1. 10
C H A P T E R
Money and Banking

2. What is money?
Examples of Money Cattle, cigarettes, shells, stones, gold, pepper, wampum, and even beer as money So what is Money? Money is anything that does what money does

3. Six Characteristics of Money
Durability
Portability
Divisibility
Uniformity
Limited Supply
Acceptability

4. Medium of Exchange Unit of Account Store of Value FUNCTIONS OF MONEY
Money can be used for buying and selling goods and services
without money we have the problems of barter and the coincidence of wants
money allows for greater specialization and trade and productive efficiency
Unit of Account
Prices are quoted in dollars and cents.
Store of Value
money allows us to transfer purchasing power from present to future.
it is the most liquid (spendable) of all assets
a convenient way to store wealth.

5. Why Monetary Side is Important
Without money there would be barter.
Barter is the direct exchange of goods and services for other goods and services.

6. BARTER
a. Definition: the exchange of one good or service for another good or service
b. Problems with barter:
coincidence of wants:
a situation in which the good or services that one trader desires to obtain is the same as that which another desires to give up and an item that the second trader wishes to acquire is the same as that which the first trader desires to surrender
you have to find somebody who wants to trade the item that you want to get AND who also wants the item that you have that you want to trade
With barter there will be less specialization because of the difficulty of overcoming the coincidence of wants.
If you can't find someone to trade with, you will have to produce it yourself
Less specialization means less output and MORE SCARCITY

7. What problems does barter entail?
REVIEW
What problems does barter entail?
Barter requires the "double coincidence of wants." If someone wants something, he or she will have to find someone who wishes to part with that good and at the same time wishes to exchange the good for something that the first party wishes to part with.

8. WHAT ABOUT CREDIT CARDS?
Credit cards are not money, but their use involves short-term loans; their convenience allows you to keep M1 balances low because you need less for daily purchases.

9. Money’s Value
Commodity money = objects that have value in themselves and that are also used as money (salt, cattle, gems, etc)
Representative Money = objects that have value because the holder can exchange them for something else of value
Fiat Money = valuable because the government says its valuable “legal tender”

10. WHAT BACKS THE MONEY SUPPLY?
Money as Debt
The government's ability to keep its value stable provides the backing.
People cannot convert paper money into a fixed amount of gold or any other precious commodity
Value of Money
Acceptability
Legal Tender - fiat money
Relative Scarcity
Money and Prices
Value of the Dollar
D = 1/Price Level
Inflation and Acceptability

11. MONEY SUPPLY Definition… Currency Checkable Deposits Token Money
Federal Reserve Notes
Intrinsic Value
Checkable Deposits
Commercial Banks
Thrift Institutions
Review: If I take $10 from my wallet and put it into my checking account, what happens to M1?

12. = Plus... MONEY SUPPLY M2 M1 Near-monies Savings Deposits
Money Market Deposit Accounts (MMDAs)
Smaller Time Deposits
Money Market Mutual Funds (MMMFs)
Review: If I take $10 out of my wallet and put it into my savings account
what happens to M1?
what happens to M2?

13. REMEMBER The following are NOT part of M1: currency in banks
currency and checkable deposits owned by the government
currency and checkable deposits owned by the Federal Reserve Banks

14. = Plus... MONEY SUPPLY Illustrated… Large Time Deposits
$100, or more
Illustrated…

15. MONEY SUPPLY M1 M2 M3 plus Checkable deposits equals M1
Currency (coins & paper money)
plus Checkable deposits
equals M1
$1101
2000 Data
(billions of dollars)

16. MONEY SUPPLY plus Savings deposits, M1 M2 M3 plus Checkable deposits
Currency (coins & paper money)
plus Checkable deposits
equals M1
plus Savings deposits,
including MMDA’s
plus Small time deposits
plus Money market mutual fund
(MMMF) balances
equals M2
$1101
$4827
2000 Data
(billions of dollars)

17. MONEY SUPPLY plus Savings deposits, plus Savings deposits,
Currency (coins & paper money)
plus Checkable deposits
equals M1
plus Savings deposits,
including MMDA’s
plus Small time deposits
plus Money market mutual fund
(MMMF) balances
equals M2
Currency (coins & paper money)
plus Checkable deposits
equals M1
plus Savings deposits,
including MMDA’s
plus Small time deposits
plus Money market mutual fund
(MMMF) balances
equals M2
plus Large time deposits
equals M3
$1101
$4827
2000 Data
(billions of dollars)
$6853

19. What is not money?
currency and checkable deposits of the government, Federal Reserve, and banks
income is not money income is a FLOW concept: you earn income over time (e.g.. $500 a week)
money is a STOCK concept: you have a given amount at a point in time ( e.g. $500 in your wallet and checking account right now)
when we talk about "money demand" we will mean a demand for more liquidity (more in my wallet) NOT an increase in my income
Can you get an increase in your income and have less money?
YES, if you put more of your income in the stock market and less in your checking account

20. Stable Value! through... So, What Backs the Money Supply?
Appropriate Fiscal Policy
Intelligent Management of the Money Supply

21. illustrated... Transactions Demand, Dt Asset Demand, Da
THE DEMAND FOR MONEY
Transactions Demand, Dt
varies directly with nominal GDP
Asset Demand, Da
varies inversely with the interest rate
illustrated...

