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
- Usable for buying and selling goods
- 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
- Society uses monetary units to measure the relative worth of goods, services, ect.
- 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
- Enables people to transfer purchasing power from present to future
- 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
- Debts of the government
- All checkable deposits
- Debts of commercial banks and savings institutions
- 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)
- DEFINE: Intrinsic value, value of the metal contained in the coin, is less than the face of the coin
- 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
- 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
- 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
- EQUATION: Money, M1= Currency + Checkable Deposits
- Large component of M1 (48%)
- 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
- 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
- (S&L and saving banks) Accept deposits from households and businesses and then use the funds to finance housing mortgages and provide loans
- A variety of places allow people to write checks in any amount on the funds they have deposited
- A Qualification
- Excluding government financial holdings from the money supply allows for better assessment of the amount of money available
- 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
- Depositor can easily withdraw fund from a savings account or request to have it moved to a checkable account
- Small Time Deposits
- Funds from time deposits become available after maturity
- 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
- EQUATION: Money, M2 = M1 + saving deposits (including MMDAs) + small time deposits + MMMFs
- DEFINE: Certain highly liquid financial assets that do not directly function as a medium, but can still be converted into currency
- 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
- EQUATION: Money, M3 = M2 + large time deposits
- Anything that is widely accepted as a medium of exchange can be used as money
- 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
- A large increase in the gold stock might increase the money supply to rapidly, causing inflation
- The major components of the money supply are debts
- Value of Money
- Acceptability
- Currency and checkable deposits are money people accept them as money
- 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
- 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
- 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
- Value of money depends on its supply and demand
- 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)
- (Dollar Value=1/Price level)
- When the CPI goes up the value of the dollar goes down
- 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
- Inflation depreciates the value of currency
- Stabilization of Money's Value
- Stabilization requires:
- Appropriate fiscal policy
- Intelligent management or regulation of the money supply
- Appropriate fiscal policy
- 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
- System of private profit seeking banks may not contain sufficient safeguards against creating too many checkable deposits
- The demand for Money
- Two reasons why the public want money:
- Make purchases
- Hold it as an asset
- Make purchases
- Transactions Demand, Dt
- Transactions demand for money
- Define: Using money as a medium of exchange for purchasing goods and services
- 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
- 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
- Rate of interest (money does not collect interest, bonds do)
- Second reason for having money comes from its function as a store of value
- 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 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
- 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
- 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.
- 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
- This doesn't make much sense in the whole since the money just round and round
- 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
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- Board of Governors
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- 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
- Seven members of the BOG
- Federal Open Market Committee aids the BOG
- 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
- 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
- Blend private and public control
- Bankers' Banks
- Make loans and accept deposits for banks rather than the public
- Make loans and accept deposits for banks rather than the public
- Blend private and public control
- Commercial Banks and Thrifts
- Thrifts are subject to monetary control by the Federal Reserve System
- 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
- Issuing currency
- Federal Reserve Independence
- Independent agency of the gov.
- Protects Fed from political pressures
- 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
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