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Econ201 Lecture notes.docx

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University of Maryland
ECON 201
Naveen Sarna

Chapter 16 Money multiplier- amount of money the banking system generates w/ each dollar of reserves - The money multiplier equals 1/R - In example: R=10% and money multiplier=1/R=10 - $100 of reserves creates $1000 of money Ex. While cleaning apartment, find $50 and deposit bill to checking account - What’s max amount that money supply could increase = $200 Reserve requirement is 20% Bank hold no excess reserves money multiplier 1/R= 1/.2= 5 Max possible inc in deposits is 5x50= 250 but money supply also includes currency which falls by $50 So max inc is $200 - What’s min amount that money supply could increase =$0 if bank make no loans from deposits, currency falls by $50 and deposits inc by $50, money supply remains unchanged Bank not lending out money so money multiplier won’t work The Fed’s 3 Tools of Monetary Control 1. Open Market Operations (OMOs)- the purchase and sale of US gov bonds by the Fed - Federal Reserve vs Government- both want to take economy forward (output of jobs and price stability) o But both completely separate and Federal Reserve not controlled by gov o FR- controlling money supply, cannot produce money, but can buy gov paper from the market o Gov gets revenue from taxes and spending money on gov purchases - To inc money supply- Feds buy govt bonds, paying w/ new dollars o Which are deposited in banks, inc reserves o Which banks use to make loans causing money supply to expand - To reduce money supply, fed sells govt bonds, taking dollars out of circulation and process works in reverse 2. Reserve Requirements (RR)- affect how much money banks can create by making loans - to inc money supply- Fed reduces RR, banks make more loans from each dollar of reserves which inc money multiplier and MS - to reduce money supply- Fed raises RR, and process works in reverse Fed rarely uses RR to control MS, frequent changes would disrupt banking 10/24/13 Chapter 17 Price of Money: value of money in terms of ability to buy g/s (1/price) - Value of money dec when price inc - Price of 1 dollar in terms of candy if candy= $2  $1= .5 candy - Graph: y- axis= value of money, x- axis= quantity of money o Vertical line (monoey supply curve) if inc shift right- away from origin, stays vertical Money demand- whether keep money in wallet or the bank - More in pocket= higher money demand (money used for transaction purposes) Ex. Price of groceries inc, want more money in pocket or bank? - Pocket bc need more money to buy more groceries now - Higher price= higher money demad o BUT higher Price= lower value of money (so need more money in pocket) o Higher value= lower money demand (inverse relationship) - Graph: on same graph o Equilibrium value of money Ex. If Fed raises money supply (M^s), effect on value of money? - Supply curve/ straight line shifts right and value of money dec (at equilibrium) - As money value goes down, prices [inc M^s = dec money value= higher P] Velocity of Money- rate at which money changes hands P*Y= nominal GDP = (price level) x (real GDP) M= money supply V= velocity Velocity: V= (P*Y)/ M Ex. Pizza in 2008 Y= real GDP= 3000 pizzas P= price level= price of pizza= $10 P*Y= nominal GDP= value of pizzas= $30,000 M= money supply= $10,000 V= velocity= 30000/10000/3 The average dollar was used in 3 transactions Ex. Economy has enough labor capital and land to produce Y=800 bushels of corn - Rest on PPT Velocity is fairly stable over time Quantity Equation: money supply*velocity= price*real GDP Multiply both sides of velocity formula by M M*V= P*Y 1. V is stable 2. so change in M causes nominal GDP (P*Y) to change by same % 3. a change in M does not affect Y - money is neutral and Y determined by technology and resources Inc M*V=incP*Y (V and Y are constant) 4. so P changes by same % as P*Y and M 5. rapid money supply growth causes rapid inflation Fed reserve has ability to control inflation Over long run, inflation and money growth rates move together, as quantity theory predicts Seigniorage (seen-your-idge)- The “revenue” raised from printing money - to spend more w/o raising tatxes or selling bonds, the gov can print money - printing money to raise revenue causes inflation, inflation is like a tax on people who hold money inflation and interest rates - nominal interest rate (i) not adjusted for inflation - The Fisher Effect: i= r + π o Relationship btwn nominal interest and inflation rate o Nominal goes up 10% then inflation goes up 10% - S=I determines r R= no change, predetermined by supply/ demand for funds (determined by intersection of savings and investment) Π= money demand/ money supply determines inflation ) inc in π causes an equal increase in i - Nominal interest governed by fisher effect Real vs Nominal Variable- - Nominal variables measured in monetary units ($) o Nominal interest rate (rate of return measured in $) and nominal wage ($ per hour worked), taxes, common spending - Real variables measured in physical units o Real GDP, # of goods/ workers/ houses, etc. Prices are normally measured in terms of money - Relative price- price of one good relative to (divided by) another o Relative price of CDS in terms of pizza o Price of cd/ price of pizza= ($15/cd)/($10/pizza)= 1.5 pizzas per cd - Relative prices measured in physical units, so they are REAL variables Classical Dichotomy- theoretical separation of nominal and real variables - no overlap, any change in one variable will not change the other variable (change in nominal can only change other nominal, not real variable) - If central bank doubles the money supply: o All nominal variables (including prices) will double o All real variables (including relative prices) will remain unchanged o If change nominal variable- can change inflation rate (b/c change prices) and nominal interest rate Monetary neutrality- proposition that changes in the money supply do not affect real variables - Doubling money supply causes all nomial prices to double, relative prices o Price of cd= 15/10= 1.5 pizzas per cd, BUT after nominal prices double = ($30/cd)/($20/pizza)= 1.5 pizzas per cd NO CHANGE in relative price Second Exam: Nov 12 (Nov 7= Mock exam, Nov 14= exam answer review) Chapter 13, 16 and 17 (monetary policies), 18 and 19, 20 Lecture 10/29 Different Kinds of Saving Private saving= household’s income not used for consumption or paying taxes Y-T-C Public saving tax revenue minus government spending T-G Natonal saving= private saving + public saving Portion of national income not used for consumption? or paying taxes Y-C-G Na
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