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AGEC 105 (15)
Lecture 16

AGEC 105 Lecture 16: Ag Econ - Lecture 16

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Texas A&M University
Agricultural Economics
AGEC 105
Ariun Ishdorj

Macroeconomic Policy Fundamentals Topics of Discussion 1) Characteristics of Money 2) Federal Reserve System 3) Changing the Money Supply 4) Money Market Equilibrium 5) Effects of Monetary Policy on the Economy 6) The Federal Budget Deficit 7) The National Debt 8) Fiscal Policy Options Functions of Money • Medium of Exchange o Facilitates payment to others for good and services • Unit of Accounting o Assembling profitability of businesses, household budgets, and aggregate variables like GDP • Store of Value o Money is a liquid asset which has value in investment portfolios and cash flow decisions of businesses and households Functions of the Fed 1. Supply the economy with paper currency 2. Supervise member banks 3. Provide check collection and clearing services 4. Maintain the reserve balances of depository institutions 5. Lend to depository institutions 6. Act as a federal governments baker and fiscal agent 7. Regulate the money supply The Fed’s Policy Tools • Reserve requirements o Depository institutions are required to maintain a specific fraction of their customers’ deposits as reserves • Discount rate o Rate depository institutions pay when they borrow from the Feds • Open Market operation o Fed can buy or sell government securities to alter the money supply • Quantitative easing or QE o Fed can also buy or sell mortgage backed securities if needed Determinants of the Money Supply • Existing money supply curve o It is perpendicular to the quantity axis, implying it is unaffected by the interest rate • Expansionary monetary policy actions o Will shift the MS curve to the right over a period of 12 months of so • Contractionary monetary policy actions o On the other hand, will shift the money supply curve to left over a similar time period Change in Money Supply • We can skip tracing deposits through the economy by using the following money supply (M S equation o M = S1.0 / RR) x TR = MM x TR ▪ where TR represents total reserves and RR is the reserve requirement ratio ▪ the expression with the brackets is known as the money multiplier ▪ we can restate this equation in terms of the change in the money supply as follows: • M =S(1.0 / RR) x TR = MM x TR Impacts of Policy Tools • Expansionary actions o Fed buys securities o Fed lowers the discount rate o Fed lowers required reserve ratio • Effects in action o Total reserves increase o Total reserves increase o Money multiplier increases • Contractionary actions o Fed sells securities o Fed raises the discount rate o Red raises required reserve ratio • Effects of action o Total reserves decrease o Total reserves decrease o Money multiplier decreases What is QE? • Quantitative easing or QE refers to Federal Reserve actions to buy government bonds and mortgage-back securities • Primary aim is to add liquidity in the banking system • Secondary aim is lower long term interest rates to stimulate investment in the economy, including the housing sector • Several applications o QE1, QE2, QE3 Determinants of the Money Demand • The money demand curve is gi
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