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Answer & Explanation:1.Week 7 Ch 11 The Monetary System.pptWeek 7 Ch 12 Money Growth and Inflation-1.ppt2.Week 8 Ch 13 Open-Economy Macroeconomics_Basic Concepts.pptWeek 8 Ch 15 Aggregate Demand and Aggregate Supply.ppt
week_7_ch_11_the_monetary_system.ppt
week_7_ch_12_money_growth_and_inflation_1.ppt
week_8_ch_13_open_economy_macroeconomics_basic_concepts.ppt
week_8_ch_15_aggregate_demand_and_aggregate_supply.ppt
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16
The Monetary System
PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
The Meaning of Money
• Money
– Set of assets in an economy
– That people regularly use
– To buy goods and services from other
people
• The functions of money
– Medium of exchange
– Unit of account
– Store of value
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
The Meaning of Money
• Medium of exchange
– Item that buyers give to sellers when they
want to purchase goods and services
• Unit of account
– Yardstick people use to post prices and
record debts
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
The Meaning of Money
• Store of value
– Item that people can use to transfer
purchasing power
• From the present to the future
• Liquidity
– Ease with which an asset can be
converted into the economy’s medium of
exchange
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4
The Kinds of Money
• Commodity money
– Money that takes the form of a commodity
with intrinsic value
• Gold, cigarettes
• Intrinsic value
– Item would have value even if it were not
used as money
• Gold standard – Gold as money
• Or paper money that is convertible into gold
on demand
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5
The Kinds of Money
• Fiat money
– Money without intrinsic value
– Used as money because of government
decree
– “This note is legal tender for all debts,
public and private”
• Fiat
– Order or decree
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
Money in the U.S. Economy
• Money stock
– Quantity of money circulating in the
economy
• Currency
– Paper bills and coins in the hands of the
public
• Demand deposits
– Balances in bank accounts; depositors
can access on demand by writing a check
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
7
Money in the U.S. Economy
• Measures of money stock
– M1
• Demand deposits, Traveler’s checks
• Other checkable deposits, Currency
– M2
• Everything in M1
• Savings deposits, Small time deposits
• Money market mutual funds
• A few minor categories
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
8
Figure 1
Two Measures of the Money Stock for the U.S. Economy
The two most widely followed measures of the money stock are M1 and M2. This
figure shows the size of each measure in January 2013.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
Where is all the currency?
• January 2013: $1.1 trillion currency
outstanding
– Implies the average adult holds about
$4,490 of currency
– Much of the currency is held abroad
– Much of the currency is held by drug
dealers, tax evaders, and other criminals
• Currency is not a particularly good way to
hold wealth
• Can be lost or stolen; doesn’t earn interest
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
The Federal Reserve System
• The Federal Reserve (the Fed)
– The central bank of the United States
• Central bank
– Institution designed to
• Oversee the banking system
• Regulate the quantity of money in the
economy
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
The Fed’s Organization
• The Federal Reserve
– Created in 1913
– After a series of bank failures in 1907
– Purpose: to ensure the health of the
nation’s banking system
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
The Fed’s Organization
• Board of governors
– 7 members, 14-year terms
• Appointed by the president and confirmed by
the Senate
– The chairman
• Directs the Fed staff
• Presides over board meetings
• Testifies regularly about Fed policy in front of
congressional committees.
• Appointed by the president (4-year term)
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
The Fed’s Organization
• The Federal Reserve System
– Federal Reserve Board in Washington,
D.C.
– 12 regional Federal Reserve Banks
• Major cities around the country
• The presidents are chosen by each bank’s
board of directors
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
The Fed’s Organization
• The Fed’s jobs
– Regulate banks and ensure the health of
the banking system
• Regional Federal Reserve Banks
• Monitors each bank’s financial condition
• Facilitates bank transactions – clearing
checks
• Acts as a bank’s bank
• The Fed – lender of last resort
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15
The Fed’s Organization
• The Fed’s jobs
– Control the money supply
• Quantity of money available in the economy
• Monetary policy
– By Federal Open Market Committee (FOMC)
• Money supply
– Quantity of money available in economy
• Monetary policy
– Setting of the money supply
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16
Federal Open Market Committee
• FOMC
– 7 members of the board of governors
– 5 of the twelve regional bank presidents
• All twelve regional presidents attend each
FOMC meeting, but only five get to vote
– Meets about every 6 weeks in
Washington, D.C.
– Discuss the condition of the economy
– Consider changes in monetary policy
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17
Federal Open Market Committee
• Fed’s primary tool: open-market operation
– Purchase & sale of U.S. government
bonds
• FOMC – increase the money supply
– The Fed: open-market purchase
• FOMC – decrease the money supply
– The Fed: open-market sale
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
Banks and the Money Supply
• Money
– Currency + Demand deposits
• Behavior of banks
– Can influence the quantity of demand
deposits in the economy (and the money
supply)
“I’ve heard a lot about money,
and now I’d like to try some.”
