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7/29/2019 Money, Baking, and Credit
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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
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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.
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Portability
Divisibility
Durability
Stability
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Monetary assets (Liquid
assets)Non-monetary Assets
(illiquid assets)
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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.
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Metallic coins and paper
currency are the onlyforms of legal tender.
Legal tender is fiatmoney
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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.
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1. Ease and safety Transaction
Paying for goods and services with
check is easier and less risky than payingwith paper money
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2. Lower Transaction Costs
Transaction deposits are popular
precisely because they lower transactioncosts compared with the use of metal orpaper currency.
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3. Transaction Records
They provide a record of financial
transactions
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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.
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Funds that cannot be used for paymentdirectly but must be converted into
currency for general use.
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Nontransaction deposits that are notmoney but can be quickly converted
into money.
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Interest-earning accounts provided bybrokers that pool funds into such
investments as treasury bills.
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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.
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M1: Spendable
Currency
Demand deposits
M2: Spendable plus Convertible
Time deposits Money market mutual
funds
Savings deposit
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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
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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.
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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
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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.
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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.
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Collecting higher interest payments on
the loans they make than they paytheir depositors for those funds.
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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.
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$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
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A system that requires banks to
hold reserves equal to somefraction of their checkabledeposits.
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Money, Interest Rates andAggregate Demand
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Market where money demand and
money supply determine the equilibriumnominal interest rate.
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Transaction purposes
Precautionary Reasons
Asset purposes
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For a given
level of
income, real
money
demanddecreases
as the interest
rate increases.
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When income
increases,
real money
demandincreases at
every interest
rate.
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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.
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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.
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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
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Open market operations
Involve the purchase of sale and government bonds
by the Federal Reserve System
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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.
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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
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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
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- 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.
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- 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.
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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
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Boston, New York, Philadelphia,
Richmond, Atlanta, Dallas, Cleveland,Chicago, St. Louis, Minneapolis- St, Paul,Kansas City, and San Francisco
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FED was created in 1913
It was privately owned by the banks that
belong to it. Banks are not required tobelong to the FED.
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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.
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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.
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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.
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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
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-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
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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.
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Economists once considered thevelocity of money a given.
The velocity is less stable whenmeasured using the M1 definition andover shorter periods of time.
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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%.
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The economy faces an Inflationary Gap.
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I. How the CommercialBanks Implement the Feds
Monetary Policies
- monetary policy must
ultimately be carried out
through the commercialbanking system
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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
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III. Fiscal and Monetary Problems
- macroeconomic problem arise if
the federal governments fiscaldecision makers differ with the
Feds monetary policy
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IV. Alleviating Coordination
Problems
- attempt is made to reach aconsensus on the appropriate
policy response, both monetary
and fiscal; still there is often somedisagreement
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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
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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
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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.
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VII. Unexpected Global and TechnologicalEvents
- terrorists attacks on 09/11/11- 1997-1998 currency crisis in East Asia,
economic activity either slowed or
declined