is whatever is generally accepted in exchange for goods and services — accepted not as an object to be consumed but as an object that represents a temporary abode of purchasing power to be used for buying still other goods and services.” — Milton Friedman (1992)

What is Money? 1.A medium of exchange : U sed to buy and sell goods and services. Avoids barter 2. A store of value: Allows transfer of purchasing power from one period to another. 3.A measure of value: Converts worth to a monetary value. 4.A standard of deferred payment: Makes future payments possible.

1.Commodity Money : has value itself, deer skins 2.Fiat money: just because

1.Acceptable : used by most people 2.Standardized quality : all looks the same 3.Durable: goes through the wash 4. Valuable large enough and portable 5. Divisible allows impulse buying

Two basic measurements of the money supply are M1 and M2: The components of M1 are: Currency Checking Deposits (including demand deposits and interest-earning checking deposits) Traveler's checks M2 (a broader measure of money) includes: M1, Savings, Time deposits under $100,000, and, Money mutual funds The Supply of Money

6 of 61 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Measuring the Money Supply, August 2011 M1 = $9,545 billion M2 = $2,108.8 billion

The Composition of Money in the U.S. The size and composition of the two most widely used measures of U.S. money supply (M1 & M2) are shown above. Money Supply, M1 (in billions) Currency (in circulation) Demand deposits Other checkable deposits Traveler’s checks Total M1 $ $1,596 Money Supply, M2 (in billions) M1 Savings deposits a Small time deposits Money market mutual funds Total M2 $1,596 4,445 1, $8,328 $1,596 $8,328 a Including money market deposit accounts. Source: The M1 and M2 Money Supply of the U.S –––––––––– (as of May 2009) ––––––––––

1. __ A $100 bill 4. __ A $50 traveler’s check 10. __ A $10,000 treasury bill 6. __ A quarter 2. __ A 6-month certificate of deposit 5. __ A $5,000 American Express credit line 7. __ A $1 off coupon clipped from the paper 8. __ A $100 balance in a checking account 3.__ A $10,000 retirement account invested in stocks 9. __ A $200 balance in a savings account a b c b aa a ccc

The Changing Nature of M1 In the 1980s, interest-earning checking accounts M1  In the 1990s, money market mutual funds M1  ,050 1,350 Billions of $ Interest-earning checkable deposits $309 $312 $672 Total $1,293 1,200 Demand deposits Currency M1

Currenc y Interest-earning checkable deposits The Changing Nature of M1 Billions of $ Total $1, $761 $309 $318 Demand deposits M1 In the 1980s, interest-earning checking accounts M1  In the 1990s, money market mutual funds M1 

Function: 1.accept and maintain deposits. 2.make loans.

Types:. 1.Commercial Banks. 2.Savings and Loans 3.Credit Unions 4.Savings Banks.

The Functions of Commercial Banking Institutions Assets Vault cash Reserves at the Fed Loans outstanding U.S. government securities Other securities Other assets Total Checking deposits Savings and time deposits Borrowings Other liabilities Net worth Consolidated Balance Sheet of Commercial Banking Institutions April 2009 (billions of $) Liabilities $ ,051 1,265 1,412 1,630 $ 12,070 $ 600 6,851 2, ,291 $ 12,070 Banks provide services and pay interest to attract checking, savings, and time deposits (liabilities). Most of these deposits are invested and loaned out, providing interest income for the bank. Banks hold a portion of their assets as reserves (either as cash or deposits with the Fed) to meet their daily obligations toward their depositors.

14 of 61 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Balance Sheet for a Large Bank, 12/31/10 The items on a bank’s balance sheet of greatest economic importance are its reserves, loans, and deposits.. The left side of the balance sheet always equals the right side.

Banks maintain only a fraction of their assets (deposits) as reserves to meet the requirements of depositors. an decrease in required reserves lets banks make more loans, expand the money supply

1.Printing Money 2.Making Loans a. Key Ingredients: Deposits – Household savings Required Reserves – money held at the bank or at the FRS (around 10%) Excess Reserves – loan able funds = Deposits – Required Reserves A depository institution can make loans up to the value of its excess reserves

Main Street Bank Situation: Demand deposits = $50,000 Reserve requirement =10 % Actual reserves at bank = $10,000 Excess Reserves: Demand deposits = $50,000 Reserve requirement= 10 % Actual reserves = $10,000 - Required reserves = $5,000 = Excess reserves = $5,000

Excess Reserves ($5,000) can be loaned By making a loan, the bank has created money. The original deposits are still in Main Street Bank, but now there is an additional $5,000 out floating around.

