Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 15 Money, Banking, and Central Banking

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Chapter Outline The Functions of Money Properties of Money Defining Money Financial Intermediation and Banks Federal Deposit Insurance The Federal Reserve System: The U.S. Central Bank

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Did You Know That... It is illegal to carry more than $5 worth on pennies or nickels out of the U.S.? Recent upswings in prices of zinc and copper have pushed the value of these metals used in the coins above the coins’ face value. By banning the international transport and melting of pennies and nickels, the government is trying to prevent people from profiting from selling coins that are already generating losses to taxpayers.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Did You Know That… (cont’d) Coins, paper currency, and bank accounts from which people transmit debit-card and check payments are included in the Federal Reserve’s measure of the total amount of money that we can use to purchase goods and services. Money has been important to society for thousands of years and is part of our everyday existence.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Money –Any medium that is universally accepted in an economy both by sellers of goods and services and by creditors as payment for debts

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Table 15-1 Types of Money 2009: Mackerel fish?

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Functions of Money The functions of money –Medium of exchange vs. barter –Unit of accounting –Store of value (purchasing power) if …. –Standard of deferred payment

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Properties of Money Liquidity –The degree to which an asset can be acquired or disposed of without much danger of any intervening loss in nominal value and with small transaction costs –Money is the most liquid asset.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Properties of Money (cont’d) Question –What is the cost of holding money (its opportunity cost)? Answer –It is the alternative interest yield obtainable by holding some other asset.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Properties of Money (cont’d) Questions –What backs money? –Is it gold, silver, or the federal government? Answer –Your confidence –“Fiducia”=trust

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Defining Money Money is important –Changes in the rate at which the money supply increases or decreases affect important economic variables (at least in the short run) such as inflation, interest rates, employment, and the level of real GDP. Money Supply –The amount of money in circulation

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Defining Money (cont'd) M1 –Currency –Checkable (transaction) deposits –Traveler’s checks not issued by banks –Where are credit cards?

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Defining Money (cont'd) M2 = M1 plus 1.Savings and small denomination time deposits 2.Balances in retail money market mutual funds 3.Money market deposit accounts

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Financial Intermediation and Banks Most nations have a banking system that encompasses two types of institutions. 1.Private banking institutions. 2.Central bank.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Federal Reserve System (cont'd) Depository institutions –7,500 commercial banks –1,300 savings and loans –11,000 credit unions All may purchase Fed services

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 15-5 Bank Failures Source: Federal Deposit Insurance Corporation.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Federal Deposit Insurance In 1933, at the height of bank failures, the Federal Deposit Insurance Corporation (FDIC) was founded to insure the funds of depositors and remove the reason for runs on banks. –The FDIC is a government agency that insures the deposits held in banks and most other depository institutions; all U.S. banks are insured this way. –Problem: Moral Hazard

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Financial Intermediation and Banks (cont'd) Central Bank –A banker’s bank –Usually an official institution that also serves as a country’s treasury’s bank –Central banks normally regulate commercial banks.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Federal Reserve System: The U.S. Central Bank (cont’d) The Fed –The Federal Reserve System; the central bank of the United States –The most important regulatory agency in the U.S. monetary system –Established in 1913 by the Federal Reserve Act; signed by President Woodrow Wilson

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 15-6 Organization of the Federal Reserve System Source: Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes and Functions, 7th ed. (Washington, D.C., 1984), p. 5.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 15-7 The Federal Reserve System Source: Board of Governors of the Federal Reserve System.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved The Federal Reserve System (cont'd) Functions of the Fed 1.Supplies the economy with currency (money) 2.Provides a payment-clearing system 3.Acts as the government’s fiscal agent 4.Supervises (regulates) depository institutions 5.Acts as a “lender of last resort” 6.Applies monetary policy

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Myth #15: The Fed is part of the government The Federal Reserve is operationally independent of the federal government However, the Fed was created out of the Federal Reserve Act of 1913; and Congress has the right to dissolve it and approve its Board of Governors The Fed also has to report to Congress twice a year