week-2 into to money and banking and basic overview of u.s. financial system & interest rates...
TRANSCRIPT
Week-2 Into to Money and Bankingand Basic Overview of U.S.
Financial System & Interest RatesMoney and Banking Econ 311Instructor: Thomas L. Thomas
o The first and most important issue with this view is incomplete information which comprises several components:
o Search Cost – finding all the people willing to make a funds exchange – matching lenders (savers) to borrowers (spenders) – Real cost and Nominal Costs
o Transaction Cost – paying for enforceable contracts, accounting costs, collection costs, etc.
o Asymmetric Information – default / losses.
Information & Transaction Costs
o Asymmetric Information – the lender does not know enough about the borrower to make a accurate decision – “the borrower always knows better how well he can pay back the loan.”
o Adverse selection is a problem created when there is asymmetric information before a transaction occurs. It occurs when borrowers who are most likely to default are the ones most actively seeking to obtain loans and are thus selected.
o Moral hazard occurs – after the transaction occurs.
o The problems created by by adverse selection and moral hazard are an important impediment to well functioning financial markets - and cause systemic fall in confidence e.g. most recent financial market crisis.
Asymmetric Information – Moral Hazard
o Moral hazard in the financial markets is the risk or hazard that the borrower might engage in activities that are undesirable (immoral) from the lenders point of view.
o Strategic default is one example – people walk away from their mortgage because their home value has declined below that outstanding balance on the loan.
o Moral hazard can also occur from the lending perspective where management engages in activities that benefit themselves at the expense of the owners shareholders – this is called the separation theorem.
o This is often referred to as conflicts of interest. Conflicts of interest are a moral hazard that occur when a person or institution has multiple objectives (interests), and as a result, have conflicts between those objectives.
Moral Hazard
o Financial Innovation the development of any new financial products and services is an important force making the financial market more efficient.
o For example dramatic improvements in technology have lead to new products and the ability to deliver financial services electronically like e-finance and the ATM (POS).
o It also has a dark side and can lead to moral hazards, and financial crises like the most recent one.
o When the financial system sizes up (liquidity dries up) it may produce a financial crisis.
o A financial crisis is characterized by sharp declines in asset prices, the failure of numerous financial institutions and rising unemployment.
Financial Innovation
o The Dialectic Process was developed by the German Philosopher Georg Wilhelm Fredric Hegel (1770-1831).
o According to Hegel society is burdened with contradictions and tensions.
o Through these contradictions and tensions one goes through a process (dialectic) to discover what he called the “absolute idea or absolute knowledge.
o Professor Edward Kane applied this term to banking in the 1970’s
o It carries the idea that baking regulation is cyclical interaction between opposing economic and political forces.
o Such rules foster a cat and mouse gam benefiting particular institutions thereby motivating other institutions to find loopholes in the system.
o Management’s goals become finding ways to circumvent restrictions in order to capture key markets.
o Now if a number of institutions are successful in such avoidance, than the regulations are changed and a new dialectic cycle begins.
Regulation& Dialectic Process
o Money also referred to as the money supply is defined as anything that is generally accepted in payment for goods or services or in the repayment of debt.
o Money is linked to changes in economic activity and variables that affect all of us and are important to the heath of the economy.
o When an economy undergoes pronounced fluctuations evidence suggest that money plays an important role in generating a business cycle.
o Monetary theory relates the quantity of money and monetary policy to changers in aggregate economic activity.
Money and Monetary Policy
o The average price of goods and services in the economy is called the aggregate price level.
o Inflation is a continual increase in the price level, affecting individuals, business, and governments.
o The price level and money supply generally rise together (Why?)
o Milton Friedman, a Nobel Laureate in Economics made the famous statement “Inflation is always and everywhere a monetary phenomenon.”
o In addition to inflation, money plays an important role in interest rate fluctuations.
Money & Inflation
o Because money can affect many different economic variables, policymakers often concentrate on the conduct of monetary policy which is the management of money and interest rates.
o The organization that is responsible for conducting monetary policy is the central bank. For the United States the central bank is the Federal Reserve System (12 banks).
o Fiscal policy involves decisions around government spending and taxation.
o A budget deficit is the excess of government expenditures over tax revenues for a particular time period.
o A budget surplus arises when tax revenues exceed government expenditures.
o The government must finance deficit by borrowing in the financial markets.
