What Is Money and Why Do We Need It?

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What Is Money and Why Do We Need It?. Money Assets that people are generally willing to accept in exchange for goods and services or for payment of debts. Asset Anything of value owned by a person or a firm. The Functions of Money. Medium of exchange : buy stuff with money - PowerPoint PPT Presentation

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<p>Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.</p> <p>M1: The Narrowest Definition of the Money SupplyM1 includes means of payment:Currency: paper money and coins in circulation. in circulation means not held by banks or the government2 The value of all checking account deposits at banks3 The value of travelers checksHow Is Money Measured in the United States Today?1 Because balances in checking accounts are in the money supply, banks play an important role in the way money supply increases and decreases. What about Credit Cards and Debit Cards?You havent paid until you write a check to your bank.Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 433How Do Banks Create Money in a Fractional Reserve Banking System?Reserves Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve.Required reserves Reserves that a bank is legally required to hold, based on its checking account deposits.Required reserve ratio The minimum fraction of deposits banks are required by law to keep as reserves.Excess reserves Reserves that banks hold over and above the legal requirement.Banks buy interest yielding assets with deposits they dont keep in reserves:Govt securities, loans to households and firmsChapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 435How Do Banks Create Money?</p> <p>A Banks Balance Sheet</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 436How Do Banks Create Money?</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 437How Do Banks Create Money?</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 438How Do Banks Create Money?Bank Balance SheetsBalance Sheet for Bank of America, December 31, 2008The items on a banks balance sheet of greatest economic importance are its reserves, loans, and deposits. The difference between the value of Bank of Americas total assets and its total liabilities is equal to its stockholders equity. As a consequence, the left side of the balance sheet always equals the right side.</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 439How Do Banks Create Money?BANKINCREASE IN CHECKING DEPOSITSWachovia$1,000PNC+ 900 (= 0.9 x $1,000)Third Bank+ 810(= 0.9 x $900)Fourth Bank+ 729(= 0.9 x $810). + . + . +Total Change in Checking Account Deposits=$10,000 Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4310How Do Banks Create Money?Simple deposit multiplier The ratio of the amount of deposits created by banks to the amount of new reserves.</p> <p>Change in bank reserves =RR x Change in depositsThe Simple Deposit Multiplier versus the Real-World Deposit Multiplier:Not everything that one bank lends gets deposited in other banks.Much leaks out as currency holdings rather than deposits.And banks may not lend to full extent the canthey hold excess reserves.Real world deposit multiplier is less than the simple multiplier.Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4311The Functions of a Modern Central BankThe Bankers Bank:Lender of last resort in crisesBank run: When many depositors rush to withdraw money at the same time...They run to get to the cashier.Silent run: Major creditors dont turn over their loans to a bank.Bank panic: Many banks experience runs at the same time.Operates clearing system for interbank payments.Oversees financial intermediaries - ensure their soundness. - ensure public confidenceThe Government's Bank:Manages government transactions.Controls availability of money and credit.</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4312The Federal Reserve SystemThe Organization of the Federal Reserve SystemFederal Reserve Districts</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4313How the Federal Reserve Manages the Money SupplyMonetary policy The actions the Federal Reserve takes to manage the money supply and interest rates in pursuit of economic objectives.To manage the money supply, the Fed uses three monetary policy tools:1 Open market operations: Fed buys and sells govt securitiesFederal Open Market Committee (FOMC) sets target federal funds rate.Federal funds are reserves that banks borrow and lend to each other.Fed buys bonds to increase the supply of reserves and lower the fed funds rate.2 Discount policy: Fed lends to banks @ discount rate injects reserves into banking system directly3 Reserve requirements: lowering reserve requirement converts required reserves to excess reserves that banks can lendTwo other actorsthe nonbank public and banksalso influence the money supply.</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4314Multiple Creation of Money and CreditFed buys something MB upA bondA bank IOUSeller deposits proceed in Bank AMoney supply increases Bank As deposits @ Fed upBank A now has more reservesBank A holds reserves against its new deposit (required + excess)Bank A makes loan to customerBorrower now has more deposits Money has just been createdBorrower buys somethingSeller holds onto currency and deposits the rest in its Bank BBank Bs deposits @ Fed up:</p> <p>The Feds Balance Sheet</p> <p> Owns Owes .Gold, Forex Federal Reserve NotesCurrency in CirculationVault Cash ReservesBank IOUs Bank Deposits @ Fed(Discount loans) Bank A Bank B :Securities Govt Deposits Govt Bonds MBSs Miscellaneous</p> <p>Monetary Base High Powered= MB Money = H = MBNote: MB = Currency + Bank Reserves = Cu + RMs = Currency + Demand Deposits = Cu + D</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 43Connecting Money and Prices: The Quantity EquationM V = P YThe Quantity Theory of MoneyVelocity of money The average number of times each dollar in the money supply is used to purchase goods and services included in GDP.</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4316The Quantity Theory Explanation of InflationWe can transform the quantity equation from:Growth rate of the money supply + Growth rate of velocity = Growth rate of the price level (or inflation rate) + Growth rate of real output</p> <p>to:Inflation rate = Growth rate of the money supply + Growth rate of velocity Growth rate of real outputorIf velocity is constant, then the growth rate of velocity is zero. This allows us to rewrite the equation one last time:Inflation rate = Growth rate of the money supply Growth rate of real outputChapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4317High Rates of InflationVery high rates of inflationin excess of hundreds or thousands of percentage points per yearare known as hyperinflation.</p> <p>Economies suffering from high inflation usually also suffer from very slow growth, if not severe recession.Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4318The Quantity Theory of MoneyHigh Inflation in ArgentinaMoney Growth and Inflation in Argentina</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4319The German Hyperinflation of the Early 1920sMakingtheConnectionDuring the hyperinflation of the 1920s, people in Germany used paper currency to light their stoves.</p> <p>Chapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4320K e y T e r m sAssetBank panicBank runCommodity moneyDiscount loansDiscount rateExcess reservesFederal Open MarketCommittee (FOMC)Federal Reserve SystemFiat moneyFractional reserve banking systemM1M2Monetary policyMoneyOpen market operationsQuantity theory of moneyRequired reserve ratioRequired reservesReservesSimple deposit multiplierVelocity of moneyChapter 13: Money, Banks, and the Federal Reserve System 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien, 2e.# of 4321</p>

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