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Money, Banking & Financial Institutions (Components of the Money…

- - - - Money allows society to escape the complications of barter.
        
        .Money provides a convenient way of exchanging goods, money enables society to gain the advantages of geographic and human specialization.
  - - - Money aids rational decision making by enabling buyers an sellers to easily compare the prices of various goods, services and resources.
        
        Money permits us to define debt obligations, determine taxes owed, and calculate the nation's GDP.
  - - - People do not spend all their income, they store some of their wealthy as money to buy things later.
        
        When inflation is nonexistent or mild, holding money is a relatively risk-free way to store your wealth for later use.
        
        Key advantage that money has over all other assets is that it has the most liquidity, or spendability.
        
        An asset's liquidity is the ease with which it can be converted quickly into the most widely accepted and easily spent form of money, cash, with little or no loss of purchasing power.
        
        Cash = Perfectly Liquid.
        
        House = Highly Illiquid
- - - - Narrowest Definition - Consists of 2 components
        
        1. Currency: Coins & Paper Money (in the hands of the public)
        
        Coins issued by US Treasury AND Paper Money issued by Federal Reserve System (The US Central Bank)
        
        Currency = Token Money
        
        Face Value of any piece of currency is unrelated to its intrinsic value (the value of the physical material (metal or paper and ink).
        
        Governments ensure that face values exceed intrinsic values.
        
        2. Checkable Deposits (all deposits in commercial banks and "thrift"/savings institutions on which checks of any size can be drawn)
        
        Checkable Deposits are safe & convenient and makes up a large component of the M1 Money Supply.
        
        Checks are nothing more than a way to transfer the ownership of deposits in bank ad other financial institutions and are generally acceptable as a medium of exchange.
        
        People can convert checkable deposits into paper money an coins on demand; checks drawn on those deposits are thus the equivalent of currency.
    - - Broader Definition of Money = M1 + Several Near Monies
        
        Near Monies are certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits.
        
        1. Savings deposits, including money market deposit accounts (MMDA)
        
        Depositor can easily withdraw funds from Savings account at a bank/thrift OR request funds to be transferred from a Savings to a Checkable Account.
        
        A person can withdraw funds from a MMDA, which is an interest-bearing account containing a variety of interest-bearing short-term securities.
        
        MMDA's have a minimum balance requirement and a limit on how often a person can withdraw funds.
        
        2. Small-denominated (less than $100,000) time deposits.
        
        Funds from time deposits become available at their maturity date e.g a person can convert a 6-month time deposit (certificate of ddeposit/CD) to currency without penalty 6 months or more after it has been deposited.
        
        The financial institution pays a higher interest rate on these deposits than it does on its MMDA's.
        
        People can cash in a "CD" at anytime but will pay severe penalty
        
        3. Money market mutual funds held by individuals
        
        A depositor can redeem shares in a money market mutual fund (MMMF) offered by a Mutual Fund Company (3rd party).
        
        Such companies use the combined funds of individual shareholders to buy interest-bearing short-term credit instruments such as certificates of deposit and U.S. Government securities. Then they can offer interest on the MMMF accounts of the shareholders (depositors) who jointly own those financial assets.
        
        The MMMF's in M2 include ONLY the MMMF accounts held by individuals; those held by businesses and other institutions are excluded.
        
        Money, M2 = M1 + Savings Deposits, including MMDA's + Small-Denominated (less than $100,000) time deposits + MMMF's held by individuals
  - - - Reason: To avoid double counting
    - - Reason: To enable a better assessment of the amount of money available to the private sector for potential spending. The amount of money available to households and businesses is of keen interest to the Federal Reserve in conducting its monetary policy.
- - - - Savings & Loan Associations and Mutual Savings Banks accepts the deposits of households and businesses and then use the funds to finance housing mortgages and to provide other loans.
      - Credit Unions accept deposits from and lend to "members", who usually are a group of people who work for the same company.
- - - - Paper Money = Circulating debt of the Federal Reserve Banks
      - Checkable Deposits = The debts of commercial banks and thrift institututions
      - Paper Currency & Checkable Deposits have NO intrinsic value.
        
        If the government backed the currency with something tangible like gold, then the supply of money would vary with how much gold was available.
        
        By not backing the currency, the government avoids this constraint and indeed receives a key freedom - the ability to provide as much or as little money as needed to maintain the value of money and to best suit the economic needs of the country.
        
        By choosing not to back the currency, the government has chosen to give itself the ability to freely "manage" the nation's money supply.
        
        It's monetary authorities attempt to provide the amount of money needed for the particular volume of business activity that will promote full employment, price-level stability and economic growth.
        
        If nation's gold stock increase due to new discovery it might increase the money supply too rapidly and trigger rapid inflation
        
        A decline in gold production might reduce the money supply to the point where recession and unemployment resulted.
  - - - Currency and checkable deposits are money because people accept them as money. They are acceptable as a medium of exchange.
        
        We accept paper money in exchange because we are confident it will be exchangeable for real goods, services, and resources when we spend it.
    - - Our confidence in the acceptability of paper money is strengthened because the government has designated currency as legal tender.
        
        The general acceptance of paper currency in exchange is more important than the government's decree that money is legal tender, however.
        
        The government has never decreed checks to be legal tender, and yet they serve as such in many of the economy's exchanges of goods, services, and resources.
        
        Government agencies do however insure individual deposits of up to $250,000 at commercial banks and thrifts. That fact enhances our willingness to use checkable deposits as a medium of exchange.
    - - The value of money, like the economic value of anything else, depend on its supply & demand.
        
        Money derives its value from its scarcity relative to its utility.
        
        The utility of money lies in its capacity to be exchanged for goods now or in future.
        
        The economy's demand for money depends on the total dollar volume of transactions in any period plus the amount of money individuals & businesses want to hold for future transactions.
        
        With a reasonably constant demand for money, the supply of money provided by the monetary authorities will determine the domestic value or "purchasing power" of the monetary unit.
  - - - Purchasing Power of the Dollar
        
        The amount a dollar will buy varies inversely with the price level (interest rate); that is a reciprocal relationship exists between the general price level and the purchasing power of the dollar.
        
        When the Consumer Price Index (CPI) or Cost-Of-Living Index goes up, the value of the dollar goes down, and vice versa.
        For ex. If price level doubles, the value of the dollar declines by one-half, or 50%
        
        Equation Form: $V = 1/P
        
        Divide 1 by the price level P expressed as an index number (in hundredths). If the price level is 1 then the value of the dollar is 1. If the price level rises to say 1.20, $V falls to 0.833; a 20 percent increase in the price level reduces the value of the dollar by 16.67 percent.
      - Inflation & Acceptability
        
        When a nation's currency became worthless or unacceptable in exchange they can move to a foreign currency (to counter hyperinflation) or they might simply revert to barter (trading goods without money).
        
        Instances of runaway inflation or hyperinflation, happened when the government issued so many pieces of paper currency that the purchasing power of each of those units of money was almost totally undermined.
        
        Runaway inflation may significantly depreciate the value of money between the time it is received and the time it is spend. Rapid declines in the value of a currency may cause it to cease being used as a medium of exchange.
  - - - Since the purchasing power of money and the price level vary inversely, stabilization of the purchasing power of a nation's money requires stabilization of the nation's price level.
        
        Such price-level stability mainly necessitates intelligent management or regulation of the nation's money supply and interest rates (monetary policy).
        
        It also requires appropriate fiscal policy supportive of the efforts of the nation's monetary authorities to hold down inflation.
        
        Monetary Authorities make available a particular quantity of money, such as M2 but can change that amount through their policy tools.