Monetary Policy and Fiscal Policy
o Transaction Costs – the time and money spent carrying out financial transactions are the major problems faced by individual lenders.
o Financial intermediaries can substantially lower transaction cost because their size allows them to take advantage of economies of scale.
o For example banks and insurance companies have large staffs of lawyers who can produce airtight contracts that can be used over and over again.
o In addition, they have the resources to develop data systems and expertise to determine a borrowers credit worthiness. This is often referred to as economies of scope.
o Economies of scope lower the cost of information production for each service by applying one information source to to many different services.
Function of Financial Intermediaries – Transaction Costs
o Financial intermediaries bring numerous transaction partners together by creating assets (products) with risk characteristics that people are comfortable with.
o In addition, the lower transaction costs and risk sharing enable the financial intermediaries to earn a profit (spread) between the return they earn on a risky asset, and payments they make on the assets they have sold.
o Financial intermediaries also promote risk sharing by helping individuals diversify the amount of risk they are exposed. Diversification entails investing in a collection (portfolio) of assets whose assets do not always move together, thereby reducing the over all risks compared to that of individual investments. (Note Mutual Funds and Loan Portfolios)
Function of Financial Intermediaries – Risk Sharing
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Individual Investment – An Economic Perspective
Savings and investment is an intertemporal choice between current consumption and future consumption.
The individual will save and consume at level that gives him/her the highest level of satisfaction (utility) depicted by curves U1 through U4 for a given level of income (budget).
The highest attainable level of utility is point C1 where U3 is tangent to the individual’s budget line.
Current Consumption at time t
Future Consumption at time t+1
U3
U2U1
U4
Budget Line
C1
A
B
O
CurrentConsumption
Fu
ture
C
on
su
mp
tion
Savings
D
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Individual Investment – An Economic Perspective Continued
We can apply this same analysis to the owner of a single firm who can either:
consume the firm’s present earnings by liquidating the assets (points O,A)
Or save / invest into future returns (points A, D)
Note the production frontier acts like a budget constraint.
In this case the production frontier represents the combinations of savings and consumption that is used to produce wealth / utility.
Note the curved shape of the frontier is due to the law of diminishing returns.
The level of consumption and investment also equal to the point of highest utility at point C1.
Current Consumption at time t
Future Consumption at time t+1
U3
Production Frontier
C1
A
B
O
Consumption
Fu
ture
R
etu
rns
Investment
D
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Individual Investment – An Economic Perspective Continued
Introducing the capital market allows us to examine investment decisions where there are many owners (shareholders) – this is called the Separation Theorem.
The capital investment decision becomes the company (managers) undertake physical investment until the return from the investment = the market rate of return/interest at point P.
This level of investment results in some dividend flow or appreciation of wealth to the shareholders.
Shareholders make their financial decision by either borrowing or lending in the capital market until their individual time value of money = the capital market return.
This results in the highest aggregate utility at point C2 indifference curve U2.
Future Consumption at time t+1
Total InvestmentWith CML
Current Consumption at time t
ABO
1+r
D
E
C1
C2
U1
U2
Capital Market Investment Line (CML)
Required rateOf Return
F
P
OldInvestme
nt
Old Future
ReturnsTota
l R
etu
rns
Wit
h C
ML
o Money Market Instruments – because of their short maturities these traded debt instruments exhibit the least price fluctuations (called volatility) so are the least risky investments (Why?)
o General Types of Money Market instruments include: U.S Treasury Bills
Negotiable Bank Certificates of Deposit
Commercial Paper
Repurchase Agreements
Federal Funds
Bankers Acceptance
Money Market Instruments
o These are short-term debt instruments of the U.S. Government generally called T-bills.
o T-bills are usually issued with one of three original maturities 91 days (13 weeks), 182 days (26 weeks), 364 days (52 weeks).
o The minimum denomination is $10,000 sold to the highest bidder in weekly auctions by the Federal Reserve Bank of New York.
o Bids are expressed in a percentage of the bill’s Par Value (Face). For example, a bid of 99.55 on a 26 week T-bill means the buyer is willing to pay a purchase price of 99.55% of the face value.
o Because T-bills are sold at a discount, purchasers make money by what they pay for the T-bill and Face Value, and on the maturity of the bill.
