Chapter 35: Function of money
Functions of money
Medium of exchange
To buy and sell goods
Unit of account
Goods valued in dollars
Store of value
Hold some wealth in money form
Without money, we would need to exchange goods : Barter system
Components of U.S. Money supply
M1
Money, M1= sum of these
Checkable deposits
Other liquid deposits
Intitutions
Commercial banks
Thrift institutions
Saving and loan associations
Mutual savings banks
Credit unions
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M2
M2 = M1 + near-monies
Near monies
Money market mutual funds (MMMF)
Currency - coins and Federal reserve notes (paper money)
Value of any piece of currency is unrelated to its inrtinsic value
What backs money up
Not backed by anything tangible, such as Gold
Why is it valuable
Acceptablility
Legal tender
Relative scarcity
Money and Prices
Prices affect purchasing power of money
Hyperinflation renders money unacceptable
Stabilizing money's purchasing power
intelligent management of money supply and interest rates - monetary policy
Appropriate fiscal policy
pages 694-700
People can choose to hold some or all their wealth in a variety of assets
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.
Currency
Small-denominated time deposits
less than 100,000USD
Credit cards are not money, they are short term loans ❌
Cheques and debit cards are money ✅
Federal Reserve Notes and coins are Token money : 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.
Primary depository institution
supplement the commercial banks
Accept deposits, issue mortgages and loans
Accept deposits and lend money to members
Financial assets that are not themselves a medium of exchange but that have extremely high liquidity and thus can be readily converted into money.
Guaranteed by government's ability to keep value stable. Money as debt
Government grants itself freedom to provide as much or little money to best suit country's economic needs
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.
Fiat money
Savings accounts
Medium of exchange
Excluded from money supply is currency held by banks, checkable deposits of the government or Federal reserve held by commercial banks or thrift institutions
Paper money and checkeble deposits are debts or promises to pay
Medium of exchange
derives its value from its scarcity relative to its utility
$V=1/P
reciprocal relationship exists between general price levels and dollar purchasing power
If price rises to 1.20 then value of dollar ($V) falls to 0.8333 (= 1/1.20)
Fractional Reserve system, Interest Rates and Equilibrium Interest rate (Page 701-711)
The US Federal reserve system is a monitory authority, that supports the banking system
Congress passed Federal reserve act of 1913.
centralize and public control.
Board of governors (central authority)
7 board members with 14 year terms, stagnated, one member replaced every 2 years.
12 Federal reserve banks
Commercial banks
Thrift institutions
The public
(household and businesses)
Federal Open Market Committee (FOMC)
12 individuals:
The 7 board of governors
The president of NY Federal reserve bank.
4 presidents from the remaining Federal reserve banks, each on a 1-yr rotating basis
4300 commercial banks
7000 or so thrifts
World's largest commercial banks are in China, Japan, UK, France and USA
Functions
Issue currencies
Hold resevrs and set reserve requirments
Lend money to financial institutions
Collect checks
Act as fiscal agent for US Government (collecttaxes owed to government)
Supervise banks
Control money supply
Federal reserve independence
Established by congress as an independent agency
Protects the Fed from political pressures
Enabled Fed to take actions to increase interest rates to stem inflation
Executive agencies fall under president. Federal do not report to government
Fractional reserve system
Goldsmiths stored gold and gave a receipt, made loans by issuing, receipts used as money by public
Characteristics: Banks create money through lending, Banks are subject to panics or runs (disadvantage)
Lending and Money supply
Fed can alter money supply by modulating incentives and restrictions it places on banks and thrifts
any decision by the Fed that influences bank lending will tend to change: (1) the total amount of checkable-deposit money in the economy; (2) the overall money supply; (3) interest rates; and (4) overall economic activity.
Lesser volumes of loans and higher interest rates when Feds prompt banks to decrease lending
Interest: Price paid for the use of money
Interest rates are determined by money supply and demand
Transaction demand for money Dt
Asset demand for money Da
Total demand for money Dm
Determined by nominal GDP, independent of interest rates
Money as store of value, varies inversely to interest rates
Equilibrium interest rates
Interest rates and bond prices inversely related, pay a fixed annual interest payment, Lower bond prices will raise interest rates
Digital currency
Blockchain: a sequence of updates that tracks ownership of digital money, central bank digital currencies may eclipse private cryptocurrencies
Boston, New York, Philidelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, San Francisco + Alaska + Hawaii
Quasi-public Bank : Private ownership and public control
Bankers' banks
Reserve balances: Funds that commercial banks and thrift institutions hold on deposit at the central bank.
Federal reserve Notes:
Federal Reserve System
US bureau of engraving and printing
Coins:
US Treasury
US Mint
Loan officers / debts or liabilities
(banks and thrifts)
❓A system in which commercial banks and thrift institutions hold less than 100 percent of their checkable-deposit liabilities as reserves of currency held in bank vaults or as deposits at the central bank.
Deposit insurance (guarantees) prevent bank runs
Access to credit is easier when Fed policy prompts banks to increase lending
Money aids rational decision making by enabling buyers and sellers to easily compare the prices of various goods, services, and resources
transfer purchasing power from the present to the future
Money
Society gains advantages:
Human specialization
Geographic specialization
Inflation non-existent or low
Gold, Stocks, Real estate
Safety and convenience
interest-bearing short-term credit instruments only; only includes the MMMF accounts held by individuals
Short term credit instruments :
Certificates of deposit
U.S. government securities
no intrinsic value ❗
Price-level stability; Full employment; Economic growth
FOMC
Federal Open Market Committee
Open-market operation
bills;bonds;notes
25% are national (or federal) commercial banks
Demand for money as a medium of exchange
demand for money varies directly with nominal GDP
To facilitate purchases
To hold as an asset
Stocks, bonds, money
Dm = horizontally adding asset demand for money to transaction demand for money
This is the equilibrium price of money
Bond prices
inversely related to interest rates
Bond prices rise when interest rates fall
Bond prices fall when interest rates rise
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Interest yield (%) = Interest payment / Face value
Price determined by supply and demand for bonds
the more you pay for a fixed future amount, the lower your percentage return
sold in financial markets.
M1 = Currency in circulation, checkable deposits, and other liquid deposits