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Tuesday, November 20, 2007

Econ -Unit 4- Chap 13 Notes

Money and Banking

  • The Functions of Money
    • Medium of Exchange
      • Usable for buying and selling goods
      • Social intervention with which resource suppliers and producers can be paid that can be used to buy and item on the marketplace
      • Allow society to gain the advantages of geographic and human specialization
    • Unit of Account
      • Society uses monetary units to measure the relative worth of goods, services, ect.
      • Permits us to define debt obligations, taxes owed, and calculate GDP
    • Store of Value
      • Enables people to transfer purchasing power from present to future
      • Money preferred for store value since it is the most liquid of all assets
  • The Supply of Money
    • Anything that is widely accepted as a medium of exchange can be used as money
    • Money Definition M1
      • Definition of U.S. money supply is called M1
        • Currency (Coins and paper money) in the hands of the public
          • Debts of the government
        • All checkable deposits
          • Debts of commercial banks and savings institutions
      • Currency: Coins + Paper Money
        • All coins in circulation in the US are token money
          • DEFINE: Intrinsic value, value of the metal contained in the coin, is less than the face of the coin
          • WHY: Prevent people from melting down coin for profit (Melt the coin worth 25 cents but that contains 75 cents worth of metal)
        • Coins make up 2-3% of M1
        • Paper money make up 50% of M1
          • All paper money is in the form of Federal Reserve Notes
      • Checkable Deposits
        • Large component of M1 (48%)
        • An endorsement
          • Because it requires an endorsement theft or lose of your checkbook is not nearly as bad as losing an identical amount of currency
        • More convenient to write a check than to transport large sums of money
        • Checks are nothing more than a way to transfer the ownership of deposits in banks
          • EQUATION: Money, M1= Currency + Checkable Deposits
      • Institutions that Offer Checkable Deposits
        • A variety of places allow people to write checks in any amount on the funds they have deposited
        • Commercial Banks: Primary depository institutions
          • Accept deposits of households and businesses, keep the money until it is demanded
        • Thrift Institutions: Savings and loan associations, mutual savings banks, and credit unions supplement the commercial banks
          • (S&L and saving banks) Accept deposits from households and businesses and then use the funds to finance housing mortgages and provide loans
          • (Credit unions) Accept deposits from and lend to members
      • A Qualification
        • Excluding government financial holdings from the money supply allows for better assessment of the amount of money available
    • Money Definition M2
      • Second definition of money includes M1 + several near-monies
        • DEFINE: Certain highly liquid financial assets that do not directly function as a medium, but can still be converted into currency
        • Three categories of near-monies
          • Savings Deposits
            • Depositor can easily withdraw fund from a savings account or request to have it moved to a checkable account
            • Can withdraw from money market deposit account
          • Small Time Deposits
            • Funds from time deposits become available after maturity
          • Money Market Mutual Funds
            • Depositor can redeem shared in a MMMF offered by a mutual fund company
              • EQUATION: Money, M2 = M1 + saving deposits (including MMDAs) + small time deposits + MMMFs
    • Money Definition M3
      • Third definition: Includes LARGE time deposits
        • There is a market where these can be sold at any time
          • EQUATION: Money, M3 = M2 + large time deposits
  • What "Backs" the Money Supply
    • Money as Debt
      • The major components of the money supply are debts
      • Paper currency and checkable deposits have no intrinsic value
      • Managing the money supply is more sensible than linking it to gold
        • A large increase in the gold stock might increase the money supply to rapidly, causing inflation
        • A decrease in the gold supply might reduce money supply causing a recession
        • People cannot convert paper money to gold
    • Value of Money
      • Acceptability
        • Currency and checkable deposits are money people accept them as money
      • Legal Tender
        • Government has designated currency as legal tender
          • DEFINE: Paper money is a valid and legal payment of debt
        • Paper money in our economy is fiat money
          • DEFINE: It's money because the government said it is
        • The general acceptance of the paper currency is more important than what the government says
