1. { Banking: Basic Operation and Money Modules 25 & 26

2.  Banks are a financial intermediary  Two jobs  Take deposits  Provide loans (liquidity) to finance illiquid investments by borrowers  Role of the Federal Reserve is different  “Dual Mandate” – full employment, low inflation  Banks cannot lend ALL their money Banking

4.  Banks must keep substantial quantities of liquid reserves on hand (post Depression)  Currency or deposits in the Federal Reserve  Money in the bank vault  Banks must have sufficient assets to cover their financial liabilities PLUS depositor withdraws Banking

5.  T-accounts  Summarize a business’s financial position STANDARD BUSINESS> BANK>

6.  Banks are different from standard businesses in T-accounts  Must have some money set aside with the Fed by law (assets column)  Required Reserve Ratio – required amount of deposits a bank must hold (usually 10%)  Bank runs and subsequent bank failure  “Fractional Reserve Banking” – when central banks require reserves Banking

7.  Money creation  Through their activity, banks actual CREATE money Banking

8. Paper money is obsolete and should be removed from circulation all together. Four-Corner Debate

9.  Just a reminder: M1 = measures money in circulation and demand deposits (checking)

10.  Monetary Base  Sum of currency in circulation AND reserves held by banks.  DIFFERENT- Bank reserves are NOT considered part of the money supply, but ARE part of the monetary base!  Checkable bank deposits, part of money supply aren’t part of monetary base monetary base

11.  Money multiplier  Ratio of money supply to the monetary base  Tells us the total number of dollars created in the banking system by each $1 addition to the monetary base  Simple money multiplier:  $1/rr** ** rr = Reserve rate Banking

12. SO:  If the reserve rate is 10% and the Fed adds $100 to the monetary base, then the money supply will increase BY: 1/.10 = 10 10x$100 = $1000

13.  Assume money lent out is spent and will end up back in another bank  Some may keep cash in our wallet (leakage)  Assumptions  Not worried about leakage  Banks lend out ALL their money (save Req. Reserve Rate)  What if a bank keeps too much in reserves? – excess reserves  What happens if rr falls?

14.  Banking Regulations  Deposit Insurance  Capital Requirements  Reserve Requirements  Discount Window

15.  The Federal Reserve  One of the most important, controversial elements of the US economy  Many conspiracy theories about the founding of the bank, the role of the bank, and its propensity to create debt burdens.  Little government oversight, but not a private entity  Oversight through appointment The Federal Reserve

16.  Historic Analysis  Various “national banks” in our history  Panic of 1907  JP Morgan’s role  VERY similar to today (8% unemp)  Trusts speculating on the stock market (Knickerbocker Trust)  United Copper Company’s stock  Currency supply issues, credit markets frozen  Progressives feared Morgan’s power, and tried to limit his influence

17.  Jekyll Island gathering  Wealthiest men in America, politicians gathered in secret to plan and organize a new national bank.  1913- Federal Reserve Act instituted a new national bank, regulated, and regulated, and set basic set basic requirements for requirements for lending and lending and currency currency involvement. involvement.  Unanimously passed in Congress

19.  Dual mandate of the Fed  Keep unemployment low and keep prices (inflation) stable  This is achieved through open market operations  Effectiveness?  1930s issues  Crisis in the 1980s  2008 Recession The Fed

20.  The Federal Reserve System and Function  Two parts to the Fed  Board of Governors (US Gov, appointed)  12 Regional Fed Banks (Private)  Functions  Provide Financial Services  “bank for banks”  Supervise and Regulate Banks  Maintain stability of financial system  Conduct monetary policy The Fed: Banking Functions

22.  Fed Functions and Market Performances  What if a bank has insufficient funds?  Federal funds market  Borrow reserves from banks with excess!  Overnight loan, w/interest  Federal funds rate  Fed can adjust RR to alter money supply (last time: 1992) The Fed: Banking Functions

23.  Discount Rate  Banks in need of RR funds can borrow directly from the fed using the “discount window”  Discount rate- usually 1% above the FFR to encourage banks to borrow from each other  Fed can adjust to also alter money supply (ex- 2008 it was 0.25% interest!!)  Cost of being short reserves falls, encouraging banks to lend! The Fed: Banking Functions

24.  Open-Market operations  Mainly short-term (1 year) US Treasury bill purchases  Purchased through commercial banks (financial market banks)  BAD idea to buy directly from government (historically terrible)  Pays banks for bills by crediting reserve accounts of commercial banks The Fed: Banking Functions

25.  Fed creates the money to purchase the bills  “Click of the mouse,” created at the Fed’s own discretion  Does not directly enter the money supply, BUT, sets the money multiplier in motion  Increases reserves, commercial banks then lend out excess reserves easier, which increases money supply. The Fed: Banking Functions

26. The Federal Reserve should be ended because it has too much control over the economy. Four-Corner Debate