Monetary Policy Video Summaries

Video 1:
This video discusses the three different types of money. The first and most basic is commodity money which can be defined as the use of goods and services that have a similar function as money.
The second, which is not in use anymore, is representative money that is used to represent a precious metal such as gold or silver. A draw back of this type of money is that when the value of the metal changes, it affects the value of the actual currency. The third type, and the one we use today, is fiat money. Fiat money is not backed by a precious metal but simply by the word of the government that it has value. Then there are also three functions of money. The first is as a medium of exchange meaning that it is through money that exchange happens. The second is store of value which is when you put money away it is expected to still have the same value when you take it back. Inflation is a disincentive of saving. The third is unit of account meaning that the price of an object implies something of its worth and quality.

Video 2:
To create a money market graph we must first label our axis. The vertical axis, as in most graphs, is price but in this case the price paid to borrow money so it will be labeled as the interest rate. The horizontal axis is quantity of money. Then we have the demand for money which slopes downward because when interest rate is high, demand for money is going to be low and vice versa; it is an inverse relationship. The only difference of the money market graph is that the supply of money is vertical because it does not vary based on interest rate, it is fixed by the FED. So to bring the interest rate down, the FED can increase money supply.

Video 3:
There are three FED tools of monetary policy which include required reserve, discount rate, and the buying and selling of bonds. The required reserve is the percentage of the banks total deposits which they must keep either as vault cash or reserve with a FED branch. The discount rate is the rate at which banks can borrow money from the FED, however, this is not guaranteed to be effective because it is only an incentive. The third tool is the buying and selling of bonds which is used the most often. During an expansionary or recession period (easy money), the required reserve will be decreased so that it becomes excess money to make more loans, the discount rate will be lowered and the FED will buy bonds to increase money supply. During a contractionary or inflation period (tight money), the required reserve and the discount rate will be raised, and the FED will sell bonds to lower the money supply. The federal funds rate is the rate at which banks borrow money from each other.

Video 4:
Loanable funds is the money available in the banking system for people to borrow. In this video we learn how to make a loanable funds graph which has interest rates in the vertical axis and quantity of loanable funds in the horizontal axis. Demand for loanable funds is downward slopping and supply of loanable funds, which comes from the amount of money people have in banks, is upward slopping. In this market, more money saved equals more money for loans so savings are a positive affect. During a government deficit, they will demand money to spend it causing a shift of the demand on a money market graph to the right (increase) and the interest rate will go up. Since the change in one graph affects the other, in the loanable funds graph, the demand for loanable funds will also increase causing the interest rate to raise. Another way to show an increase in interest rates is by decreasing the supply of loanable funds and in return increasing the interest rate.

Video 5:
Another important concept is the money creating process which involves the money multiplier, one over the required ratio, and multiple deposit expansion. Banks create money by making loans which they make from the excess reserves, so if someone deposited $500 in a bank with a required ratio of 20%, that bank will be able to loan out $400. The $400 will then be deposited at another bank which can loan out $320 dollars and so on; this is the process of multiple deposit expansion. If we add up all potential loans we come up with $2500 that were created from the initial $500 deposit. This number can be derived by multiplying the loanable amount times the money multiplier. However, this amount is not guaranteed because it is only an assumption that each bank will loan out all of their excess reserves.

Video 6:
There is a connection between the money market, loanable funds, and AD - AS graphs. An example of this can be seen by  graphing the changes that occur during a government deficit. In the money market, the demand for money will increase so it is moved to the right and the money supply stays the same. This will cause either an increase in demand of loanable funds or a decrease in supply of loanable funds so that the interest rate is equal to that in the money market. The AD - AS graph will also have an increase in aggregate demand causing an increase in both price level and GDP. With the equation of exchange, MV = PQ, we can also see how a change in money supply means a change in price just like the graphs show. The Fisher effect says that interest rate and price level are equivalent so if there is a 1% increase in the interest rate it will yield a 1% increase of inflation.