Chapter 13
Money
- Money is an asset that is widely accepted as a means of payment in the economy
- Asset: something of value that is owned by someone
- Means of payment: Anything acceptable as payment for goods and services
- Debit cards and credit cards are not money, they are means of payments
- Checking account funds are assets
Money Supply
- Cash in the hands of the public: Currency and coins held by the non-bank public
- Checkable deposits: accounts held by households and business firms at commercial banks
- Demand deposits: most basic checking account, on demand be paid in cash
- Automatic transfers from savings accounts: interest-paying savings accounts that automatically transfer funds into demand deposit accounts as you write checks
- Traveler’s checks: specially printed checks that you can buy from banks or other private companies
- Money supply = cash in the hands of the public + checking account deposits + traveler’s checks
M1 vs. M2
- Cash, checkable deposits, and traveler’s checks = M1
- M2: includes all of M1 plus additional types of deposits that can fairly easily be turned into cash or checking deposits
- M2 examples: savings deposits, money market deposits, money market funds, certificates of deposits under $100,000
- M2 is much larger than M1
Functions of Money
- Means of payment: how the payment is actually made
- Store of value: a form in which wealth can be held
- Unit of account: common unit for measuring how much something is worth, refers to the way we think about and record transactions
History of the Dollar
- Federal Reserve System: The monetary authority of the United States, charged with creating and regulating the nation’s supply of money
Why Paper Currency is accepted as a Means of Payment
- Commodity money: furs or jewels, had important uses other than a means of payment
- People were willing to accept paper money because the currency could be exchanged for a valuable commodity such as gold or silver and because the issuer could print new money only when it acquired new gold or silver
- Fiat money: something that serves as a means of payment by government declaration
Banking System
- Financial intermediaries: business firms that specialize in brokering between savers and borrowers
- Intermediary can reduce the risk to savers by spreading loans among a number of different borrowers
- Depository institutions: accept deposits from the general public and end the deposits to borrowers
- Commercial banks: largest group of depository institutions
Commercial Banks
- Private corporation that provides services to the public
- Most important service is to provide checking accounts
Balance Sheet: two-column list that provides information about the financial condition of a bank at a particular point in time
- One side are assets: everything of value that it owns
- Liabilities: the amount that the bank owes
Bank’s Assets
- Bond: promise to pay funds to the holder of the bond, issued by a corporation or government agency when it borrows money, gradually or all at once in the future
- Loan: promises, signed by households or non-corporate businesses to pay back funds
- Bank’s cash does not pay any interest at all
- The bank must always be prepared to honor its obligations for withdrawals, so it must have some cash on hand to meet these requirements
- Reserves: Vault cash plus balances held at the Fed
- Required reserves: the minimum amount of reserves a bank must hold, depending on the amount of its deposit liabilities
- Required reserve ratio: the minimum fraction of checking account balances that banks must hold as reserves
- Excess reserves: reserves in excess of required reserves
Bank’s Liabilities
- Checking account deposits
- Other deposits: funds that households and firms hold at the bank in some form other than checking accounts, such as savings accounts or certificates of deposit
- Bank borrowing: Banks themselves sometimes borrow funds by taking out loans from other banks, or by issuing their own bonds
Shareholders’ Equity
- = total assets – total liabilities
Federal Reserve System
- Central bank: the nation’s principal monetary authority responsible for controlling the money supply
- Instead of a single central bank, the US is divided into 12 Federal Reserve districts
Federal Open Market Committee
- Establishes monetary policy
Functions of the Fed
- Supervising and regulating banks
- Acting as a “bank for banks”
- Discount rate: the interest rate the Fed charges on loans to banks
- Issuing paper currency
- Check Clearing: transferring funds from one bank’s reserve account to another’s
- Guiding the Macro economy
- Dealing with Financial Crises: lender of last resort to make sure that banks have enough reserves to meet their obligations to depositors
The Fed and the Money Supply
- Open market operation: the Fed buys or sells government bonds in the bond market
How an Open Market Purchase can increase the Money Supply
- Banks never hold excess reserves
- Households and businesses do not withdraw or deposit cash
Money Multiplier
- Number by which we multiply the injection of reserves to get the total change in the money supply
- Money multiplier = 1/RRR
- Money Supply = 1/RRR x Reserves
How an Open Market Sale Can Decrease the Money Supply
- Selling government bonds
Important Provisos about the money multiplier
- Changes in the public’s cash holdings: smaller increase in lending and checking accounts
- Increased Reserve Holdings: money multiplier smaller than it would be
Other Fed Actions that Change Money Supply
- Changes in the Required Reserve Ratio
- Raise the ratio = money supply decreases
- Changes in the Discount rate
- Rise in the discount rate = decrease in money supply
- Lower discount rate = increase in money supply
- Changes in the interest rate on reserves
- Increase in IOR rate = decrease in money supply
Banking Panics
- Fractional reserve system: its reserves are only a fraction of its total deposits
Bank Insolvency
- Insolvent: condition of a firm when total assets are less than total liabilities
- Reasoning: bankruptcies of businesses and households that have borrowed money from the bank
Banking Panic
- Run on the bank: an attempt by many of a bank’s depositors to withdraw their funds
- Banking panic: a situation in which fearful depositors attempt to withdraw funds from many banks simultaneously
- In the past, a banking panic would force many banks to “close their doors” even if they were solvent
End of Banking Panics
- Federal Reserve is ready to inject reserves
- FDIC had a major impact on psychology of banking public
- FDIC protection comes with costs: must pay insurance, higher rates on loans and higher fees for their services
Role of Regulation
- Bank capital: another name for shareholders’ equity in a bank
- Capital ratio: a bank’s capital as a percentage of its total assets
Non-Banks and the Shadow Banking System
- Shadow Banking system: the entire collection of non-bank financial intermediaries
- Non-bank: a financial intermediary less strictly regulated than a bank and with no government-guaranteed deposits
