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AU.S. dollar bill is actually a FederalReserve Note,issued by the Federal Reserve.
FederalReserve currency is legaltenderin the United States, which means the federal government requires that it beaccepted in payment of debts and requires that cash or checks denominated indollars be used in payment of taxes.
Households and firms have confidence thatif they accept paper dollars in exchange for goods and services, the dollarswill not lose much value during the time they hold them.
Thenarrowest definition of the money supply: The sum of currency in circulation,checking account deposits in banks, and holdings of traveler’s checks.
Reservesare not loaned out or invested.Vault cashis physically kept within the bank
Banksmake consumer loansto households and commercialloansto businesses.Aloan is an asset to a bank because it represents a promise by the person takingit out to make certain specified payments to the bank
Depositsinclude checking accounts, savings accounts, and certificates of deposit,andare liabilities to banks because they are owed to the households or firms thathave deposited the funds
Inthis case, the simple deposit multiplier is equal to $10,000/$1,000 = 10.
Thereare two ways to explain how we know your initial $1,000 deposit ultimatelyleads to a total increase in deposits of $10,000.
First,each bank in the process is keeping reserves equal to 10 percent of itsdeposits.Forthe banking system as a whole, the total increase in reserves is $1,000—theamount of your original currency deposit—so the system as a whole will end upwith $10,000 in deposits because $1,000 is 10 percent of $10,000
SimpleDepositMultiplier versus the Real-World Deposit Multiplier
The story we have told about theway an increase in reserves in the banking system leads to the creation of newdeposits and, therefore, an increase in the money supply, has been simplifiedin two ways.
First, we assumed that banks do notkeep any excess reserves.
Second, we assumed that the wholeamount of every check is deposited in a bank; no one takes any of it out ascurrency.
The effect of these two factors isto reduce the real-world deposit multiplier to about 2.5 during normal times.
We can summarize these importantconclusions:
1. Whenbanks gain reserves, they make new loans, and the money supply expands.
2. Whenbanks lose reserves, they reduce their loans, and the money supply contracts.
Abanking system in which banks keep less than 100 percent of deposits asreserves.
,like the Federal Reserve in the United States, can help stop a bank panic byacting as a lender of last resort.
Inacting as a lender of last resort, a central bank makes loans to banks thatcannot borrow funds elsewhere.
TheEstablishment of the Federal Reserve System
Withthe intention of putting an end to bank panics and their accompanyingrecessions, Congress passed the Federal Reserve Act in 1913, setting up theFederal Reserve System—often referred to as “the Fed.”
Loansthe Federal Reserve makes to banks.
TheFederal Reserve committee responsible for open market operations and managingthe money supply in the United States.Toincrease the money supply, the FOMC directs the tradingdesk,located at
the Federal Reserve Bank of New York, to buyU.S. Treasury securities from
Todecrease the money supply, the FOMC directs the trading desk to sellTreasury securities.
Byinitiating open market operations, the Fed completely controls their volume,thuscan make them both large or small and implement them quickly withoutadministrative delay or required changes in regulations
Theactions the Federal Reserve takes to manage the money supply and interest ratesto pursue macroeconomic policy objectives.
To manage the money supply, the Feduses three monetarypolicy tools:
1. Openmarket operations
Allthree of these monetary policy tools are aimed at affecting the reserves ofbanks as a means of changing the volume of checking account deposits
Bylowering the discount rate, the Fed can encourage banks to take more loans andthereby increase their reserves, giving them a stronger incentive to make moreloans to households and firms, which will increase checking account depositsand the money supply.Raisingthe discount rate will have the reverse effect
Whenthe Fed reduces the required reserve ratio,itconverts requiredreserves into excess reserves
Acurve that shows the relationship in the short run between the price level andthe quantity of real GDP supplied by firms.
Ahigher price level increases the interest rate and reduces investment spending,thereby reducing the quantity of goods and services demanded.
Ahigher price level in the United States relative to other countries causes netexports to fall, reducing the quantity of goods and services demanded.
Shiftsof the Aggregate Demand Curve versus Movements along It
Ifthe price level changes but other variables that affect the willingness ofhouseholds, firms, and the government to spend are unchanged, the economy willmove up or down a stationary aggregate demand curve.
Ifany variable other than the price level changes, the aggregate demand curvewill shift.
TheVariables That Shift the Aggregate Demand Curve
•Changesin government policies
Changes in Government Policies
Monetarypolicy The actions the Federal Reserve takes tomanage the money supply and interest rates to pursue macroeconomic policyobjectives.
Fiscalpolicy Changes in federal taxes and purchases thatare intended to achieve macroeconomic policy objectives.
Lowerinterest rates shift the aggregate demand curve to the right as consumption andinvestment spending increase, and higher interest rates shift the aggregatedemand curve to the left as consumption and investment spending decrease.
Anincrease in government purchases or a decrease in taxes shifts the aggregatedemand curve to the right, and a decrease in government purchases or anincrease in taxes shifts the aggregate demand curve to the left.
Ifhouseholds become more optimistic about their future incomes and firms becomemore optimistic about the future profitability of investment spending, theaggregate demand curve will shift to the right.
Conversely,if they become more pessimistic, the aggregate demand curve will shift to theleft.
Ifthe exchange ratebetween the dollar and foreign currencies rises, net exports will fall becausethe price in foreign currency of U.S. products sold in other countries willrise, and the dollar price of foreign products sold in the United States willfall.
Netexports will increase if the value of the dollar falls against othercurrencies.
Anincrease in net exports at every price level will shift the aggregate demandcurve to the right.
Achange in net exports that results from a change in the price level in theUnited States will result in a movement along the aggregate demand curve, not ashift of the aggregate demand curve.
Iffirms and households in other countries buy fewer U.S. goods or if firms andhouseholds in the United States buy more foreign goods, net exports will fall,and the aggregate demand curve will shift to the left.
Ifreal GDP in the United States increases faster than real GDP in othercountries, net exports will fall.Conversely,if it grows more slowly, net exports will rise
A lower price level raises the realvalue of householdwealth (whichincreases consumption), lowers interest rates (whichincreases investment and consumption), and makesU.S. exports less expensive and foreignimportsmore expensive(which increases net exports).
TheLong-Run Aggregate Supply Curve
TheShort-Run Aggregate Supply Curve
As prices of final goods and servicesrise, prices of inputs rise more slowly.
Thereason for this is that somefirms and workers fail to accurately predict changes in the price level.
Shiftsof the Short-Run Aggregate Supply Curve versus Movements along It
If the price level changes but other variables are unchanged, the economy will move up or down a stationary aggregate supply curve; if any variable other than the price level changes, the aggregate supply curve will shift.
1. Increases in the Labor Force and in the Capital Stock
2. Technological Change
3. Expected Changes in the Future Price Level
4. Adjustments of Workers and Firms to Errors in Past Expectations about the Price Level
5. Unexpected Changes in the Price of an Important Natural Resource
If workers and firms expect the pricelevel to increase by a certain percentage, the SRAS curve will shift by an equivalent amount,holding constant all other variables that affect the SRAScurve.
Unexpected Changes in the Price of anImportant Natural Resource
Supply shock An unexpected event that causes the short-run aggregate supply curve to shift.
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