Money, Banking, and Monetary Policy

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Module 23 Notes with 5 Steps Book Notes

Money supply - total value of the financial assets in the economy that are considered money

currency in circulation

traveler's checks

bank deposits

etc.

stocks & bonds

stocks - equity financing -> avoids debt

use of a bond - can be bought in secondary market - debt financing - commits company to interest payments

characteristics of money

portable

uniform

durable

divisble

universally accepted

Functions of money

1. medium of exchange

things that are used like money when no money is available

dollars/hour for labor

dollars/pound of apples

if it weren't for money, we would be bartering

heart surgeon wanting meth

2. store of value

a means of purchasing power over time

units of currency measure the relative worth of goods and services

3. Unit of account

a measure used to set prices and make economic calculations

keeping money for a later use - does not lose value unless prices are rapidly increasing

Money supply (measuring)

m1 - contains only currency in circulation

m2 - contains m1 + savings deposits + small time deposits + money market mutual funds + etc.

Types of money

commodity money - a good used as a medium of exchange that has intrinsic value in other ways

gold, cigarettes

commodity backed money - ties up fewer valuable resources (bank notes)

medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it could be converted into valuable good on command

fiat money - ties up fewer valuable resources (ca$h money)

value derives from its official government as means of exchange

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Module 24 Notes with 5 Steps Book

having money today is worth more than having money in the future

sooner you consume, the sooner you can pay for things you want

prefer to pay debts as late as possible

repayment tomorrow not one year for tomorrow unless it has interest placed on it

time value of money - most important reason for paying interest on savings and charging interest on borrowing

Present value and future value

relationship between dollars today and dollars ONE YEAR FROM NOW:

FV = PV x (1+r)

to solve for present value:

PV = FV / (1+r)

to solve between dollars today and dollars TWO years from now:

FV = PV (1+r)^2

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Module 25 and 5 Steps notes

Banks

financial intermediary

liquid assets handed by vault or by the bank's account at the federal reserve

t-account - a t chart designed to show a business' or bank's assets alongside their liabilities

lending process made possible by fractional reserve system

DRR v. RRR?

whichever is bigger

deposit insurance

to prevent bank runs

gives people their deposit account money back up to $250k

bank runs

lead to bank failure

caused by fear of bank failure

bank regulation

deposit insurance - guarantee that depositors will be paid even if the bank doesn't have the money

eliminates the need for bank runs

reserve requirements - reserve ratio etc. set by federal reserve (10%)

discount window - the ability for banks to borrow from federal reserve

Determining the money supply

banks create money

Fractional Reserve Banking

reserve ratio = cash reserves / total deposits

asset - anything owned by the bank or owed to the bank

liability - anything owned by depositors or lenders to the bank

money multiplier = 1 / reserve requirement

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Module 26 and 5 steps notes

banks loaned more than they had. it caused unsanctioned currency recessions each decade

federal reserve - created 1913

board of governors - oversees entire system; like a government agency; 14 yr terms; 7 members; appointed by president; chair/vice chair chosen from members

12 regional reserve banks - each serve region of the country (federal reserve districts); audit books of private sector banks to ensure their financial health; open market ops in NYC; oversee banking & issue currency

federal reserve system - created 1913 to bring stability to the nations financial system

quasi-public

based on history and needs in america

keeping stable prices

functions

provide financial services

check clearing

allowing checks to go from one bank account to another

supervise and regulate all banking institutions

for the good of the people

maintain overall stability of the financial systems

lender of last resort

regulate money supply in america

goal - stable prices NOT economic growth

targeting interest rates

Decisions of monetary policy are made by governors and 5 regional bank presidents (four year terms)

Glass - Steagall Act of 1933 separated banks into two categories

commercial banks - depository banks that accepted deposits and were covered by deposit insurance

investment banks - engaged in creating and trading financial assets (stocks) but not covered by insurance (more risky)

Member banks - credit unions are NOT BANKS - non member banks must follow same rules

all nationally chartered banks must join

many state banks choose to join (only members can borrow)

Committees assist board of governors - fed advisory council

only in times of crisis

Have the ability to change money supply

easy money (expansionary policy) - designed to fix recession and increase aggregate demand, lower unemployment rate, and increase rGDP (a)

tight money (contractionary policy) - avoids inflation by decreasing AD which lowers the price level and decreases rGDP back to full unemployment level (b)

Open market operations

buying bonds = bigger bucks

buying securities - commercial banks hold treasury bonds as an asset - when the fed offers to buy them, banks receive excess cash reserves and the fed gets the bonds

money supply increases and interest rate falls

selling bonds = smaller bucks

selling securities - commercial banks go to buy bonds rather than keep excess cash reserves. banks get the bonds and their excess cash reserves fall, and money destruction process begins

money supply decreases and interest rate spikes

federal funds rate - a set target interest rate and the FOMC then proceeds to engage in OMOs to hit that target rate

interest rate that banks charge other banks for SHORT TERM loans

Changing the discount rate

interest rate that banks use when they borrow money from other banks

The Fed tends to change the discount rate in lockstep with the federal funds target rate

changing the required reserve ratio

rarely used