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, D_t
    
    • 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, D_a
    
    • 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, D_m
    
    • 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