U.S. Treasury Bills
o A Certificate of deposit is a debt instrument sold by banks to depositors that pays a stated annual interest and at maturity pays back principal.
o Negotiable CD are CDs sold in the secondary market.
o In the 1960s when Regulation Q was in effect it was difficult for large banks to retain large depositors.
o When Regulation Q was in effect during times of high interest rates investors could earn more money by investing directly into T-bills.
o Reg Q Ceilings prohibited banks from paying higher interest rates. Consequently banks like City Bank of New York (now Citibank) created Negotiable CDs that had large face values usually $1 million, that could be sold by the depositor in the secondary market if the depositor needed cash before maturity. (Why would this make them more attractive to corporate customers?)
o Negotiable CDs have original maturities of less than one year, have a coupon or stated rate which is expressed as a percentage of Par (what does this imply?)
o Interest calculations assume a 360 day year – thus the yield is called a bond yield.
Negotiable CDs
o Commercial Paper is a short-term debt instrument issued by large banks or well known corporations like Microsoft.
o Traditionally large well known firms dominated the market – but smaller highly rated companies began to issue commercial paper in the 1980s.
o Commercial paper has expended into world markets and the Eurocommercial paper market is centered in London.
o While commercial paper can be sold in the secondary market, due to their short-term nature a secondary market is virtually nonexistent. Most are held to maturity.
Commercial Paper
o Repurchase agreements (Repos) are effectively short-term loans with maturities less than two weeks.
o T-bills and other debt securities are used as collateral.
o A large corporation may have idle fund in its bank account for which it is willing to lend out for a short period. The firm buys a T-bill from the bank at a discount.
o The bank agrees to repurchase the T-bill at par or a price slightly higher than the price the firm paid for the T-bill in the original exchange. In effect the firm gave the bank a short-term loan.
o A reverse repo is in the opposite direction and depends on who is the buyer and who is the seller. Usually repo is designated to the seller and reverse repo is designated to the purchaser.
o Repos have become an important funding source for banks as well as lending tool since they are not counted as on balance sheet loans.
Repurchase Agreements
o These are overnight loans between banks of their deposits at the Federal Reserve
o Note these are not funds from the federal government.
o One reason a bank may borrow FED funds is that it does not have enough deposits in its Fed Account to meet the minimum required reserves.
o Banks may also find themselves in a position where their loan demand exceeds their available deposit balances e.g. short on funding.
o Funds are transferred from one bank’s account to the other bank’s Fed account using the Fed’s wire transfer system.
o Fed funds are borrowed either through direct negotiations between institutions or via Brokers.
Federal (FED) Funds
o Are short-term securities of global importance.
o They are short-term credit agreements often called time drafts, through which international trade is financed.
o Because merchants or sellers often have difficulty assessing the credit worthiness of overseas customers, they may be more comfortable if a bank guarantees payment for the goods ordered.
o Suppose an importer orders goods and at the same time goes to the bank to finance the purchase. Typically the financing is though a letter of credit (LC). The LC certifies the bank will standby the importer.
o The importer present the LC to the Exporter who now is more comfortable engaging in the transaction. If the financing is approved, the bank notifies the exporter’s bank that funds are forthcoming. Upon guarantee of the payment the exporter ships the goods and forwards shipping documents and a draft (authorization for payment) issued with a specific payment date to his bank. The bank then sends the shipping documents and the draft for collection to the importer’s bank. At that point the importer’s bank stamps the draft “Accepted” and the draft becomes a Bankers Acceptance (BA). The exporter’s bank ships the funds and receives payment from the importer when the goods arrive and are confirmed and inspected by the bank
Bankers Acceptance
o If the importer’s bank has already advanced the funds and it wans to recover the funds before the importer repays the short-term loan it may sell the acceptance to market investors .
o At this point, the purchaser of a BA ha s promise of two parties, the importer and the importer’ s bank that the BA will be paid on the maturity date. For this reason a BA is sometimes called two-name paper.
o Investors purchase the BA security at a discount form the face amount where the investor makes a profit by the difference from what was paid to the investor’s bank to buy the BA and the total funds that the investor receives at maturity.
o Thus, bankers acceptances serve not only as short-term assets to money market investors, but also as a short-term funding source for large banks financing international transactions.
