Review Day 2 Tuesday May 3 rd Unit4

Review Day #2: Tuesday May 3 rd Unit-4 Macro Review Money, Money Supply, Bank Accounting, & Fiscal and Monetary Policy

Fed vs. Government • The Federal Reserve creates money – By buying bonds in open market operations – Too much money can lead to inflation • The Government creates debt – By borrowing money for deficit spending – Too much debt can lead to crowding out Money Market = Fed Loanable Funds = Gov’t

Money Market Use for Gov’t Debt questions Illustrates Fed’s Monetary Policy Model of Saver & Borrowers MS is is fixed by Fed Supply = National Savings MD = Desire to “hold money” Demand = Investment (I) (borrowers Fed buys/sell bonds to shift MS => this changes short term interest rates (federal funds rate) for capital goods => leads to innovation Crowding Out: Gov’t borrows too much => real interest rates rise = Business Investment falls (I ↓) MD rarely shifts [transaction demand)

2 Types of Monetary Policy Expansionary Contractionary Policy Nominal Interest Rate Currently 1. 0% Currently 0. 25% target => Sell Bonds, ↑ discount rate & ↑ reserve requirement MS 2 MS 1 Affects AD ---------P 2 ------- P 1 MD Qty of $ Y* MS ↓ => ↑ interest rate => C↓ & I ↓ => AD ↓ SRAS 1 E 1 ------- i 2 -----i 1 -------- LRAS 1 Price Level Y 1 AD 2 Real GDP AD 1

MONEY Types of Money Commodity money Fiat money (Std. of value) Measuring Money Supply M 1 - most liquid M 2 - slightly less liquid M 3 = least liquid (cash, checking deposits, travelers checks, etc…) (M 1 + savings acct. , money markets, …) (M 2 + large time deposits (over $100, 000) )

Fractional Reserve Banking System Banks Create Money by lending 1 st Bank Balance Sheet Example: – $100 Deposit – 10% Reserve Ratio This loan causes money creation. Excess Reserves can be lent out by bank

Money Multiplier = 1/R Reserve Requirement = 10% Money Multiplier = 1/10% Money Supply Change = Money Multiplier X 1 st Loan 10 * $90 = $900 increase Money Supply = 10

Quantity Theory of Money Monetarists economists believe that money is neutral! That is changes in Money Supply (MS) have no affect on real GDP in long run Qty Theory of Money Equation Velocity of money is relatively constant Real GDP is fixed in short run ↑ MS only will ↑Price Level

Review • Practice Questions • Practice Free Response 1 D 14 A 2 B 15 D 3 D 16 D 4 E 17 A 5 D 18 D 6 B 19 B 7 C 20 E 8 B 9 D 10 D 11 A 12 C 13 E