Paper Micro

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Study Guide for Module 5 (Ch. 13) HW Set and Test

Just a few items of note for this module:

M1 consists of currency, checkable deposits, and traveler’s checks. These are the most liquid forms of money. M2 consists of all of M1 as well as money market deposits and money market mutual funds, , and savings deposits.

If small time deposits are redeemed for cash, M1 will increase but M2 will remain the same because M2 includes all of M1.

Assume M1 consists of $200 cash and $500 checkable deposits. Also assume that M2 in addition to M1 includes money market deposits of $1,000 and small time deposits of $3,000:

M1 M2

Cash $200 $200

Checkable Deposits $500 $500

Money Market Deposits $1,000

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Small Time Deposits $3,000

Totals $700 $4,700

Now, assume that the small time deposits are converted to cash. M1 will increase to $3,700 ($700+$3,000). M2 will stay the same because all of M1 is still included in M2:

M1 M2

Cash $200 $200

Checkable Deposits $500 $500

Money Market Deposits $1,000

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Small Time Deposits $3,000 $3,000

Totals $3,700 $4,700

The Fed may use the banking reserve requirement to increase or decrease the money supply (as noted in the lecture). This is facilitated by the money multiplier which is 1÷reserve % requirement.

When the reserve requirement is decreased, banks have more to lend (and collect interest upon) as well as invest (such as real estate or the stock market).

When the reserve requirement is increased the exact opposite of the above holds true.

Assume two different situations:

Situation 1 Situation 2

Reserve Requirement 20% 5%

Multiplier (1÷20% and 1÷5%) 5 20

Amount Deposited Into the Bank $10,000 $10,000

Potential Growth $50,000 $200,000

Notice as the reserve requirement decreases, the...