Bankers Acceptance Continued
o Capital market instruments are debt and equity securities whose maturities are greater than one year.
o The exhibit far wider price fluctuations than money market instruments and are considered to be fairly risky instruments. They Include:o Corporate Stockso Mortgageso Corporate Bondso U.S. Government Long-term Securitieso Government Agency Securitieso State and Local Government Bondso Bank Commercial Loanso Consumer Loans
Capital Markets
o Stocks are equity (ownership) claims on the net assets and income of a corporation.
o The total market value of all U.S stocks exceeded $17 trillion at the end of 2010.
o However, the amount of new stock issued any given year is less than 1% of the total market.
o Individuals own around ½ of the value of all shares outstanding and the other half held by mutual funds, pension funds, and insurance companies.
Stocks (Equities)
o Mortgages are loans to house holds and firms looking to purchase land buildings, or both where the land and structure or both serve as collateral on the debt obligation.
o Mortgages are by far the largest debt market in the United States.
o Mortgages are provided by Commercial Banks, Savings and Loans, Mutual Savings Banks, and Insurance Companies.
o For certain niche markets government agencies also fund mortgages like the Federal Farm Home Loan Bank, and the Veterans Administration.
Mortgages
o Residential Mortgages used to purchase residential housing outstanding balances are more than quadruple that of commercial and farm loans.
o Residential mortgages can take the form of Fixed Term Loans, Hybrids, and Adjustable Rate loans.
o Residential Mortgages can be conforming and Non-conforming transactions.
o In 1970 Congress Authorized Fannie Mae to purchase residential mortgage loans. Fannie Mae worked with Freddie Mac to develop uniform documents and notional standards that would be known as a conforming loan.
o The Office of Federal Housing Oversight (OFHEO) set the criteria on what constitutes a Conforming Loan Limit for the two agencies.
o The criteria includes a debt to income ration and documentation limits.
o The maximum Loan Amount is set based on the October-to-October change in median home prices. Loans above this maximum price are called Jumbo loans and are “non-conforming.”
o Freddie and Fannie can only buy conforming transactions and repackage these loans into secondary mortgage backed securities making the demand for non-conforming loans much less.
Residential Mortgages
o Commercial mortgages are use to finance land buildings, and premises that can be used for operations or for investment properties.
oCommercial mortgages where the borrower uses the land or building and resides on the property for operating purposes are called owner occupied.
oCommercial mortgages where the borrower does not occupy the property and collects rents or is intended for resale are called investor Properties.
Commercial Mortgages
o Under U.S. Federal income tax law, a real estate investment trust (REIT) is "any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages" under Internal Revenue Code section 856.
o They sell a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
o Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.
o Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.
o Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.
Real Estate Investment Trusts - REITS
o Land Development Loan – when raw land need to be made construction ready a the borrower obtains a land development loan. The land may be subdivided and sold in a number of parcels for commercial or residential use. (phased performance covenants)
o Acquisition and Development Loan is used if the land is ready for development and needs improvement to infrastructure or existing buildings.
o Mini Perm Loan is a temporary loan used to settle an outstanding construction or commercial property loan that once completed will produce income. After three to five years of generating income the mini perm is replaced with longer-term financing.
o A Takeout Loan replaces financing on projects where a temporary short-term construction loan currently exists. (Require guarantees).
o Interim Construction Loan pay for the labor and materials to finish a project.
Commercial Construction Mortgages
o Corporate Bonds – Long-term debt instruments issued by investment grade corporations that pay holders interest generally bi-annually and the principal at maturity.
o Mortgage-backed Securities - are bond like instruments backed by a bundle of individual mortgages whose interest and principal are paid to the holders. These are often referred to as credit derivatives – since they derive their value from other debt instruments.
o U. S. Government Securities - long-term debt instruments issued by the U.S. Treasury to finance deficits of the Federal Government. Because they are the most widely traded bonds in the United States – they exhibit the most liquidity.
o U.S. Government Agency Securities are – Long-term bond issued by government agencies like Ginnie Mae, the Federal Farm Credit Bank, etc.
o State and Local Government Bonds – called municipal bonds are long-term debt instruments by states and local governments to finance expenditures on roads, infrastructure, schools, and large program. (Tax advantage).
o Consumer and Commercial Bank Loans – largest debt instruments to private sector.
Capital Market Instruments Continued
o Depository Institutions – are financial intermediaries that legally accept deposits from individuals and firms and make loans using a portion of the deposits. Hence they are highly leveraged institutions.
o They include commercial banks, thrift institutions, savings and loan associations, mutual savings banks, and credit unions.
o Because they are involved in the creation of money via deposits and the money multiplier the study of money and banking focuses on these financial institutions.