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
19
Banks and the Money Supply
• Reserves
– Deposits that banks have received but
have not loaned out
• The simple case of 100% reserve banking
– All deposits are held as reserves
• Banks do not influence the supply of money
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
20
Fractional-Reserve Banking
• Fractional-reserve banking
– Banks hold only a fraction of deposits as
reserves
• Reserve ratio
– Fraction of deposits that banks hold as
reserves
• Reserve requirement
– Minimum amount of reserves that banks
must hold; set by the Fed
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
21
Fractional-Reserve Banking
• Excess reserve
– Banks may hold reserves above the legal
minimum
• Example: First National Bank
– Reserve ratio 10%
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
22
Fractional-Reserve Banking
• Banks hold only a fraction of deposits in
reserve
– Banks create money
• Assets
• Liabilities
– Increase in money supply
– Does not create wealth
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
23
The Money Multiplier
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
24
The Money Multiplier
• The money multiplier
– Original deposit = $100.00
– First National lending = $ 90.00 [= .9 ×
$100.00]
– Second National lending = $ 81.00 [= .9 ×
$90.00]
– Third National lending = $ 72.90 [= .9 ×
$81.00]
–…
– Total money supply = $1,000.00
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
25
The Money Multiplier
• The money multiplier
– Amount of money the banking system
generates with each dollar of reserves
– Reciprocal of the reserve ratio = 1/R
• The higher the reserve ratio
– The smaller the money multiplier
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
26
Financial Crisis of 2008–2009
• Bank capital
– Resources a bank’s owners have put into
the institution
– Used to generate profit
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
27
Financial Crisis of 2008–2009
• Leverage
– Use of borrowed money to supplement
existing funds for purposes of investment
• Leverage ratio
– Ratio of assets to bank capital
• Capital requirement
– Government regulation specifying a
minimum amount of bank capital
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
28
Financial Crisis of 2008–2009
• If bank’s assets rise in value by 5%
– Because some of the securities the bank
was holding rose in price
– $1,000 of assets would now be worth
$1,050
– Bank capital rises from $50 to $100
– So, for a leverage rate of 20
• A 5% increase in the value of assets
• Increases the owners’ equity by 100%
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
29
Financial Crisis of 2008–2009
• If bank’s assets are reduced in value by
5%
– Because some people who borrowed from
the bank default on their loans
– $1,000 of assets would be worth $950
– Value of the owners’ equity falls to zero
– So, for a leverage ratio of 20
• A 5% fall in the value of the bank assets
• Leads to a 100% fall in bank capital
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
30
Financial Crisis of 2008–2009
• If bank’s assets are reduced in value by
more than 5%
– Because some people who borrowed from
the bank default on their loans
– For a leverage ratio of 20
• The bank’s assets would fall below its
liabilities
• The bank would be insolvent
– Unable to pay off its debt holders and depositors
in full
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
31
Financial Crisis of 2008–2009
• Many banks in 2008 and 2009
– Incurred sizable losses on some of their
assets
• Mortgage loans and securities backed by
mortgage loans
– Shortage of capital induced the banks to
reduce lending
• Credit crunch
• Contributed to a severe downturn in
economic activity
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
32
Financial Crisis of 2008–2009
• U.S. Treasury and the Fed
– Put many billions of dollars of public funds
into the banking system
• To increase the amount of bank capital
– Temporarily made the U.S. taxpayer a
part owner of many banks
– Goal: to recapitalize the banking system
• So that bank lending could return to a more
normal level – occurred by late 2009
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
33
Fed’s Tools of Monetary Control
• Influences the quantity of reserves
– Open-market operations
– Fed lending to banks
• Influences the reserve ratio
– Reserve requirements
– Paying interest on reserves
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
34
Fed’s Tools of Monetary Control
• Open-market operations
– Purchase and sale of U.S. government
bonds by the Fed
– To increase the money supply
• The Fed buys U.S. government bonds
– To reduce the money supply
• The Fed sells U.S. government bonds
– Easy to conduct
– Used more often
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
35
Fed’s Tools of Monetary Control
• Fed lending to banks
• To increase the money supply
• Discount window
• At the discount rate
– Term Auction Facility
• To the highest bidder
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
36
Fed’s Tools of Monetary Control
• The discount rate
– Interest rate on the loans that the Fed
makes to banks
– Higher discount rate
• Reduce the money supply
– Smaller discount rate
• Increase the money supply
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
37
Fed’s Tools of Monetary Control
• Term Auction Facility
– The Fed sets a quantity of funds it wants
to lend to banks
– Eligible banks bid to borrow those funds
– Loans go to the highest eligible bidders
• Acceptable collateral
• Pay the highest interest rate
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
38
Fed’s Tools of Monetary Control
• Reserve requirements
– Minimum amount of reserves that banks
must hold against deposits
• An increase in reserve requirement
– Decre …
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