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Unit Three: Banking and Monetary Policy

Unit Three: Banking and Monetary Policy. Topic: Money. Learning Targets. I can define money and list the characteristics of money. I can describe the purpose of a monetary standard, and what the current monetary standard is in the U.S.

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Unit Three: Banking and Monetary Policy

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  1. Unit Three: Banking and Monetary Policy Topic: Money

  2. Learning Targets • I can define money and list the characteristics of money. • I can describe the purpose of a monetary standard, and what the current monetary standard is in the U.S. • I will be able to describe how a change in one of the factors of money supply or money demand will affect the nominal interest rate. • I will calculate the time value of money.

  3. Money • Def: anything that can be used as a medium of exchange, measure of value, and store of value. • Medium of exchange • Measure of value • Store of value

  4. Characteristics of Modern Money • Portable • Durable • Divisible • Stable

  5. Monetary Standards • Def: mechanism which maintains the characteristics of the money supply; the “reliability” standard. • Current monetary standard in the U.S.: inconvertible fiat money standard.

  6. The Money Market • Def: where nominal interest rates (the “price” of money) are determined based on the supply and demand of money.

  7. Money Supply • The supply of money is determined by the Federal Reserve. • M1 = currency and checkable deposits (money that is readily accessible) • M2 = M1 + savings + small time deposits + money market mutual funds • M3 = M2 + large time deposits • M1 is the supply of money used in the money market we are studying.

  8. Money Demand • The demand for money is determined by liquidity (money that is moveable), interest rates and price level (determine if money is used for consumption or saving) . • Transaction demand: depends on GDPn. • Asset demand: refers to money as a store of value.

  9. The Money Market Money i (nominal interest rate) Q of money

  10. Value of Money • P is the price of goods and service measured in terms of money; 1/P is the value of money measured in terms of goods and services. • What happens to the value of money when there is an increase in P? • What determines the value of money?

  11. Time Value of Money • Compounding – you earn interest on deposited money, and then you earn interest on the interest!

  12. Time Value of Money • Present value of money – the amount of money needed today (using current interest rates) to produce a given amount of money in the future. • Equation: PV = A / (1+r)n • Future value of money – the amount of money in the future that an amount of money (using current interest rates) will equal. • Equation: FV = A (1+r)n • where A is the principal investment, r is the interest rate and n is the number of years.

  13. Examples • You want to receive $200 more in 10 years. The interest rate is 5%. How much do you need to put in now? • Answer: PV = A / (1+r)n, therefore, $200 = A / (1+.05)10 = $325. • If you put $100 in a bank today at an interest rate of 5%, how much will it be worth in ten years? • Answer: FV = A (1+r)n, therefore, FV = 100 (1+.05)10 = $163.

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