Financial Intermediaries - Depository Institutions
o Commercial Banks – raise funds by issuing demand and savings, and time deposits.
o They uses these funds to make commercial, consumer and mortgage loans.
o Banks obtain an operating charter at the federal of state level - those that are chartered at the federal level are called national banks.
o The regulator for most national banks is the Comptroller of the Currency (OCC) which was created by the National Banking Act of 1864.
o The National Banking act established standards a bank must meet before receiving a national charter.
o The current duel banking system where both the federal government and state governments issue bank charters is traced back to this period.
o The Federal Reserve System was created by the Federal Reserve Act of 1913 to ensure the existence of both a flexible payment system and as the lender of last resort to banks.
o As a result all federally chartered banks must be members of the Fed and the Fed also provides supervision over federally chartered banks as well as state chartered banks that join the Fed. Note virtually all banks now belong to the FED.
Depository Institutions – Commercial Banks
o These institutions sometimes called Thrifts, also are chartered either federally or by states.
o The Federal Home Loan Bank Board and the Office of Thrift and Supervision (OTS) was established in 1932 to oversee and supervise thrifts.
o These institutions are primarily funded through savings deposits called shares and time and DDA deposits.
o In the past these institutions could only make residential mortgage loans but the regulations have been loosened such they act as commercial banks. (Note many have actually been acquired by commercial banks).
Depository Institutions – S&Ls and Mutual Saving Banks
o Are smaller co-ops organized around a particular group or union of members, employees of a firm etc. who basically own the organization.
o They acquire funds form deposits of the members and used these funds to make consumer loans – most often to its members.
o They are also chartered though either states for the federal government.
o The major regulator for credit unions is the National Credit Union Administration (NCUA).
Depository Institutions – Credit Union
o Finance Companies raise funds by selling commercial paper and by issuing stock and bonds. They lend the funds to consumers to purchase consumer durable goods like automobiles, furniture, and for home improvement where the goods or homes serve as collateral.
o Mutual Funds are financial intermediaries that sell shares to large groups of individuals and use the funds to purchase diversified pools portfolios of stocks and bonds. They allow shareholders to reduce transaction cost by large blocks of stocks or bonds. They help members hold more diversified portfolios and make money through management fees.
o Money Market Funds are similar to mutual funds but offer deposit like accounts that pay interest to the depositors. Like mutual funds they sell shares to acquire money market instruments and use the instruments to pay interest to their share deposits.
o Investment Banks are not banks but help corporations issues securities like stock and bonds. They help the corporations decide what type of security to issue and then underwrite the security by purchasing the security at a predetermined price and then selling them in the market. They make money by underwriting fees and from the difference they pay to the corporation to obtain the initial offering and what they sell the stock in the market.
Other Depository Institutions
o Economists define money as anything that is generally accepted in payment for goods, services, or the repayment of debt.
o When most people talk about money today they think of coin or currency.
o However to define money as only coin or currency is too narrow a definition for economist. For example, checks are also accepted for payment so would they also be considered money?
o Money is also confused with wealth. Money is used to make purchases of goods and services whereas wealth is the total collection of the individual’s assets which includes money.
o Money is also used to describe income. Income on the other hand is a flow of earnings at a point in time. Whereas money is a stock – it is a certain amount at a given time by looking at the total money balances you cannot tell where it came from or necessarily when it was accumulated. (What is the difference between nominal and real values?)
Money
o In every economy money serves three basic functions:o Medium of exchange – here money is
used to pay for goods and services.o Unit of account – used to measure the
relative value of something ( Market economies and prices help move goods and services to highest perceived value.
o Store of value – where money acts as a repository of purchasing power to utilized at a future date.
Functions of Money
o Medium of exchange – here money is used to pay for goods and services which promotes economic efficiency by reducing the time spent in exchanging goods and services (called transaction cost).
o If I want to eat in a barter economy I must find someone who wants to learn about money and banking and produces the food I like to eat.
o In such an economy transactions only occur between two individuals if both peoples wants are satisfied. This is called double coincidence of wants. (Important concept in a market economy).
o The time necessary trying to satisfy all the potential double coincidences is high in a barter economy. Money reduces the time to find all the people who will be wiling to trade goods and services.
