Unit 9 - Functions of Money n The Functions of Money A society without any form of money is called a barter economy. Goods and services are traded directly

Unit 9 - Functions of MoneyUnit 9 - Functions of Money

The Functions of MoneyThe Functions of Money

A society without any form of money is called A society without any form of money is called a barter economy. Goods and services are a barter economy. Goods and services are traded directly for other goods and services.traded directly for other goods and services.

In a barter economy there must be a double In a barter economy there must be a double coincidence of wants for a trade to take coincidence of wants for a trade to take place.place.

Macroeconomics

Unit 9 - Functions of MoneyUnit 9 - Functions of Money The Functions of MoneyThe Functions of Money

In a barter economy trading and In a barter economy trading and specialization are limited.specialization are limited.

Thus, the standard Thus, the standard of living is lower.of living is lower.

Macroeconomics

Is money the root of all evil?Is money the root of all evil?

1.1. YesYes

2.2. NoNo

3.3. Not sureNot sure

4.4. Most of the timeMost of the time

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An economy without any form of money An economy without any form of money (barter) still is likely to have acts of (barter) still is likely to have acts of robbery, burglary and violence. Thus, robbery, burglary and violence. Thus, money must not be the root of all evil.money must not be the root of all evil.

Money makes it Money makes it easier to commit easier to commit crimes and commit evil. crimes and commit evil.

Macroeconomics

Which of the following is NOT a Which of the following is NOT a recognized function of moneyrecognized function of money

1.1. Medium of Medium of exchangeexchange

2.2. Standard of Standard of valuevalue

3.3. Creator of Creator of wealthwealth

4.4. Store of valueStore of value

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Medium of ExchangeMedium of Exchange

Money is exchanged for products. Money is exchanged for products.

Macroeconomics


Standard of ValueStandard of Value

Money prices make it easier to Money prices make it easier to determine how much products are determine how much products are worth.worth.

Macroeconomics


Store of ValueStore of Value

Money makes it easier to accumulate Money makes it easier to accumulate wealth.wealth.

Macroeconomics


Money Supply MeasuresMoney Supply Measures

Common U.S. money supply measures Common U.S. money supply measures are:are:

The Monetary BaseThe Monetary Base M1M1 M2M2 M3M3

Macroeconomics



The monetary base is:The monetary base is:Bank reserves + Currency in the Bank reserves + Currency in the Hands of the Non-bank Public.Hands of the Non-bank Public.Bank reserves are funds held by Bank reserves are funds held by banks that can be loaned out. banks that can be loaned out.

Currency includes paper money and Currency includes paper money and coins.coins.

Macroeconomics



M1 = Currency + Traveler’s Checks + M1 = Currency + Traveler’s Checks + Demand Deposits + Other Checkable Demand Deposits + Other Checkable Deposits.Deposits.

M1 contains forms of money that you M1 contains forms of money that you can use to buy common products at can use to buy common products at groceries, department and other groceries, department and other stores.stores.

Macroeconomics



M2 = M1 + MMMFs + Short Term CDs + M2 = M1 + MMMFs + Short Term CDs + Small Time DepositsSmall Time Deposits

MMMF = money market mutual funds (a MMMF = money market mutual funds (a form of savings).form of savings).CD = certificate of deposit (savings with a CD = certificate of deposit (savings with a fixed interest rate)fixed interest rate)Small time deposits = money in small Small time deposits = money in small savings accounts.savings accounts.

Macroeconomics



M3 = M2 + Large Time Deposits + RPs + M3 = M2 + Large Time Deposits + RPs + Eurodollars + Institution held MMMFsEurodollars + Institution held MMMFs

Large time deposits = money in large Large time deposits = money in large (corporate) savings accounts.(corporate) savings accounts.RP = repurchase agreements (savings with RP = repurchase agreements (savings with collateral in the form of bonds).collateral in the form of bonds).Eurodollars = dollar savings in foreign Eurodollars = dollar savings in foreign countries.countries.

