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Unit 9 - Functions of Money n The Functions of Money A society without any form of money is called a barter economy. Goods and services are traded directly.

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Presentation on theme: "Unit 9 - Functions of Money n The Functions of Money A society without any form of money is called a barter economy. Goods and services are traded directly."— Presentation transcript:

1 Unit 9 - Functions of Money n The Functions of Money A society without any form of money is called a barter economy. Goods and services are traded directly for other goods and services. In a barter economy there must be a double coincidence of wants for a trade to take place. Macroeconomics

2 Unit 9 - Functions of Money n The Functions of Money In a barter economy trading and specialization are limited. Thus, the standard of living is lower. Macroeconomics

3 Is money the root of all evil? 1. Yes 2. No 3. Not sure 4. Most of the time 0 of 5

4 Unit 9 - Functions of Money n An economy without any form of money (barter) still is likely to have acts of robbery, burglary and violence. Thus, money must not be the root of all evil. n Money makes it easier to commit crimes and commit evil. Macroeconomics

5 Which of the following is NOT a recognized function of money 1. Medium of exchange 2. Standard of value 3. Creator of wealth 4. Store of value 0 of 5

6 Unit 9 - Functions of Money n Medium of Exchange Money is exchanged for products. Macroeconomics

7 Unit 9 - Functions of Money n Standard of Value Money prices make it easier to determine how much products are worth. Macroeconomics

8 Unit 9 - Functions of Money n Store of Value Money makes it easier to accumulate wealth. Macroeconomics

9 Unit 9 - Functions of Money n Money Supply Measures Common U.S. money supply measures are: The Monetary Base The Monetary Base M1 M1 M2 M2 M3 M3 Macroeconomics

10 Unit 9 - Functions of Money n Money Supply Measures The monetary base is: Bank reserves + Currency in the Hands of the Non-bank Public. Bank reserves are funds held by banks that can be loaned out. Currency includes paper money and coins. Macroeconomics

11 Unit 9 - Functions of Money n Money Supply Measures M1 = Currency + Travelers Checks + Demand Deposits + Other Checkable Deposits. M1 contains forms of money that you can use to buy common products at groceries, department and other stores. Macroeconomics

12 Unit 9 - Functions of Money n Money Supply Measures M2 = M1 + MMMFs + Short Term CDs + Small Time Deposits MMMF = money market mutual funds (a form of savings). CD = certificate of deposit (savings with a fixed interest rate) Small time deposits = money in small savings accounts. Macroeconomics

13 Unit 9 - Functions of Money n Money Supply Measures M3 = M2 + Large Time Deposits + RPs + Eurodollars + Institution held MMMFs Large time deposits = money in large (corporate) savings accounts. RP = repurchase agreements (savings with collateral in the form of bonds). Eurodollars = dollar savings in foreign countries. Macroeconomics

14 Unit 9 - Functions of Money n Money Supply Measures For the latest money supply statistics, visit: Macroeconomics

15 Unit 9 - Functions of Money n The Federal Reserve System The Federal Reserve System is the central banking system of the United States. It was created in 1913, and includes 12 central banks, a Federal Reserve Board, various committees, and member banks. Macroeconomics

16 Unit 9 - Functions of Money n The Federal Reserve System The Federal Reserve acts independently from Congress. Macroeconomics Federal Reserve Building in Washington, D.C. The Capitol in Washington, D.C.

17 Unit 9 - Functions of Money n Organization of the Federal Reserve System Macroeconomics Fed Board (7 members) FOMC (12) FAC Central Banks (12) and Central Bank Branch Banks (25) Bank

18 Unit 9 - Functions of Money n Organization of the Federal Reserve System The FOMC is the Federal Open Market Committee. It consists of the 7 Board members plus 5 central bank presidents. It is the decision-making committee. The FAC is the Federal Advisory Committee. Macroeconomics

19 Unit 9 - Functions of Money n The Federal Reserve System Federal Reserve Functions include: Control of the money supply Control of the money supply Supervision of banks Supervision of banks Check clearing Check clearing Statistics gathering and research Statistics gathering and research Macroeconomics

