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Money, Banking, and Monetary Policy and Money Creation - Coggle Diagram

- - - - Liquidity
        
        The degree to which an asset can be converted quickly into cash with little or no loss of purchasing power. Money is said to be perfectly liquid, whereas other assets have lesser degrees of liquidity.
- - - - The most narrowly defined money supply, equal to currency in the hands of the public and the checkable deposits of commercial banks and thrift institutions.
      - Two components
        
        Currency (coins and paper money) in the hands of the public.
        
        Checkable deposits in commercial banks and “thrift” or savings institutions on which checks of any size can be drawn, at any time and as often as desired.
      - Key definitions and concepts
        
        Currency: Coins + Paper Money
        
        U.S. currency consists of metal coins and paper money
        
        Federal Reserve Note
        
        Paper money issued by the Federal Reserve Banks.
        
        Token money
        
        Bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency still circulating, money for which the face value exceeds the commodity value.
        
        Checkable Deposits
        
        Any deposit in a commercial bank or thrift institution against which a check may be written.
        
        Safer and more convenient
        
        Institutions That Offer Checkable Deposits
        
        Commercial bank
        
        A firm that engages in the business of banking (accepts deposits, offers checking accounts, and makes loans).
        
        Commercial bank loans provide short-term financial capital to businesses, and they finance consumer purchases of automobiles and other durable goods.
        
        Thrift institution
        
        A savings and loan association, mutual savings bank, or credit union.
        
        Savings and loan associations and mutual savings banks accept the deposits of households and businesses and then use the funds to finance home 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.
        
        Two Qualifications
        
        By excluding currency held by banks when determining the total money supply, we avoid this problem of double counting.
        
        Excluded from the money supply are any checkable deposits of the government (specifically, the U.S. Treasury) or the Federal Reserve that are held by commercial banks or thrift institutions. This exclusion enables a better assessment of the amount of money available to the private sector for potential spending.
  - - - A more broadly defined money supply, equal to M1 plus noncheckable savings accounts (including money market deposit accounts), small time deposits (deposits of less than $100,000), and individual money market mutual fund balances.
      - Components of M2
        
        Small-denominated (less than $100,000) time deposits
        
        Time deposit
        
        An interest-earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specified period.
        
        Money market mutual funds held by individuals
        
        Mutual funds that invest in short-term securities. Depositors can write checks in minimum amounts or more against their accounts.
        
        Savings deposits, including money market deposit accounts
        
        Money market deposit accounts (MMDAs)
        
        Interest-bearing accounts offered by commercial banks and thrift institutions that invest deposited funds into a variety of short-term securities. Depositors may write checks against their balances, but there are minimum-balance requirements as well as limits on the frequency of check writing and withdrawls.
        
        Savings account
        
        A deposit in a commercial bank or thrift institution on which interest payments are received; generally used for saving rather than daily transactions; a component of the M2 money supply.
      - Key definitions and concepts
        
        Near-money
        
        Financial assets that are not themselves a medium of exchange but that have extremely high liquidity and thus can be readily converted into money. Includes noncheckable savings accounts, time deposits, and short-term U.S. government securities plus savings bonds.
- - - - When a bank makes loans, it creates money
      - Checkable-deposit money created by loans constitutes about one-half of M1 money in the United States and about 10 percent of M2.
      - Banking lending creates checkable deposits that are money
        
        An individual’s IOU is not acceptable as a medium of exchange. But the claim created by the bank and given to an individual is money; checks drawn against a checkable deposit are acceptable as a medium of exchange
      - If the bank now has no excess reserves, the bank is “fully loaned up.”
        
        A single commercial bank in a multibank banking system can lend only an amount equal to its initial preloan excess reserves.
    - - When a commercial bank buys government bonds from the public, the effect is substantially the same as lending. New money is created.
      - The bank accepts government bonds (which are not money) and gives the securities dealer an increase in its checkable deposits (which are money).
        
        The selling of government bonds to the public by a commercial bank—like the repayment of a loan—reduces the money supply
    - - The asset items on a commercial bank’s balance sheet reflect the banker’s pursuit of two conflicting goals:
        
        Profit One goal is profit. Commercial banks, like any other businesses, seek profits, which is why the bank makes loans and buys securities—the two major earning assets of commercial banks.
        
