money, baking, and credit

7/29/2019 Money, Baking, and Credit

1/69


2/69

Money and its forms in the U.S.

U.S. financial institutions

How banks create money and how theyare regulated

The Federal Reserve system

Changes in the financial industry International banking and finance


3/69

Money is the set of assets inthe economy that people

regularly use to buy goodsand services from otherpeople.

It is anything that is generally

accepted in exchange forgoods and services.


4/69

Portability

Divisibility

Durability

Stability


5/69

Monetary assets (Liquid

assets)Non-monetary Assets

(illiquid assets)


6/69

Currency is consists of coins and/orpaper created to facilitate the trade of

goods and services and the payment ofdebts.

Metal coins have for centuries beensupplemented by paper currency, oftenin the form of bank notes.


7/69

Metallic coins and paper

currency are the onlyforms of legal tender.

Legal tender is fiatmoney


8/69

1. Demand Depositsbalances in bankaccounts that depositors can access on

demand2. Transaction DepositsDeposits that can

easily converted to currency or used tobuy goods and services directly.

3. Traveler's check- Transaction instrumenteasily convertible into currency.


9/69

1. Ease and safety Transaction

Paying for goods and services with

check is easier and less risky than payingwith paper money


10/69

2. Lower Transaction Costs

Transaction deposits are popular

precisely because they lower transactioncosts compared with the use of metal orpaper currency.


11/69

3. Transaction Records

They provide a record of financial

transactions


12/69

It is generally acceptable in exchangefor goods and services.

A guaranteed loan available ondemand to the cardholder, whichmerely defers the cardholders paymentfor a transaction using a demanddeposit.


13/69

Funds that cannot be used for paymentdirectly but must be converted into

currency for general use.


14/69

Nontransaction deposits that are notmoney but can be quickly converted

into money.


15/69

Interest-earning accounts provided bybrokers that pool funds into such

investments as treasury bills.


16/69

Copyright 2009 Pearson

Addison-Wesley. All rightsreserved.14-16

The central bank substantially controlsthe quantity of money that circulates inan economy, the money supply.

In the US, the central banking system is theFederal Reserve System.

The Federal Reserve System directly regulates

the amount of currency in circulation. It indirectly influences the amount of checking

deposits, debit card accounts, and othermonetary assets.


17/69

M1: Spendable

Currency

Demand deposits

M2: Spendable plus Convertible

Time deposits Money market mutual

funds

Savings deposit


18/69

18

Define money as currency pluscheckable deposits:M = C + D

M1 definition of money The Fed can control the monetary base

better than it can control reserves

Link the money supply (M) to themonetary base (MB) and let m be themoney multiplier

M m MB


19/69

1. Gold standards

Defining the dollar as equivalent to a set

value of a quantity of gold, allowingdirect convertibility from currency togold.

2. Greshams Law

The principle that cheap money drivesout dear money; given an alternative,people prefer to spend less valuablemoney.


20/69


21/69

Amedium of exchange:an asset used to buy and sell goods andservices

Astore of value:an asset that allows people to transferpurchasing power from one period toanother

A unit of account:a unit of measurement used by people topost prices and keep track of revenues andcosts


22/69

The banking industry includes: commercial banks,

savings and loans, and,

credit unions.

Banks are profit-seeking institutions: Banks accept deposits and use part of

them to extend loans and make investments.Income from these activities is their major sourceof revenue.


23/69

Banks play a central role in the capitalmarket (loanable funds market):

They help to bring together people whowant to save for the future with those whowant to borrow for current investmentprojects.


24/69

Collecting higher interest payments on

the loans they make than they paytheir depositors for those funds.


25/69

Holdings of assets at the bank or at theFederal Reserve Bank as mandated by

the Fed. Quantity of cash reserve accounts with

the Federal Reserve equal to aprescribed proportion of their checkable

deposits.


26/69

$100.00 $10.00 $90.00 $190.00

90.00 9.00 81.00 271.00

81.00 8.10 72.90 343.00

72.90 7.29 65.61 409.51

65.61 6.56 59.05 468.56

DepositMoney held in

Reserve by BankMoneyto Lend

TotalSupply


27/69

A system that requires banks to

hold reserves equal to somefraction of their checkabledeposits.


28/69

Money, Interest Rates andAggregate Demand


29/69

Market where money demand and

money supply determine the equilibriumnominal interest rate.


30/69

Transaction purposes

Precautionary Reasons

Asset purposes


31/69

For a given

level of

income, real

money

demanddecreases

as the interest

rate increases.


32/69

When income

increases,

real money

demandincreases at

every interest

rate.


33/69

no matter what is the interest rate,

whether small or big rates, banks seekingto maximize profits will increase lendingas long as they have reserves abovetheir desired level.


34/69


35/69

An increase in the

money supply lowers

the interest rate for a

given price level

A decrease in the money

supply raises the interest

rate for a given price

level.


36/69


37/69

The Federal Reserve (Fed) serves as the nationscentral bank, which is designed to oversee thebanking system and regulate the quantity of

money in the economy.

