chapter 14copyright ©2010 by south-western, a division of cengage learning. all rights reserved 1...

Chapter 14 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1

ECON

Designed byAmy McGuire, B-books, Ltd.

McEachern 2010-2011

14

CHAPTERMoney and the Financial System

Macro


The Evolution of Money

LO1

The earliest money Good – easily traded later High degree of

acceptability Functions of money

Medium of exchange Commodity money

Unit of account Store of value

Retains purchasing power over time


The Evolution of Money

LO1

Properties of the ideal money Durable Portable Divisible Uniform quality Low opportunity cost Relatively stable in value


LO1

Six Properties of Ideal Money

Exhibit 1


Representative Money and Fiat Money

LO1

Bank notes IOUs Paper money

As good as gold Representative

money Fiat money

From the power of the state

Legal tender


The Value of Money

LO1

Purchasing power of money Rate of exchange for goods and

services Higher price level in economy

Smaller purchasing power Purchasing power of $ in a year

100 ÷Price index in same year Evolution over time

Steady decline since 1960


LO1

Purchasing Power of $1 Measured in 1982–1984 Constant DollarsExhibit 2

An increase in the price level over time reduces what $1.00 buys. The price level has risen every year since 1960, so the purchasing power of $1.00 (measured in 1982-1984 constant dollars) has fallen from $3.38 in 1960 to $0.47 in 2009.


When Money Performs Poorly

LO1

Hyperinflation in Zimbabwe Prices grow by the hour

Not reliable store of value Exchange for stable

currency Barter


The Fed

LO3

Before 1863: State banks– Chartered by states

National Banking Act of 1863– National banks– Issue notes– Regulated

Dual banking system 19th century

– Panic ‘runs’


The Fed

LO3

1913 Federal Reserve System– Central bank– Monetary authority– 12 Federal Reserve districts

National banks– Had to join the Fed

State banks– Voluntary membership to

the Fed


The Twelve Federal Reserve Districts

The map shows by color the area covered by each of the 12 Federal Reserve districts. Black dots note the locations of the Federal Reserve Bank in each district. Identified with a star is the Board of Governors headquarters in Washington, D.C.

LO3

Exhibit 3


The Fed

LO3

Powers of the Fed– Issue bank notes– Buy and sell government

securities– Extend loans to member banks– Clear checks in the banking

system– Reserve requirement for member

banks Banker’s bank


LO4

Board of Governors– 7 members

• Appointed by the President• Confirmed by the Senate• 14-year nonrenewable term• Insulated from political pressure• 1 chair: 4 years

– Set and implement monetary policy– Oversees the 12 reserve banks


LO4

Federal Open Market Committee FOMC– Open-market operations

• The Fed buys, sells government securities

– 7 board governors– 5 presidents of reserve banks– Advise the board


Organization Chart of the Federal Reserve System

Members of the Board of Governors: appointed by the president, confirmed by the Senate. Seven board members also belong to the 12-member Federal Open Market Committee, which advises the board. The Board of Governors controls the Reserve Banks in each of the 12 districts, which in turn control the US banking system.

LO4

Exhibit 4


Regulating the money supply– Open-market operations– Discount rate– Reserve requirements

Deposit insurance– Federal Deposit Insurance

Corporation, FDIC• $250,000 per depositor per bank• 90% banksLO4


Goals– High level of employment

in economy– Economic growth– Price stability– Interest rate stability– Financial market stability– Exchange rate stability

LO4


Before 1930s: Own corporate stock; bonds After 1930s

– Banking = heavily regulated

• Loans, government securities

• Ceiling on interest rates for deposits 1970s: Inflation

• Increase interest rates

• Withdrawals Money market mutual fund

• Limited check writingLO4


Money market deposit accounts– $8 billion in 1978– $200 billion in 1982

Deposit insurance Unregulated interest rates Wider variety of assets Moral hazard problem

LO4


Savings banks– Wild gambles

– Insolvency– Collapse of a growing number of banks

– 1989 what was then largest financial bailout– 3,418 in 1984– 1,220 in 2008

Credit unions– Declined 34%

LO4


LO4

Failures of U.S. Savings Banks Peaked in 1989

Exhibit 5


Demise of commercial banks– Risky decisions– Unsound loans– Failures, mergers, acquisitions– 14,496 in 1984– 7,085 in 2008

LO4


Failures of U.S. Commercial Banks Peaked in 1988

LO4

Exhibit 6


LO4

Large number of U.S. banks

– Past restrictions on bank branches Branching restrictions

– Inefficiencies

– Bank failures (Great Depression) Bank holding company

– Owns several banks

– Offers other services Bank mergers

– Expand geographically


Largest U.S. Banks Based on Total Domestic Deposits

LO4

Exhibit 8(a)


World’s Largest Banks Based on Total Assets

LO4

Exhibit 8(b)

chapter 14copyright ©2010 by south-western, a division of cengage learning. all rights reserved 1...

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