Please enable JavaScript.
Coggle requires JavaScript to display documents.
Unit 6
Chapter 34 - Money, The Federal Reserve and the Banking System …
-
-
-
Medium of Exchange: buying and selling; replaces complications of barter (goods are exchanged)
Unit of account: to measure worth of things; it also permits us to define debt obligations, determine taxes owed and calculate the nation's GDP
Store of value: enables people to transfer purchasing power from the present to the future; you don't normally spend entire paycheck on payday
-
-
Currency (cash) is not the only form of money; certain debts of government and financial institutions also are used as money; total quantity (stock) of money depends upon what forms of money (cash, checkable deposits, etc) are included in the tally
M1 and M2 are two best known tallies
M1 = currency (coins and paper money) + checkable deposits at commercial banks + other liquid deposits (checkable deposits held at credit unions and other thrift institutions PLUS savings deposits at commercial banks or thrift institutions
M2 = M1 + small denominated time deposits + retail money market funds (indivi)
Supply of coins (US Dpt of Treasury) and notes (Federal Reserve System - US central bank)
Checkable deposits provided by commercial banks and thrifts (savings institutions)
Token Money: face value of any piece of currency is unrelated to its intrinsic value (the metal or paper)
Thrift institutions = savings and loan associations, mutual savings banks, credit unions
- Savings and loan associations and mutual savings banks: accept deposits of households and businesses and then use it to finance home mortgages and to provide other loans
- Credit unions: accept deposits from and lend to members (usually group of people who work for the same company)
Demand Deposits: checkable deposits of banks and thrifts
NOW = negotiable order of withdrawal accounts
ATS = automatic transfer service accounts
Share draft accounts
Near-monies: 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
Money Definition M2
M2 = M1 + near-monies
Near-monies included in M2:
- small-denominated time deposits (less than $100 000)
- retail money market funds (MMMF held by individuals; $500 or more)
-
-
-
Thrift Institutions (savings and loan associations, mutual savings banks, credit unions)
-
-
-
7 Board member, 14 years, staggered to 2 years
blend private and public control, serve as US Central Bank and Bankers' banks
-
12 = 7 board of governor + president of NY Fed Reserve Bank + 4 presidents from remaining Fed Reserve Banks (1yr rotation)
Meet and control "open-market operations"
-
-
Fed Functions and Responsibilities
- Issuing currency
- Holding reserves and setting reserve requirements: allows commercial banks and thrifts to deposit currency with the Fed = reserve balances; Fed sets reserve requirements = % of indiv check account balances that banks and thrifts must maintain
- Lending to financial institutions and serving as an emergency lender of last resort: discount rate = interest rate at which Fed makes routing short-term loans to banks and thrifts
- Providing for check collection: clearing of checks between different banks
- Acting as federal government's fiscal agent: provider of financial services
- Supervising banks: periodically assesses bank profitability, compliance to regulations and investigates questionable practices
- Controlling the money supply: incl interest rates;
Fed Independence
- to protect the Fed from political pressure
-
-
Federal Reserve Notes: US Bureau of Engraving and Printing
Coins: US Mint
Checkable deposits: loan officers (banks and thrifts)
Fractional Reserve Banking System = only a portion (fraction) of checkable deposits are backed by reserves of currency either 1) stored on-site in vaults of commercial banks and thrifts or 2) kept as reserve balances on deposit at the central bank
Goldsmiths
- banks can create money through lending
- banks operating on the basis of fractional reserves are vulnerable to "panics" of "runs"
- The overall volume of checkable-deposit money circulating in the economy depends upon the total outstanding volume of loans that have been extended by banks and thrifts at any point in time
Fed influence over Lending and the Money supply
Policy changes on the volume of loans and the interest rates, changes in
- total amount of checkable-deposit money in economy
- overall money supply
- interest rates
- overall economic activity
-
Interest = the price paid for the use of money; the price borrowers must pay lenders for transferring purchasing power to the future, the price that borrowers must pay lenders to compensate them for not being able to use their money until it is repaid and the price that borrowers must pay to use $1 for 1 year.
DEMAND FOR MONEY
Reasons the public wants to hold some wealth as money:
- to facilitate purchases (transactions) = transactions demand for money
- to hold as an asset (store of value) = asset demand for money
Transactions Demand, Dt
Nominal GDP is main determinant of amount of money demanded for transactions
- straight vertical line on graph of interest rate and transactional demand for money because it depends on nominal GDP and not on interest rate
Asset Demand, Da
- straight line down sloping on graph of interest rate and asset demand for money
- asset demand varies inversely with the interest rate because of the opportunity cost involved in holding currency and checkable deposits that pay no interest of very low interest
- because of money's function as a store of value (wealth can be held in tangible assets)
- when holding money, an opportunity cost is incurred because interest is lost
- this is why the amount of money demanded as an asset varies inversely with the interest rate (which is the opportunity cost of holding money as an asset)
-- when the interest rate rises, being liquid and avoiding capital losses becomes more costly
-- when interest rate falls, the cost of being liquid and avoiding capital losses declines
Total Demand, Dm
- determined by horizontally adding the transactions demand for money to the asset demand for money
- downward sloping line
- represents the total amount of money the public wants to hold, both for transactions and as an asset, at each possible interest rate
Money Supply, Sm
- combining the money supply with the total money demand portrays the market for money and determines the equilibrium interest rate ie
EQUILIBRIUM INTEREST RATE
- combine demand for money with the supply of money to determine the equilibrium interest rate
- Sm is a vertical line because the monetary authorities and financial institutions have provided the economy with some particular stock of money
- at equilibrium interest rate the quantity of money demanded equals the quantity of money supplied
AN INCREASE IN THE MONEY SUPPLY WILL LOWER THE EQUILIBRIUM INTEREST RATE, WHILE A DECREASE IN THE MONEY SUPPLY WILL REAISE THE EQUILIBRIUM INTEREST RATE
Interest Rates and Bond Prices
- inversely related
- when the interest rate increases, bond prices fall and vice versa
- bonds are bought and sold in financial markets, with the price of bonds being determined by the interaction of bond demand with bond supply
- $50/$1000 = 5% interest yield
- interest rate increases; older bonds must sell for less (face value) to complete with new interest rate: $50/$667 = 7.5%
- interest rate decreases to 2.5%: $50/$2000 = 2.5%
- bond is paying out $50 and new buyers buy at the price below the line - denominator
- The more you pay today for a fixed future amount, the lower your percentage return
What "backs" the money supply? The money supply in the US is "backed" (guaranteed) by the government's ability to keep the value of money relatively stable, which in turn depends largely on the government's effectiveness in managing the money supply