If the Excess Reserves are loaned The borrowed money is spent and deposited at another bank. The second bank’s reserves are now up $5,000 - it must keep 10% or $500 - it can then loan out $4,500 ($5,000 – $500) This process can be repeated at each step. 10% of the money is lost at each step The more that is required to be held in reserve, the less money can be created The lower the reserve requirement, the greater the amount of money that can be created

Bank New cash deposits: Actual Reserves New Required Reserves Potential demand deposits created by extending new loans Initial deposit (bank A) Second stage (bank B) Third stage (bank C) Fourth stage (bank D) Fifth stage (bank E) Sixth stage (bank F) Seventh stage (bank G) $1,000.00$ $ Total$5,000.00$1,000.00$4, All others (other banks)1, Creating Money from New Reserves When banks are required to maintain 20% reserves against demand deposits, the creation of $1,000 of new reserves will potentially increase the supply of money by $5,000.

From the table a deposit of $1000, with a 20% reserve requirement led to a $4000 expansion of the money supply Is there a pattern here? It just takes 3 easy steps

2. Multiply the initial change in the excess reserves by the money multiplier $1000 * 5 = $ Find the reciprocal of the required reserve 1/20% = 1/1/5= 5 3.Subtract out the initial change $ $1000 = $4000

1.Deposit of $10,000 2.Required reserve 10% 3.Increase in the money supply? How about if the reserve requirement was 20%? 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ a.10,000 c. 100,000 b.9,000 d. 90,000 a.200,000 c. 100,000 b. 40,000 d. 50,000

1.Deposit of $16,000 2.Required reserve 25% 3.Increase in the money supply? How about if the reserve requirement was 20%? How about if the reserve requirement was 10%? 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ a.144,000 c. 80,000 b.48,000 d. 64,000

1. Loan making changes the money supply 2. Increases in loans leads to increased spending which increases the money supply. 3. BUT, decreases in loan making, or even paying back a loan decreases the money supply.

Type of Deposit Current Requirement Limits Checkable Deposits $0 - $6 million 0 % 3% $6 - $42.1 million 3 3 Over 42.1 million Non-checkable non-personal savings and time deposits 0 0-9

1.Created in Responsible for: a. overseeing the money supply b. coordinating commercial bank operations c. regulating depository institutions

The Public: Households & businesses Commercial Banks Savings & Loans Credit Unions Mutual Savings Banks The Board of Governors is at the center of the banking system in the U.S. The seven members of the Board of Governors also serve on the Federal Open Market Committee The FOMC is a 12- member board that establishes Fed policy regarding the buying and selling of government securities. Federal Reserve Board of Governors 7 members appointed by the president, with the consent of the U.S. Senate 12 Federal Reserve District Banks (25 branches) Open Market Committee Board of Governors & 5 Federal Reserve Bank Presidents (alternating terms, New York Bank always represented).

Board of Governors – 7 members appointed by President - 14 yr terms at 2 yr intervals for continuity & independence -not more than one from each district

(Board of Governors) Each district bank monitors the commercial banks in their region and assists them with the clearing of checks. The Board of Governors of the Federal Reserve System is located in Washington D.C.

____________________ 2.____________________, ____________________ 3.____________________ 4._________________, _________________, _________________ 5.________________, _________________, _________________, 6._________________, ________________, _________________, _________________, _________________, _________________ 7._________________, _________________ 8._________________, ________________, _________________, _________________ 9._________________, _________________ 10._________________, ________________, ________________, __________________ 11._________________, _________________, _______________, 12._________________, ________________, _________________, _________________, _________________, _________________

1 Boston 2 New York City, Buffalo 3 Philadelphia 4 Cleveland, Pittsburgh, Cincinnati 5 Richmond, Baltimore, Charlotte 6 Atlanta, Nashville, Birmingham, Miami, Jacksonville, New Orleans 7 Chicago, Detroit 8 St. Louis, Louisville, Memphis, Little Rock 9 Minneapolis, Helena 10 KC, Denver, Omaha, Oklahoma City 11 Dallas, San Antonio, El Paso 12 SF, Salt Lake City, LA, Port., Seattle, Honolulu

2. Federal Open Market Committee -12 members = 7 Governors (for majority) plus 5 Pres or VP from 1 NY 2 Bost, Phila, or Richmond, 3 Atl, Dallas, or StL 4 Minn, KC, or SF, LA 5 Clev, or Chicago set policy on buying & selling bonds on open mkt 3. Federal Advisory Council outsiders 12 members - 1 each selected by Board of each Region

Make sure they are following the rules Makes clearing check easier Replace money or increase or decrease money in circulation Moves checks from region to region Borrows, writes checks, takes deposits

= * * M V P Y V elocity P rice Output - the amount of money in circulation - the number of times each $ is spent in a year (considered to be stable) - the actual output of goods and services - the level of prices M one y M V P Y

= * * M V P Y V elocity P rice Y =output If V and P are constant, then an increase in M will lead to a proportional increase in Y GDP increases. but if V and Y are constant (at full employment), then an increase in M will lead to a proportional increase in P =Inflation. P Y Total Sales (GDP) = *