Review Notes

- what is money?

- commodity money

- fiat money

- characteristics of "good" money

- durability

- divisibility

- homogeneity

- portability

- stability of supply

- scarcity

- uses of money?

- medium of exchange

- store of value

- measure of value (unit of account)

- standard of deferred payment

- measures of money

- M₁ = currency + Demand Deposits (what are those?)

- M₂ = M₁ + small time deposits (what are those?)

- M₃ = M₂ + large time deposits + institutional money market funds

- L = M₃ + other liquid assets

- difference = liquidity with money being more liquid as more narrowly defined.

- fractional reserve banking

- reserve ratio (rr) = the percent of Demand Deposits (DD) not loaned out.

- assume that:

- all banks have the same reserve ratio (rr)

- no banks hold excess reserves (reserves in excess of that implied by rr)

- there are no cash drains from the system

- how much money is created by an increase of $ 1,000 in DD?

- the potential money multiplier = m_p

- for every dollar in additional deposits, how much could the money supply increase?

- m_p = 1/rr (why? remember that rr = reserve ratio)

- if RR = total (planned) reserves, then rr*(DD) = RR

- the actual money multiplier = m_a

- for every dollar in additional deposits, how much does the money supply increase?

- why do banks hold Excess Reserves?

- xr = the excess reserve ratio = the proportion of demand deposits that banks do not loan out in excess of the reserve ratio (rr).

- m_a = 1/(rr + xr) (why?)

- what is the monetary base (MB)?

- currency plus reserves

- Hence, m_a = MS/MB

- MS = money supply = M1

- or MS = m_a*MB

- Multibank expansion of the money supply