        Liquidity The other goal is safety. For a bank, safety lies in liquidity, specifically such liquid assets as cash and excess reserves. A bank must be on guard for depositors who want to transform their checkable deposits into cash. Similarly, it must guard against more checks clearing against it than are cleared in its favor, causing a net outflow of reserves. Bankers thus seek a balance between prudence and profit. The compromise is between assets that earn higher returns and highly liquid assets that earn no returns.
      - Federal funds rate
        
        The interest rate that U.S. banks and other depository institutions charge one another on overnight loans made out of their excess reserves.
    - - Commercial banking system can lend—that is, can create money—by a multiple of its excess reserves
        
        Initially, all banks are meeting this 20 percent reserve requirement exactly. No excess reserves exist; or, in the parlance of banking, the banks are “loaned up” (or “loaned out”).
        
        If any bank can increase its loans as a result of acquiring excess reserves, an amount equal to those excess reserves will be loaned to one borrower, who will write a check for the entire amount of the loan and give it to someone else, who will deposit the check in another bank. This third assumption means that the worst thing possible happens to every lending bank—a check for the entire amount of the loan is drawn and cleared against it in favor of another bank, thereby reducing the first bank’s quantity of excess reserves and its ability to generate a profit by extending additional loans at interest.
        
        The reserve ratio for all commercial banks is 20 percent.
      - The Banking System’s Lending Potential
        
        The banking system can lend excess reserves by a multiple of 5 (= $400/$80) when the reserve ratio is 20 percent. Yet each single bank in the banking system is lending only an amount equal to its own excess reserves.
        
        An individual bank can safely lend only an amount equal to its excess reserves, but the commercial banking system can lend by a multiple of its collective excess reserves.
    - - The multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1 divided by the reserve requirement.
        
        By multiplying the amount of excess reserves E by m, we calculate the maximum amount of new checkable-deposit money, D, that the banking system can create
      - Higher reserve ratios mean lower monetary multipliers and therefore less creation of new checkable-deposit money via loans; smaller reserve ratios mean higher monetary multipliers and thus more creation of new checkable-deposit money via loans.
      - Reversibility: The Multiple Destruction of Money
        
        Just as checkable-deposit money is created when banks make loans, checkable-deposit money is destroyed when loans are paid off.
- - - - Paper money is the circulating debt of the Federal Reserve Banks
      - Checkable deposits are the debts of commercial banks and thrift institutions
      - By not backing the currency, the government grants itself the freedom to provide as much or as little money as may be needed to best suit the country’s economic needs. By choosing not to back the currency, the government gives itself the ability to freely “manage” the nation’s money supply. Its monetary authorities are free to provide whatever amount of money is needed to promote full employment, price-level stability, and economic growth.
    - - Acceptability
        
        Currency and checkable deposits are money because people accept them as money
      - Legal Tender
        
        Any form of currency that by law must be accepted by creditors (lenders) for the settlement of a financial debt; a nation’s official currency is legal tender within its own borders.
      - Relative Scarcity
        
        Money derives its value from its scarcity relative to its utility (its want-satisfying power). The utility of money lies in its capacity to be exchanged for goods and services, now or in the future.
    - - The purchasing power of money is the amount of goods and services a unit of money will buy.
      - The Purchasing Power of the Dollar
        
        The amount a dollar will buy varies inversely with the price level.
        
        Higher prices decrease the dollar’s value because people need more dollars to buy a particular amount of goods, services, or resources.
        
        $V=1/P
        
        To find the value of the dollar, $V, divide 1 by the price level P expressed as an index number (in hundredths).
      - Inflation and Acceptability
        
        Runaway inflation may significantly decrease the value of money between the time it is received and the time it is spent. Rapid declines in a currency’s value may cause people and businesses to reject it as a medium of exchange.
        
        At the extreme, a country may adopt a foreign currency as its own official currency as a way to counter hyperinflation.
        
        When the value of the dollar is declining rapidly, sellers do not know what to charge, and buyers do not know what to pay.
    - - Price-level stability (2 to 3 percent annual inflation) can be achieved through intelligent management of the nation’s money supply and interest rates (monetary policy)
      - It also requires appropriate fiscal policy that supports the efforts of the nation’s monetary authorities to hold down inflation