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A. Money The flow of income and money The flow of income and money Money influences economic activity Money influences economic activity Credit availability.

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Presentation on theme: "A. Money The flow of income and money The flow of income and money Money influences economic activity Money influences economic activity Credit availability."— Presentation transcript:

1 A. Money The flow of income and money The flow of income and money Money influences economic activity Money influences economic activity Credit availability influences money Credit availability influences money Interest rates affect the price of money Interest rates affect the price of money Page 20

2 B. FUNCTION OF MONEY MEDIUM OF EXCHANGE MEASURE OF VALUE STORE OF VALUE STANDARD OF DEFERRED PAYMENT Page 20

3 C. What is MONEY (M-1)? Anything ACCEPTABLE can operate as money. The key is Acceptability. GOLD COINS CURRENCY CHECKS NOT backed by Page 20

4 U S Currency of Money Supply M-1 22% = Coins and paper currency 22% = Coins and paper currency 78% = Checks – Demand deposits 78% = Checks – Demand deposits Tied to checking account Tied to checking account Federal Reserve Note = I.O.U. of the Federal Reserve Bank. Jan 1, 1975: U.S. citizens can legally buy/sell gold. U.S. no longer agrees to convert dollars held by foreigners into gold. GOLD Too much money = inflation Too little money = recession Page 20

5 B. HOW DO BANKS CREATE MONEY – D eposits 20% Hold for reserve Loans –B–B–B–BANK 1 $1,000 $200 $800 –B–B–B–BANK 2 $800 $160 $640 –B–B–B–BANK 3 $640 $128 $512 –B–B–B–BANK 4 $512 $ $ –T–T–T–TOGETHER $ $2,048 $ $1, –T–T–T–TOTAL 5,000 $1,000 $4,000 A DEPOSIT of $1,000 Creates $5,000

6 Other Definitions of Money M-1 M-1 –Currency + Checking accounts M-2 M-2 –M-1 + Savings accounts + Small C.D.s + Money Market accounts M-3 M-3 –M-2 + large C.D.s

7 FEDERAL RESERVE SYSTEM 7 Governors Board of Governors 7 Governors Board of Governors 14 yr. Appointment 14 yr. Appointment 12 Regional Banks Regional Reserve Banks Banks and Thrift Institutions American Public

8 Federal Reserve System Tools Changes in money supply

9 Federal Reserve Tools Change in the Discount Rate Change in the Discount Rate –Local banks borrow from the Federal Reserve –Discount Rate: Low interest rate is charged –Low rediscount rate: Increases money supply –High discount rate: Tightens the money supply Open market Operations Open market Operations –Fed buys government securities (bills, notes and bonds) from the public –Increases the money supply by expanded deposits –Increase in money means more funds for banks to lend Changes in the Reserve Requirements Changes in the Reserve Requirements –Fed increases the amount of reserves held on deposits –Decreases the money supply Federal Funds Rate Federal Funds Rate –The rate one bank charges another for overnight use of excess reserves Page 20

10 Government Securities (B) (N) (B) The Fed Reserve sells securities to the public from time to time. –T–T–T–The more securities it sells the greater money is available in bank demand account reserves for loans –I–I–I–Interest rates increase and fewer loans are made. –I–I–I–Interest rates decrease and greater loans are made. –C–C–C–Control credit creating ability by manipulating amount of cash kept as reserves –I–I–I–Influences interest rates or yield Page 20

11 Federal Reserve To decrease money supply. Increase reserve requirements Buy bonds Banks borrow money from Federal Reserve You pay interest to the bank. Bank pays a discount to Federal Reserve Changes in discount rate affect money supply Discount and interest rates are in percent % Real Estate loans come from savings Page 21

12 SAVINGS FLOW INTO MORTGAGE MARKET SAVINGSSAVINGS Institutional Lenders Commercial Banks Thrift Institutions Insurance Companies Mutual Savings Banks Non-Institutional Lenders Mortgage Companies Pension Funds Trusts, Etc. MORTGAGEMARKETMORTGAGEMARKET $ $ $ $ Homes Commercial Industrial Rural $$ Private Lenders $$

13 DISINTERMEDIATION Savings Thrift Institutions Non-Mortgage Lenders or Borrowers Page 21

14 Disintermediated Savings List five things savers might spend their savings on: List five things savers might spend their savings on: 1.Consumer goods 2.Entertainment 3.Travel 4.Stocks/bonds/cds/mutual funds 5.other Page 21

15 ? Money Rates ? Discount Rate = % Discount Rate = % Prime Rate = % Prime Rate = % Federal Funds Rate = % Federal Funds Rate = % Mortgage Rate Real Estate Loan = % Real Estate Loan = % –(owner occupied single family) –80% Loan –20% Down

16 Federal Reserve Impacts real estate activity Impacts real estate activity Tightens money supply and funds flow elsewhere Tightens money supply and funds flow elsewhere Raises mortgage interest rates Raises mortgage interest rates Real estate activity declines Real estate activity declines Easy money supply causes out flow of funds Easy money supply causes out flow of funds This is supply and demand of money This is supply and demand of money Housing industry suffers more than other sectors from tightening of money Housing industry suffers more than other sectors from tightening of money Page 21


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