22. Rate of interest, i (percent)
THE DEMAND FOR MONEY +
Transactions
Demand, Dt
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) Dt 10
7.5 5
2.5

23. Rate of interest, i (percent) Rate of interest, i (percent)
THE DEMAND FOR MONEY + =
Transactions
Demand, Dt
Asset
Demand, Da
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) Dt 10
7.5 5
2.5
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) 10
7.5 5
2.5 Da

24. + = THE DEMAND FOR MONEY Transactions Demand, Dt Asset Demand, Da
Total demand
for money, Dm
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) Dt 10
7.5 5
2.5
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) 10
7.5 5
2.5 Da
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) 10
7.5 5
2.5 Dm

25. + = THE DEMAND FOR MONEY ADD THE MONEY SUPPLY TO FIND THE
Transactions
Demand, Dt
Asset
Demand, Da
Total demand
for money, Dm
ADD THE
MONEY SUPPLY
TO FIND THE
EQUILIBRIUM RATE
OF INTEREST
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) Dt 10
7.5 5
2.5
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) 10
7.5 5
2.5 Da
Rate of interest, i (percent)
Amount of money
demanded (billions
of dollars) 10
7.5 5
2.5 Dm Sm 10
7.5 5
2.5
Rate of interest, i (percent) ie
Amount of money
demanded (billions
of dollars)
Equilibrium
Interest Rate

26. Rate of interest, i (percent) Amount of money demanded
THE MONEY MARKET Sm 10
7.5 5
2.5
Suppose the money
supply is decreased
from $200 billion, Sm,
to $150 billion Sm1. ie
Rate of interest, i (percent) Dm
Amount of money demanded
(billions of dollars)

27. Rate of interest, i (percent) Amount of money demanded
THE MONEY MARKET
Sm1 Sm 10
7.5 5
2.5
A temporary shortage
of money will require
the sale of some assets
to meet the need. ie
Rate of interest, i (percent) Dm
Amount of money demanded
(billions of dollars)

28. Rate of interest, i (percent) Amount of money demanded
THE MONEY MARKET Sm 10
7.5 5
2.5
Suppose the money
supply is increased
from $200 billion, Sm,
to $250 billion Sm2. ie
Rate of interest, i (percent) Dm
Amount of money demanded
(billions of dollars)

29. Rate of interest, i (percent) Amount of money demanded
THE MONEY MARKET Sm
Sm2 10
7.5 5
2.5
A temporary surplus
of money will require
the purchase of some
assets to meet the de-
sired level of liquidity. ie
Rate of interest, i (percent) Dm
Amount of money demanded
(billions of dollars)

30. THE MONEY MARKET ie Bonds are assumed Sm Sm2 as a typical asset with
lower prices associated
with higher
interest rates Sm
Sm2 10
7.5 5
2.5
A temporary surplus
of money will require
the purchase of some
assets to meet the de-
sired level of liquidity. ie
Rate of interest, i (percent) Dm
Amount of money demanded
(billions of dollars)

31. THE FEDERAL RESERVE AND
THE BANKING SYSTEM
Centralization and Public Control
Board of Governors
Assistance & Advice
Federal Open Market Committee
Three Advisory Councils
The 12 Federal Reserve Banks
Central Bank Role
Quasi-Public Banks
Banker’s Banks
Commercial Banks & Thrifts

32. THE FEDERAL RESERVE AND THE BANKING SYSTEM
Open Market
Committee
Advisory
Councils
Board of
Governors
12 Federal
Reserve Banks
Commercial
Banks
Thrift Institutions
(Savings & loan associations,
mutual savings banks, credit unions)
The Public
(Households and
businesses)

33. Setting Reserve Requirements & Holding Reserves
FED Functions & the Money Supply
Issuing Currency
Setting Reserve Requirements & Holding Reserves
Lending Money to Banks & Thrifts
Providing for Check Collection
Acting as Fiscal Agent
Supervising Banks
Controlling the Money Supply

34. Federal Reserve Independence Recent Developments
FED Functions & the Money Supply
Federal Reserve Independence
Recent Developments
Relative Decline of Banks and Thrifts
Financial Services Industry
Consolidation Among Banks and Thrifts
Globalization of Financial Markets
Electronic Transactions

35. Chapter Conclusions Federal Reserve Independence Recent Developments
FED Functions & the Money Supply
Federal Reserve Independence
Recent Developments
Relative Decline of Banks and Thrifts
Financial Services Industry
Consolidation Among Banks and Thrifts
Globalization of Financial Markets
Electronic Transactions
Chapter
Conclusions

36. KEY TERMS
medium of exchange unit of account store of value M1, M2, M3 token money Federal Reserve Notes checkable deposits commercial banks thrift institutions near-monies savings account money market deposit account (MMDA) time deposits
money market mutual fund (MMMF) legal tender transactions demand asset demand total demand for money money market Federal Reserve System Board of Governors Federal Open Market Committee (FOMC) Federal Reserve Banks financial services industry electronic transactions
Copyright McGraw-Hill/Irwin 2002
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END

37. How Banks and Thrifts Create Money
Coming up next...
How Banks and Thrifts Create Money
Chapter 14