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Transcript of Monetary Policy
Stacks on stacks on stacks....
Who is on the...
Ulysses S. Grant
John F. Kennedy
Franklin D. Roosevelt
Ok so as you may know the main reason economies worldwide have transitioned to using money is that Barter Systems are inefficient!
Before trade can occur, each trader had to have something the other wanted
Some goods cannot be split. If I John Florance is worth 5 goats, how do you exchange if you only want 1 goat?
And what do we do if some goat herders don't like John Florance and want a bunch of squirrels instead? I'd have to go get me some squirrels!
So what Exactly IS
Money is anything that is generally accepted in payment for goods and services. Money is NOT the same as
Total value of accumulated assets
Money earned for doing work or from investments
Ok so There are
Something that performs the function of money and has alternative uses...like gold, silver, cigarettes
Something that serves as money but has no other important uses like...paper money and coins
3 Functions of Money
A Medium of Exchange
Money can easily be used to buy goods and services without the complications of the barter system
A Unit of Account
Money measures the value of all goods and services. It is a measurement of value
A Store of Value
Money allows you to store purchasing power for the future. Money doesn't die or spoil
Money can further be differentiated into three forms depending on how "liquid" it is.
This is all of the money in the economy in the form of coins, cash, and checking-account deposits. It is the most liquid form of money.
This includes M1 PLUS savings accounts and small time deposits (or money held at banks that cannot be drawn within a certain time period), and Mutual Funds
This includes M1 PLUS M2 plus larger time deposits that are over $100,000.
is just a measure of how quickly and easily an asset can be converted into cash!
can easily converted into cash while
cannot be easily converted into cash without significant loss of time and value
Now to understand the differences and similarities between stocks and bonds, we'll have to think about a
Now let's imagine you're all 10 years old again and you want to start a lemonade stand. In order to get started you
ask grandma to lend you $100
for your inputs to start the company!
In exchange you give her a piece of paper that says, "IOU $100 and I will pay you back in a year plus 5% interest"
What you just gave grandma is what we call
Bonds are basically IOU's that
represent a company's or a country's debt
. It's a promise to investors that they will get their money back. So when you purchase a bond, you're literally buying debt!
(It's important to note that a bond holder has NO OWNERSHIP of a company)
Now that $100 was a good start but you're still short some money. So you decide to
sell half of your company
to your sister Amy. She gives you $50 bucks!
In exchange for her money, you give her a piece of paper that says, "
Our company has 100 shares of stock, and Amy now owns 50 shares for $1 a piece
The stocks that you have just given Amy represent
ownership of your company
. Stock owners are allowed to make decisions and make money off of company profits
Now Amy can
as a shareowner in two ways:
Portions of a corporation's profits paid out to stockholders
Money earned when stockholders sells stock for more than he/she paid for it
* If you bought $1000 worth of Apple stock in 2005, it would be worth $47,000 today.
Ok so what backs the money supply?
Right so we're off the gold standard. What makes our money valuable?
This is just a fancy IOU from the government
1. Buyers and Sellers must have confidence that it
2. Money must not be
3. Money needs to be
Decreases purchasing power
The Money Supply
Just like anything in economics there is a limited supply of money in the economy thus we can represent it the
Nominal Interest Rate (ir)
Quantity of Money
Notice the inverse relationship between interest rates and the quantity of money demanded
needs to be approached a bit differently than demand for other goods and services. It is the sum of:
is the demand for currency necessary to purchase goods and services
is the demand for money in liquid form as opposed to illiquid forms like stocks, bonds, a home, or jewelry.
Ok so for example, what would happen to the quantity demanded for money when
interest rates increase?
The quantity demanded would fall because individuals would rather have interest earning assets instead of liquid money.
Imagine Jane here has $100 in her pocket. She could keep it as liquid cash or invest it in some interest earning asset.
Easily available to purchase goods and services
Safe from risky investments
Does not generate any interest
Easier to spend
Over time can generate profits from interest rates
Difficult to convert to liquid cash to spend
Less liquid funds in an emergency
what would happen to the quantity demanded for money when
interest rates Decrease?
The quantity demanded would rise because individuals would have less incentive to convert cash into interest earning assets.
Just shift it
Time to shift the curve. The Money Demand Curve can shift for three different reasons:
If the general price level increases, individuals will require more money to purchase goods and services with thus shifting the money demand curve to the right (vice versa)
If there is a rise in incomes, there will be a higher demand for goods and services which would again increase the transaction demand for money (vice versa)
Technology like the use of credit cards, paypal, or online banking has decreased the need and use for money
Nominal Interest Rate (ir)
Quantity of Money
Notice that the supply is completely vertical. This means that the supply of money is completely independent of the interest rate
This is because a country's money supply is controlled by its central bank, or for us the Federal Reserve