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

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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