MONEY AND BANKING AP MACRO ECONOMICS

MEANING OF MONEY Money is any asset that can easily be used to purchase goods and services. Money consists of cash itself, as well as other assets that are highly liquid. (Checking Account) Liquid asset that can be quickly converted into cash. Why do we use money? Gains from trade Problems with the barter system? Double Coincidence of wants Money solves this problem

ROLE OF MONEY Medium of exchange Is an asset that individuals acquire for the purpose of trading goods and services rather than for their own consumption. Acceptable currency Smokes in prison Store of value A means of holding purchasing power over time. Money is not the only store of value Any asset that holds its purchasing power over time is a store of value Unit of account The commonly accepted measure individuals use to set prices and make economic calculations. Helps measure worth of value.

TYPES OF M0NEY Commodity money The medium of exchange was a good normally gold or silver that had intrinsic value in other uses Cigarettes in prisons and POW camps. Gold used as jewelry and ornamentation, aside from minted coins. Representative money or commodity backed money, The money itself has on monetary value but its ultimate value is guaranteed by a promise that if it can be converted into that good. Modern banks were created by gold and silver smiths in medieval and renaissance periods. Fiat money Backed by the good will an faith of the U.S.Government. Official currency.

MONEY SUPPLY Two measures of the Money Supply M1 Narrowest definition of money consists of Money in circulation (cash) Travelers checks Checkable bank deposits, (checking, debit and some money market accounts) M2 The broader definition of money Adds several other types of assets Near money or financial assets that aren’t directly usable as a medium of exchange but can be readily converted into cash or checkable bank deposits. M1 + saving accounts and time deposits (small denomination CD”S)

WHAT DO BANKS DO Financial Intermediary Liquid assets (bank deposits) to finance illiquid investments of borrowers. Banks can create liquidity because it is not necessary to keep all funds deposited with it in the form of highly liquid assets. Enough to service day to needs Creates liquidity for those who need cash in the form of loans Funds not loaned out are stored either in a banks vaults or held in the bank deposits held at the Federal Reserve. (Bank Reserves)

MONETARY BASE Monetary base Sum of currency in circulation plus and bank reserves Different from money supply in two ways Bank reserves are part of the monetary base but aren’t part of the money supply. If deposited at the Fed Reserve, in a Bank Vault as reserves, that money is not readily available for spending. Checkable bank deposits, which are available for spending are not part of the money base because they are available for spending. Not in circulation and not in the bank vault as reserves not part of the monetary base.

T TABLE BANKS Assets Required Reserves Excess Reserves loans Government securities Liabilities Deposits Equity

T TABLE FOR FEDERAL RESERVE Assets Government Debt Liabilities Monetary base (Currency in circulation + bank Reserves)

MONEY MULTIPLIER Money Multiplier is the ratio of the money supply to the monetary base. Describes the creation of money via lending from bank and Monetary policy. 1/reserve ratio Is the rat