Macroeconomics



For the latest money supply statistics, For the latest money supply statistics, visit:visit:http://www.federalreserve.govhttp://www.federalreserve.gov

Macroeconomics


The Federal Reserve SystemThe Federal Reserve System

The Federal Reserve System is the The Federal Reserve System is the central banking system of the United central banking system of the United States.States.

It was created in 1913, and includes 12 It was created in 1913, and includes 12 central banks, a Federal Reserve Board, central banks, a Federal Reserve Board, various committees, and member banks.various committees, and member banks.

Macroeconomics



The Federal Reserve acts The Federal Reserve acts independently from Congress.independently from Congress.

Macroeconomics

Federal ReserveBuilding in Washington, D.C.

The Capitol in Washington, D.C.

Unit 9 - Functions of MoneyUnit 9 - Functions of Money Organization of the Federal Organization of the Federal

Reserve SystemReserve System

Macroeconomics

Fed Board(7 members)FOMC

(12)

FAC

Central Banks (12)and Central Bank Branch Banks (25)

BankBank BankBank

Bank


Organization of the Federal Reserve SystemOrganization of the Federal Reserve System

The FOMC is the Federal Open Market The FOMC is the Federal Open Market Committee. It consists of the 7 Board Committee. It consists of the 7 Board members plus 5 central bank presidents. It members plus 5 central bank presidents. It is the decision-making committee.is the decision-making committee.

The FAC is the Federal Advisory Committee.The FAC is the Federal Advisory Committee.

Macroeconomics



Federal Reserve Functions include:Federal Reserve Functions include: Control of the money supplyControl of the money supply Supervision of banksSupervision of banks Check clearingCheck clearing Statistics gathering and researchStatistics gathering and research

Macroeconomics


The Fed and the Money SupplyThe Fed and the Money Supply

The Fed controls the money supply The Fed controls the money supply throughthrough

1. Open Market Operations1. Open Market Operations

2. Reserve Requirement Policy2. Reserve Requirement Policy

3. Discount Rate Policy3. Discount Rate Policy

Macroeconomics



Open market operations: the Fed buys Open market operations: the Fed buys and sells government bonds in the open and sells government bonds in the open market.market.

Government bonds are formal Government bonds are formal agreements between the government agreements between the government and businesses or individuals who loan and businesses or individuals who loan the government money in exchange for the government money in exchange for interest and re-payment of principal.interest and re-payment of principal.

Macroeconomics



When the Fed buys bonds, the public When the Fed buys bonds, the public receives money in exchange for bonds. receives money in exchange for bonds. The Fed prints money to pay for the The Fed prints money to pay for the bonds. This increases the money supply.bonds. This increases the money supply.

When the Fed sells bonds, the money When the Fed sells bonds, the money supply decreases.supply decreases.

Macroeconomics

United States

Treasury

Federal Reserve

The Public

Treasury securities

Payment for securities (public loans money to the

U.S. government)Payment for securities

(Fed buys securities in the open market)

Treasury Securities


Unit 9 - Functions of MoneyUnit 9 - Functions of Money The Fed and the Money SupplyThe Fed and the Money Supply

Reserve Requirement PolicyReserve Requirement Policy

When businesses or individuals deposit When businesses or individuals deposit money in a bank, the bank must keep a money in a bank, the bank must keep a percentage of the deposited amount percentage of the deposited amount (the reserve requirement). The bank (the reserve requirement). The bank can loan out the rest. can loan out the rest.

Macroeconomics

Unit 9 - Functions of MoneyUnit 9 - Functions of Money The Fed and the Money SupplyThe Fed and the Money Supply

Reserve Requirement PolicyReserve Requirement PolicyFor most checking accounts, the reserve For most checking accounts, the reserve requirement percentage is 10%. When the requirement percentage is 10%. When the reserve requirement percentage is lowered, reserve requirement percentage is lowered, banks can loan more money and money in banks can loan more money and money in circulation increases.circulation increases.