The Tools of the Fed in controlling the money supply

Open market operations

Reserve requirements

Discount rate controls


38/69

Open market operations

Involve the purchase of sale and government bonds

by the Federal Reserve System


39/69

Reserve requirements

The Fed possesses the power to change the reserverequirement of member banks by altering the reserve ratio

This can have an immediate and significant impact on theability of member banks to create money

Frequent changes in the reserve requirement would makeit very difficult for banks to plan

The Fed changes the reserve requirements infrequently, andwhen it does make changes, it is by very small amounts.


40/69

Discount rate

Interest rate that the Fed changes commercial banks for theloans it extends to them.

* If the Fed wants to contract the money supply, it will raise thediscount rate, making it more costly for banks to borrow reserves.

* If the Fed is promoting an expansion of money and credit, it willlower the discount rate, making it cheaper for banks to borrow

reserves


41/69

To increase the money supply,1.the Fed buys government bonds from the public.

2.Lower reserve requirement

3.Lower the discount rate

To decrease the money supply1.the Fed sells government bonds to the public

2.Raise reserve requirement

3.Raise the discount rate


42/69


43/69


44/69

- When the economy is headed for a

recession the and the fed wants to pursuean expansionary monetary policy toincrease aggregate demand, it will buybonds on the open market.


45/69

- When the Fed wants to contain anoverhead economy, it will pursue acontractionary monetary policy toreduce aggregate demand. It will sells

bonds on the open market.


46/69


47/69

Manipulate the supply of money It is the bankers bank Transfer funds and checks between various

commercial banks in the banking system Serves as the primary bank for the central

government Buys and sells foreign currencies and generally

assist in the completion of financial transactionswith other countries

Serve as Lender of last resort Concern with the stability of the banking system

and the money supply Can and does impose regulations on private

commercial banks Implements monetary policy


48/69

Boston, New York, Philadelphia,

Richmond, Atlanta, Dallas, Cleveland,Chicago, St. Louis, Minneapolis- St, Paul,Kansas City, and San Francisco


49/69

FED was created in 1913

It was privately owned by the banks that

belong to it. Banks are not required tobelong to the FED.


50/69

Private ownership o f the FED is essentially

meaningless because the FederalRESERVED Board of Government, whichcontrols major policy decisions, isappointed by the president of the United

States and not by stockholders.

The owners of the Fed have little controlover its operation and receive only small

fixed dividends on their modest financialstake in the system.


51/69

Feds enjoyed a considerable amount ofindependence from both the executiveand legislative branches of the

Government.

No Federal reserve board will facereappointment from the president because

the president appoints the seven membersof the Board of Governor subject to theSenate and the term of appointments is14yrs. Wherein the president tenure is limited

to two four years term.


52/69

Many of the key policy decisions aremade by its Federal Open MarketCommittee (FOMC)

FOMC makes most of the key decisionsinfluencing the direction and size ofchanges in the money supply

the chair of the FED is truly the chiefexecutive officer of the system.


53/69

Role of money is determining theequilibrium GDP, the level of prices, andreal output of goods and services

M x V= P x Q

M- money V- velocityP- level of price Q- quantity of final

goods


54/69

-refers to the turnover rate or the intensitywith which money is used.

V- represents the average number of times

a dollar is used in purchasing final goodsor services in a one year period

P x Q- represents the dollar value of all final

goods and services sold in a country in agiven year


55/69

If M increases, then one of the following musthappen:

V must decline by the same magnitude, sothat M x V remains constant, leaving P x Qunchanged.

P must rise

Q must rise P and Q must each rise somewhat, so that

the product of P and Q remains equal to

MV.


56/69

Economists once considered thevelocity of money a given.

The velocity is less stable whenmeasured using the M1 definition andover shorter periods of time.


57/69

The inflation rate tends to rise more in

periods of rapid monetary expansion thanin periods of slower growth in the moneysupply.

The relationship between the growth in the

money supply and higher inflation isparticularly strong with hyperinflation,inflation greater than 50%.


58/69


59/69


60/69

The economy faces an Inflationary Gap.


61/69


62/69

I. How the CommercialBanks Implement the Feds

Monetary Policies

- monetary policy must

ultimately be carried out

through the commercialbanking system


63/69

II. BANKS that are NOT PART of the

Federal Reserve System and Policy

Implementation

- The Fed can control depositexpansion at member banks, but it has

no control over the global and nonbank

institutions that also issue credit butare not subject to reserve requirement

limitations


64/69

III. Fiscal and Monetary Problems

- macroeconomic problem arise if

the federal governments fiscaldecision makers differ with the

Feds monetary policy


65/69

IV. Alleviating Coordination

Problems

- attempt is made to reach aconsensus on the appropriate

policy response, both monetary

and fiscal; still there is often somedisagreement


66/69

V. Timing is Critical

- because of the significant lags

before the fiscal and monetary policyhas its impact, the increase in

aggregate demand may occur at a

wrong time


67/69

VI. Imperfect Information

- some economists disagree on the

natural rate of real output, and itmay be difficult to know where

RGDP is at any given moment in

time


68/69

VII. The Shape of the Aggregate Supply

Curve and Policy Implications

- economists argue that the short-run

aggregate supply curve is relatively flat atvery low levels of RGDP, when the

economy has substantial excess capacity,

and very steep when the economy isnear maximum capacity.


69/69

VII. Unexpected Global and TechnologicalEvents

- terrorists attacks on 09/11/11- 1997-1998 currency crisis in East Asia,

economic activity either slowed or

declined

money, baking, and credit

Documents