households and businesses can afford to purchase more output

• Interest Rate Effect 

- A higher price level increases the interest rate which tends to discourage investment 

- A lower price level decreases the interest rate which tends to encourage investment 

•Foreign Purchase Effect

- A higher price level increases the demand for relatively cheaper imports

- A Lower price level increases il the foreign demand for relatively cheaper US exports 

•Shifts in Aggregate Demand

• There are two parts to a shift in AD

- a change in C, Ig, G, and/or Xn (expenditure approach to GDP)

- a multiplier effect that produces a greater change than the original change in the 4 components

•increases in AD= AD➡️

•decreases in AD=⬅️

Consumption 

•Household spending is affected by:

 - consumer wealth 

       •more wealth= more spending(AD shift➡️)

       •less wealth= less spending(AD⬅️)

-Consumer expectations 

     •positive expectations=more spending(AD➡️)

      Negative expectations=less spending(AD⬅️)

-Household indebtedness 

   •less debt=more spending(AD➡️)

   •more debt= less spending(AD⬅️) 

-Taxes

     •less taxes=more spending(AD➡️)

      •more Taxes=less spending⬅️

GROSS DOMESTIC Private investment 

•investment spending is sensitive to

    -the Real Interest Rate 

      •lower real interest rate= more investment 

       •higher real interest= less investment 

-Expected Returns

  •higher expected returns: more investment 

  •lower expected returns: less investment 

  • expected returns are influenced by:

       -expectations of future profitability 

       -technology 

       -degree of excess capacity (existing stock of capital) 

Government Spending 

 - more government spending shift right 

 -less government spending AD shift left

•net exports

   •net exports are sensitive to:

       -Exchange Rates(international value of $)

          •strong $= more imports and fewer exports= AD ⬅️

          •weak $= fewer imports and more exports= (AD➡️)

         -Relative Income

            •Strong Foreign Economies= More exports AD➡️

             •Weak foreign economies= less exports AD(⬅️)