20 Unit 9 - Functions of Money n The Fed and the Money Supply The Fed controls the money supply through 1. Open Market Operations 2. Reserve Requirement Policy 3. Discount Rate Policy Macroeconomics

21 Unit 9 - Functions of Money n The Fed and the Money Supply Open market operations: the Fed buys and sells government bonds in the open market. Government bonds are formal agreements between the government and businesses or individuals who loan the government money in exchange for interest and re-payment of principal. Macroeconomics

22 Unit 9 - Functions of Money n The Fed and the Money Supply When the Fed buys bonds, the public receives money in exchange for bonds. The Fed prints money to pay for the bonds. This increases the money supply. When the Fed sells bonds, the money supply decreases. Macroeconomics

23 United States Treasury Federal Reserve The Public Treasury securities Payment for securities (public loans money to the U.S. government) Payment for securities (Fed buys securities in the open market) Treasury Securities Unit 9 - Functions of Money

24 n The Fed and the Money Supply Reserve Requirement Policy When businesses or individuals deposit money in a bank, the bank must keep a percentage of the deposited amount (the reserve requirement). The bank can loan out the rest. Macroeconomics

25 Unit 9 - Functions of Money n The Fed and the Money Supply Reserve Requirement Policy For most checking accounts, the reserve requirement percentage is 10%. When the reserve requirement percentage is lowered, banks can loan more money and money in circulation increases. When the Fed raises the percentage, money in circulation decreases. Macroeconomics

26 Unit 9 - Functions of Money n The Fed and the Money Supply Discount Rate Policy The discount rate is the interest rate on loans from the Fed to individual banks. When the Fed raises the rate, money in circulation decreases. When the Fed lowers the rate, money in circulation increases. Macroeconomics

27 Unit 9 - Functions of Money n Fractional Reserve Banking Banks can loan out a percentage (fraction) of the money deposited by customers (and capital kept by the bank). Lets say someone deposits $1,000: Macroeconomics Bank A AssetsLiabilities $1,000 Deposits$1,000 Cash

28 Unit 9 - Functions of Money n Fractional Reserve Banking Assume that the reserve requirement is 10%, and bank A loans out 90% of the deposited money: Macroeconomics Bank A AssetsLiabilities $1,000 Deposits$100 Cash $900 Loans

29 Unit 9 - Functions of Money n Fractional Reserve Banking The person who borrows the $900 spends it. The recipient of the $900 deposits it into: Macroeconomics Bank B AALL $900 Deposits$900 Cash $900 Deposits $90 Cash $810 Loans

30 Unit 9 - Functions of Money n Fractional Reserve Banking This process of money creation continues with Bank C, bank D, etc. Macroeconomics Bank C AL $810 Deposit$810 Cash

31 Unit 9 - Functions of Money n Fractional Reserve Banking The total increase in deposits equals $1,000 + $900 + $810 + $... = $10,000. Macroeconomics

32 Unit 9 - Functions of Money n Fractional Reserve Banking $10,000 = 10 x $1,000 In general: The total increase in the nations money supply = the money multiplier x the initial deposit. The money multiplier is 1/reserve requirement. Macroeconomics

33 Unit 9 - Functions of Money n Velocity of Money Velocity is speed. Velocity of money is how fast the same quantity of money turns over to buy products (GDP) in one period of time (usually one year). Macroeconomics

34 Unit 9 - Functions of Money Velocity of Money Velocity of Money Velocity is defined as V = GDP/M If GDP = $12,000 billion and M = 2,000 billion, then V = $12,000/2,000 or: V = 6. Macroeconomics

35 Unit 9 - Functions of Money Velocity of Money Velocity of Money If V = GDP/M Then, after cross-multiplying, V = P x Q/M or P x Q = M x V The Quantity Theory of Money: As M increases, so does P. There is a direct, (but not always proportional) relationship between M and P. Macroeconomics


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