      • Relative Scarcity
        • Value of money depends on its supply and demand
        • Utility of money depends on its capacity to be exchanged for goods and services
    • Money and Prices
      • The Purchasing Power of the Dollar
        • The amount a dollar will buy varies inversely with the price level
          • When the CPI goes up the value of the dollar goes down
          • Higher prices lower the value because more dollars are needed to buy a certain amount of goods
            • Equation: D=1/P
              • (Dollar Value=1/Price level)
      • Inflation and Acceptability
        • Inflation depreciates the value of currency
        • Rapid declines in the value of currency may cause it to cease being used as a medium of exchange
        • Without the acceptable domestic medium of exchange the economy may revert to barter or pick up foreign currency
    • Stabilization of Money's Value
      • Stabilization requires:
        • Appropriate fiscal policy
        • Intelligent management or regulation of the money supply
      • Ability of banks and thrifts to honor claims against them depends their not creating too many of such claims
        • System of private profit seeking banks may not contain sufficient safeguards against creating too many checkable deposits
        • US banking system exercises substantial centralizing and government control to guard against these
  • The demand for Money
    • Two reasons why the public want money:
      • Make purchases
      • Hold it as an asset
    • Transactions Demand, Dt
      • Transactions demand for money
        • Define: Using money as a medium of exchange for purchasing goods and services
      • The main detriment amount of money demanded for transactions is the level of nominal GDP
    • Asset Demand, Da
      • Second reason for having money comes from its function as a store of value
      • Asset demand for money
        • Define: Different forms of financial assets: stocks, bonds, or money
      • Determinants of asset demand
        • Rate of interest (money does not collect interest, bonds do)
        • Asset demand for money varies inversely with the rate of interest
    • Total Money Demand, Dm
      • We find the total demand for money by horizontally adding the asset demand to transactions demand
        • The resulting line represents the total amount of money the public wants
  • The Money Market
    • Combination of demand for money with the supply of money and you have . . . MONEY MARKET! YAY!
      • Determine the equilibrium rate of interest
    • Adjustment to a Decline in the Money Supply
      • Decline the supply of money will cause a temporary shortage of money (duh) and increase equilibrium interest
        • In the event of a money shortage, people will sell bonds to try to increase supply. But it does not increase money supply as a whole. It causes the price on bonds to drop and the interest rate to rise.
        • Lower bond prices are associated with higher interest rates
    • Adjustment to an Increase in the Money Supply
      • In the case of a surplus of money people will buy more bonds
        • This doesn't make much sense in the whole since the money just round and round
        • The demand for bonds will rise cause prices to rise and interest rates to fall
  • The Federal Reserve and the Banking System
    • The Board of Governors of the Federal Reserve System direct the Federal Reserve Banks who control the lending activity pf the nations banks and thrift institutions
    • Historical Background
      • -
    • Board of Governors
      • -
    • FOMC
      • Federal Open Market Committee aids the BOG
      • Made up of twelve people
        • Seven members of the BOG
        • President of the NY FRB
        • The four remaining presidents of the FRB on a rotating basis
    • The 12 Federal Reserve Banks
      • Blend private and public control
      • Serve as nations 'central bank' and as bankers' banks
      • Central Bank
        • US central bank is made up of 12 banks coordinated by the BOG
      • Quasi-Public Banks
        • Blend private and public control
        • Not motivated by profit
        • Do not compete with commercial banks
      • Bankers' Banks
        • Make loans and accept deposits for banks rather than the public
    • Commercial Banks and Thrifts
      • Thrifts are subject to monetary control by the Federal Reserve System
    • Fed Functions and the Money Supply
      • The Fed performs several functions:
        • Issuing currency
        • Setting reserve requirement and holding reserves
        • Lending money to banks and thrifts
        • Providing for check collection
        • Acting as a fiscal agent
        • Supervising banks
        • Controlling the money supply
    • Federal Reserve Independence
      • Independent agency of the gov.
        • Protects Fed from political pressures


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