When the Fed raises the percentage, money When the Fed raises the percentage, money in circulation decreases.in circulation decreases.

Macroeconomics



Discount Rate PolicyDiscount Rate PolicyThe discount rate is the interest rate on The discount rate is the interest rate on loans from the Fed to individual banks.loans from the Fed to individual banks.When the Fed raises the rate, money in When the Fed raises the rate, money in circulation decreases.circulation decreases.When the Fed lowers the rate, money When the Fed lowers the rate, money in circulation increases.in circulation increases.

Macroeconomics

Unit 9 - Functions of MoneyUnit 9 - Functions of Money Fractional Reserve BankingFractional Reserve Banking

Banks can loan out a percentage (fraction) Banks can loan out a percentage (fraction) of the money deposited by customers (and of the money deposited by customers (and capital kept by the bank). Let’s say capital kept by the bank). Let’s say someone deposits $1,000:someone deposits $1,000:

Macroeconomics

Bank AAssets Liabilities

$1,000 Deposits$1,000 Cash

Unit 9 - Functions of MoneyUnit 9 - Functions of Money Fractional Reserve BankingFractional Reserve Banking

Assume that the reserve requirement Assume that the reserve requirement is 10%, and bank A loans out 90% of is 10%, and bank A loans out 90% of the deposited money:the deposited money:

Macroeconomics

Bank AAssets Liabilities

$1,000 Deposits$100 Cash$900 Loans


Fractional Reserve BankingFractional Reserve Banking

The person who borrows the $900 The person who borrows the $900 spends it. The recipient of the $900 spends it. The recipient of the $900 deposits it into:deposits it into:

Macroeconomics

Bank B Bank BA AL L

$900 Deposits$900 Cash $900 Deposits$90 Cash$810 Loans



This process of money creation This process of money creation continues with Bank C, bank D, etc.continues with Bank C, bank D, etc.

Macroeconomics

Bank CA L

$810 Deposit$810 Cash



The total increase in deposits equalsThe total increase in deposits equals$1,000 + $900 + $810 + $... = $1,000 + $900 + $810 + $... = $10,000.$10,000.

Macroeconomics



$10,000 = 10 x $1,000 $10,000 = 10 x $1,000 In general: In general: The total increase in the nation’s money The total increase in the nation’s money supply = supply = the money multiplier x the initial deposit.the money multiplier x the initial deposit.

The money multiplier is 1/reserve requirement. The money multiplier is 1/reserve requirement.

Macroeconomics


Velocity of MoneyVelocity of Money

Velocity is speed.Velocity is speed.

Velocity of money is how fast the Velocity of money is how fast the same quantity of money turns over to same quantity of money turns over to buy products (GDP) in one period of buy products (GDP) in one period of time (usually one year).time (usually one year).

Macroeconomics


Velocity of MoneyVelocity of Money

Velocity is defined as V = GDP/MVelocity is defined as V = GDP/M

If GDP = $12,000 billion and M = 2,000 If GDP = $12,000 billion and M = 2,000 billion, thenbillion, then

V = $12,000/2,000V = $12,000/2,000

or: V = 6.or: V = 6.

Macroeconomics

Unit 9 - Functions of MoneyUnit 9 - Functions of Money Velocity of MoneyVelocity of Money

If V = GDP/MIf V = GDP/MThen, after cross-multiplying,Then, after cross-multiplying,V = P x Q/MV = P x Q/Mor P x Q = M x Vor P x Q = M x V

The Quantity Theory of Money:The Quantity Theory of Money:As M increases, so does P. There is a direct, As M increases, so does P. There is a direct, (but not always proportional) relationship (but not always proportional) relationship between M and P.between M and P.

Macroeconomics

Documents

Unit 9 - Functions of Money n The Functions of Money A society without any form of money is called a barter economy. Goods and services are traded directly