Chapter 11 Money and Banking

Barter Economy Coincidence of wants Cumbersome Time-consuming Indivisible

Money  Attributes of Money Divisible Durable Portable and Convenient Generally accepted as payment  This gives money value

Types of Money Commodity – metal and money (gold)  Problems perishable bulky not divisible not valued equally uses up resources Gresham’s Law – bad money drives out good value varies Token – face value exceeds real value

Paper money  Bank notes – papers promising gold or silver  Fiat money – money not redeemable People know others will accept it Purchasing power – what it will buy  Legal tender – anything creditors are required to accept as payment Nonmoney substitutes – Enterprise Rental doesn’t accept cash  Credit Cards  E-checks  E-cash  Debit cards  E-Money

Money (cont.)  Functions of Money Medium of exchange - to buy and sell things Unit of Account - things are valued in dollars and cents Store of Value - method to hold wealth for the future  What gives money value? Nothing Generally accepted as payment

Money Market  Financial Markets Savers – households Borrowers – business Intermediaries – banks, credit unions, savings and loans, thrift institutions, brokers Regulator – Federal Reserve System

Money Market  Supply of Money M1 = Currency ( coins and paper) + Checkable deposits (most used) + Traveler’s checks M2 = M1 + Savings and money market accounts + Small time deposits  Demand for Money Transactions demand - to buy Asset (speculative) demand - to invest Precautionary demand - for emergencies  Money Market – determines the interest rate Equilibrium: Qsm = Qdm

Money Market (cont.)  Interest rate is the Federal Funds Rate – rate at which banks borrow from each other Discount Rate – rate at which the FED lends to banks Prime Rate – rate at which banks lend to their best customers 3 month Treasury Bill Government Bond Commercial Paper AAA Corporate Rating– rate at which banks lend to their best customers  Monetary Chain Increase money supply, Interest rates fall, I and C increase, Ad increases, GDP increases

Federal Reserve System (1913)  Established in 1913, began in 1914 as the central bank of the U.S.  Roosevelt’s Reforms – Banking Acts of 1933 and 1935 Board of Governors - 7 appt by the President to 14 year terms and confirmed by the Senate  Chairman: Ben Bernanke (4 year term)  Conducts monetary policy Open Market Committee -BoG + 5 District Pres  Buys and sell govt. bonds Three advisory councils 12 District banks: Day to day operations  3,300 member banks  Ours is 6 Atlanta Deposit insurance

Functions of the FED  Issues Paper Currency  Clear checks  Fiscal agent for the Treasury  Provides Check Clearing services  U.S. Government's bank  Supervises banks - Restricting Bank Investment practices  Control the Money Supply

Control the Money Supply Monetary Policy  Determines Monetary Policy - controlling the money supply Open Market Operations – buying and selling bonds to banks Discount Window - Lends money to banks at a discount rate  Mostly ceremonial but used in emergencies  Lender of the last resort  Discount Rate – loans to the banks Primary Credit Rate – loans to sound banks Secondary Credit Rate – loans to riskier banks Seasonal Credit Rate – loans to banks in agricultural or tourism areas Reserve Requirement – percentage of reserves that must be held in the FED  Rarely used  Sets Reserve requirements and holds reserves Reserves – funds used by banks to meet the needs of the customers and the reserve requirement

Objectives of the FED High Level of Employment Economic Growth Price stability Interest rate stability Stability in financial markets (stock market) Stability in Foreign Exchange markets

Bank Operations and Money Creation  Why are there banks? To make profits for the owners  by loaning and getting interest Banks make loans  Initial deposit $1000 for Bank A  Reserve requirement = 10%

Open Market Operations Calculator M = B(1 – rr)  M = Money Supply  B = Bonds bought or sold  rr = Reserve Requirement