Unit 4: Money 3/9/16

The future value of money through interest can be determined through two formulas depending on the way the interest is calculated.

v = future value of money     r = real interest rate    n  = inflation rate     p = present value or principal
n = # of years        k  =   interest credited per year (# of times interest is given per year, etc.)

The yearly interest rate formula  that is not compounded is       v = ((1 + r) ^ n ) * 9

The compounded interest rate formula is                                    v = ((1 + r/k) ^n * k) * 9


Demand for money and its effects on AD

The demand for money has an inverse relationship with nominal interest rates and the quantity of money demanded

As the quantity of money demanded goes down, interest rates go up.
As the quantity of money demanded goes up, interest rates go down

The demand of money shifts with changes in taxes, income and price level, or anything that changes investment prospects.

The supply of money affects AD

As money supply goes up, Interest rates goes down, which increases Investment and increases AD
As money supply goes down, Interest rates goes up, which decreases Investment and decreases AD

Financial Sector

Assets are what people and institutions own, and liabilities are what they owe. If a person took a loan out, the loan would be an assets to the bank and a liability to the person.

Banks are financial intermediaries that use liquid assets and sell services to run as a business.

Most  banks today use a fractional reserve system, where banks are required to hold a fraction of their reserves. the rest the banks are able to loan out to people.

Banks and the Creation of Money

Banks create money by lending deposits that people place in banks. Potential loans are measured by T-charts or a balance sheet.
On the banks liabilities side of the T chart are Demand Deposits and Owner's Equity.
On the banks assets side of the T chart are Required reserves and Excess Reserves, Property, Securities and bonds, and Loans.

Reserve Requirement

The Fed requires banks to always have some money readily available to meet consumers’ demand for cash.

The amount , set by the Fed, is the Required Reserve Ratio or RRR.

The Required Reserve Ratio is the % of demand deposits that cannot be loaned out

To find out the amount of money that is created by loans in the entire banking system use the formula:
Amount of Money Created = ER * 1/RRR

ER * 1/RRR is also known as the money multiplier.

The money is created by this multiplier through Multiple Deposit Expansion where one person takes their loan and places it in another bank and that bank loans his deposit out, and so on and so on

Usually, the money created is less than what is calculated because sometimes banks can hold excess reserves instead of loaning it out or people might not deposit their loan