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MONEY AND INTEREST

3.13.1 The Money Supply3.23.2 Money Creation and Circulation3.33.3 Interest and Interest Rates

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Lesson 3.1

THE MONEY SUPPLY

Define money supply, and explain how it is measuredDescribe two types of money, and explain the fractional-reserve system

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WHAT IS THE MONEY SUPPLY?WHAT IS THE MONEY SUPPLY?WHAT IS THE MONEY SUPPLY?WHAT IS THE MONEY SUPPLY?

The money supply is defined as the liquid assets held by banks and individuals.

The flow of money—and the amount of it flowing—has a direct effect on how the economy performs.

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MEASURING THE MONEYMEASURING THE MONEYMEASURING THE MONEYMEASURING THE MONEY

Liquidity is a measure of how quickly things may be converted to something of value like cash.

Liquidity is variable, depending on the nature of the asset or liability.

Change in your pocket A certificate of deposit that matures next JuneYour savings account

Less LiquidLess LiquidMore LiquidMore Liquid

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AGGREGATE MEASURES OF THE MONEY SUPPLYAGGREGATE MEASURES OF THE MONEY SUPPLYAGGREGATE MEASURES OF THE MONEY SUPPLYAGGREGATE MEASURES OF THE MONEY SUPPLY

M1M1 Money that can be spent immediatelyM2M2 All the money in M1 plus short-term investmentsM3M3 All the money in M1 and M2 plus large depositsMZMMZM Money at zero maturity

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NATURE OF MONEYNATURE OF MONEYNATURE OF MONEYNATURE OF MONEY

Two types of moneyCommodity money is based on some item of value,

for example, gold or precious stones.Fiat money is money that is deemed legal tender by

the government, and it is not based on or convertible into a commodity.

The fractional-reserve system

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Lesson 3.2

MONEY CREATION AND CIRCULATION

Describe how money is created by bank activitiesExplain how money circulates in the United States

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HOW MONEY IS CREATEDHOW MONEY IS CREATEDHOW MONEY IS CREATEDHOW MONEY IS CREATED

Printing currency and creating money are two different things.

Money is actually created by the interaction of the demand for it, banks’ use of it, and the Federal Reserve’s supply and control of it.

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DEPOSITS AND RESERVESDEPOSITS AND RESERVESDEPOSITS AND RESERVESDEPOSITS AND RESERVES

Primary reservesSecondary reserves

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THE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECT

Money on deposit, minus the reserve requirement, can be loaned to customers.

When it is, it creates new deposits, which also go out to customers as loans and create more deposits, thus expanding the amount of money in the system.

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HOW MONEY CIRCULATESHOW MONEY CIRCULATESHOW MONEY CIRCULATESHOW MONEY CIRCULATES

Transfers and circulation The Fed and fiat moneyMoney as an IOU

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Lesson 3.3

INTEREST AND INTEREST RATES

List factors that affect interest ratesExplain which factors the Federal Reserve affects

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INTEREST RATES AND BUSINESSINTEREST RATES AND BUSINESSINTEREST RATES AND BUSINESSINTEREST RATES AND BUSINESS

The money supply and the economy are linked closely to interest rates.

Generally, when rates are high, money is said to be “tight” and business tends to slow because it costs more to acquire capital.

When rates drop, more credit is accessible, and the economy tends to gather speed.

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FACTORS AFFECTING INTEREST RATESFACTORS AFFECTING INTEREST RATESFACTORS AFFECTING INTEREST RATESFACTORS AFFECTING INTEREST RATES

The federal funds rate is the amount of interest charged for short-term, interbank loans.

The discount rate is the interest rate that the Federal Reserve sets and charges for loans to member banks.

The prime rate is the rate that banks charge their best and most reliable customers.

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MONETARY POLICY AND INTEREST RATESMONETARY POLICY AND INTEREST RATESMONETARY POLICY AND INTEREST RATESMONETARY POLICY AND INTEREST RATES

The Federal Reserve sets the discount rate.The Federal Reserve only influences the federal

funds rate.