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Real Money Balances Example Worksheet

. The demand for money. A model of real money balances and interest rates. A model of real money balances, interest rates and exchange rates. Long run effects of changes in money on prices, interest rates and exchange rates. Nominal cash balances are money of the current purchasing power of a unit of money (say, a rupee). Real cash balances are money of some base-year purchasing power. A nominal rupee is nominally always a rupee. But its purchasing power in terms of real goods and services can vary from time to time with changes in the general price level. Trust money is money received or held for or on behalf of another person in relation to a real. Estate transaction, business sales transaction or property management transaction. Moneys collected by an agent for or on behalf of a strata company are also deemed to be moneys collected by the agent in respect of a real estate transaction. Jul 26, 2021 This means that – in terms of real value – money sitting in a savings account is losing somewhere between 1.5% and 2.5% a year! In order to build wealth, you need your savings to grow at a rate that not only keeps pace with inflation but beats it.

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What Is the Money Supply?

The U.S. money supply comprises currency—dollar bills and coins issued by the Federal Reserve System and the U.S. Treasury—and various kinds of deposits held by the public at commercial banks and other depository institutions such as thrifts and credit unions. On June 30, 2004, the money supply, measured as the sum of currency and checking account deposits, totaled $1,333 billion. Including some types of savings deposits, the money supply totaled $6,275 billion. An even broader measure totaled $9,275 billion.

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These measures correspond to three definitions of money that the Federal Reserve uses: M1, a narrow measure of money’s function as a medium of exchange; M2, a broader measure that also reflects money’s function as a store of value; and M3, a still broader measure that covers items that many regard as close substitutes for money.

The definition of money has varied. For centuries, physical commodities, most commonly silver or gold, served as money. Later, when paper money and checkable deposits were introduced, they were convertible into commodity money. The abandonment of convertibility of money into a commodity since August 15, 1971, when President Richard M. Nixon discontinued converting U.S. dollars into gold at $35 per ounce, has made the monies of the United States and other countries into fiat money—money that national monetary authorities have the power to issue without legal constraints.

Why Is the Money Supply Important?

Because money is used in virtually all economic transactions, it has a powerful effect on economic activity. An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.

Opposite effects occur when the supply of money falls or when its rate of growth declines. Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results.

What Determines the Money Supply?

Federal Reserve policy is the most important determinant of the money supply. The Federal Reserve affects the money supply by affecting its most important component, bank deposits.

Here is how it works. The Federal Reserve requires depository institutions (commercial banks and other financial institutions) to hold as reserves a fraction of specified deposit liabilities. Depository institutions hold these reserves as cash in their vaults or Automatic Teller Machines (ATMs) and as deposits at Federal Reserve banks. In turn, the Federal Reserve controls reserves by lending money to depository institutions and changing the Federal Reserve discount rate on these loans and by open-market operations. The Federal Reserve uses open-market operations to either increase or decrease reserves. To increase reserves, the Federal Reserve buys U.S. Treasury securities by writing a check drawn on itself. The seller of the treasury security deposits the check in a bank, increasing the seller’s deposit. The bank, in turn, deposits the Federal Reserve check at its district Federal Reserve bank, thus increasing its reserves. The opposite sequence occurs when the Federal Reserve sells treasury securities: the purchaser’s deposits fall, and, in turn, the bank’s reserves fall.

If the Federal Reserve increases reserves, a single bank can make loans up to the amount of its excess reserves, creating an equal amount of deposits. The banking system, however, can create a multiple expansion of deposits. As each bank lends and creates a deposit, it loses reserves to other banks, which use them to increase their loans and thus create new deposits, until all excess reserves are used up.

If the required reserve ratio is 10 percent, then starting with new reserves of, say, $1,000, the most a bank can lend is $900, since it must keep $100 as reserves against the deposit it simultaneously sets up. When the borrower writes a check against this amount in his bank A, the payee deposits it in his bank B. Each new demand deposit that a bank receives creates an equal amount of new reserves. Bank B will now have additional reserves of $900, of which it must keep $90 in reserves, so it can lend out only $810. The total of new loans the banking system as a whole grants in this example will be ten times the initial amount of excess reserve, or $9,000: 900 + 810 + 729 + 656.1 + 590.5, and so on.

In a system with fractional reserve requirements, an increase in bank reserves can support a multiple expansion of deposits, and a decrease can result in a multiple contraction of deposits. The value of the multiplier depends on the required reserve ratio on deposits. A hi