Functions of Money – Medium of Exchange
o Imagine how difficult it would be trying to find how many people would trade bread for shoes. Moreover how much bread equates to a pair of shoes?
o If you only had three goods then one would only need to know only three prices relative to each other to make an exchange.
o Now assume that we have 1,000 different goods to trade. Each item would need 999 different price tags to estimate how much each of the other goods is necessary to make an exchange.
o When we introduce money as a common measure, it is easy to exchange good s and services in terms of the amount of money need. This in turn also lowers transaction costs.
Functions of Money – Unit of Account
o Money also functions as a store of value – a repository of future purchasing power. Most of us do not spend all our income all at once. Rather we purchase goods and services as we need them.
o Any asset can act as a store of value. However as we noted in barter economy exchanging goods and services particularly in the future is costly.
o The ease and speed at which assets can be converted into a medium of exchange ( or exchanged for that matter) is called liquidity.
o Liquidity is highly desirable and money is the most liquid of assets because it does not have to be converted into anything else to make exchanges.
o How good money functions as a store of value depends on the price level. For example if prices double money’s value and declined by half. This is trued during extreme periods where the inflation rate exceeds 50%. (Example Germany between WWI and WWII). Can you think of a modern example today?
Functions of Money – Store of Value
o Inflation is a continual increase in aggregate prices that affects business, individuals and the government.
o Substantial evidence exists to suggest that inflation is tied to increases in the money supply.
o Demand pull inflation best known by Americans stating in 1960 and latter sometimes called wage inflation. It occurs when workers experience wage increase leading to increased demand the exceeds aggregate out put thus leading individuals to bid up prices.
o Cost push inflation or commodity inflation. It arises from either (1) increased demand for raw materials that dive up their price and the price increased is passed along tot the end product or (2) an interruption in the supply of a commodity that increases the price of the end product( give examples).
o Monetary inflation that was famously seen in Weimar Germany in the 1920s when the German government when the government printed billions of marks such that it tool billions to equal one dollar (note arbitrage and parity effects).
Inflation
o By examining the evolution of payment systems we can get a better picture of the types of money and its functions.
o Commodity Money – For thousands of years commodity money made up of various rare raw material like precious metals served as the medium of exchange. (what is the problems associated with this type of money?) (Does it have to be rare minerals – Egypt).
o Fiat Money – paper currency (lighter and easier to store and protect). Originally paper money carried a guarantee that is was convertible to commodity money (e.g. backed). Later however, governments declared (by Fiat) that paper money would be legal tender accepted for payment on all goods, services , and debt but not “backed” by precious metals. (What is the first example in U.S.)
Money Types
o Money is anything that is accepted for payment. What makes an asset money is the faith that other people will accept it for payment.
o Since there are so many different things that can be accepted for money in our modern economy – measuring how much money is in the economy is difficult.
o The Federal Reserve bank is responsible for monetary policy in the United States. However to conduct monetary policy one has to measure the money supply.
o Because of financial and technical innovation the Fed has modified how it measures money several times since the 1980.
Problem of Measuring Money
o The Feds narrowest definition for money is M1:o M1 includes the most liquid assets:o Currencyo Checking Accounts (DDA)o Traveler’s Checks – (What is this?).
o Currency includes only coin and currency in the hands of non-bank public and does not include cash in vaults or ATMS. (Why? What is Velocity?)
o Checks includes DDA for consumers and business that do not pay interest. As well as DAA account held by households that pays interest
o Traveler’s Checks only measures checks not issued by banks.
Measuring Money – M1
o M2: In addition to all the components of M1 M2 adds:o Small time deposits (TDA) – (What do we mean by
small?)o Savings deposits (Large TDA, CDs etc.) and money
market deposit accounts. o Retail money market mutual funds (Why only retail).
o What characteristics do saving accounts exhibit. Why are TDA’s less liquid?
o What are money market accounts and what is the difference between money market accounts and money market mutual funds? Why are money market and money market mutual funds less liquid than DDAs?
Measuring Money – M2
Monetary Aggregates
Currency
Traveler’s Checks
Demand Deposits
Other Check. Dep
M1 (4)M2 (4+3)
M3 (4+3+4)
Small Den. Dep.
Savings and MM
Money Market Mutual Funds Shares
Table 1 Measures of the Monetary Aggregates
Figure 1 Growth Rates of the M1 and M2 Aggregates, 1960–2011
Sources: Federal Reserve Economic Database (FRED); Federal Reserve Bank of Saint Louis; http://research.stlouisfed.org/fred2/categories/25Why would M1 and M2 move in opposite directions?