- any asset that can easily be used to purchase goods + services
- the most liquid asset, easily converted (money vs house)
- Recognized, divided up in to small parts
- Can be commodity or token, virtual etc.
Generally Accepted - buy anything and everything. Tokens for bus pass can only buy bus ride, so
not money. 78
Means of Payment
Method of settling a debt.
+ Payment made, deal is complete.
+ Loan isn't money, money is what Gus uses to pay off loan.
Functions of Money
1. Medium of Exchange - object that is generally accepted in returns for goods and services.
Money is a medium, without it, you would have to exchange goods/services with other goods/
services. Barter !
Barter - direct exchange of goods and services for other goods and services, which require a
double coincidence of wants.
Requires someone willing to give an item and get item you want to to give.
Money guarantees double coincidence.
Money enables specialize in activity in which you have comparative advantage.
2. Unit of Account
+ Agreed upon measure for stating prices of goods and services.
+ To get most out of budget, figure out whether rock concert is worth opp. cost. but that cost is in
movies, ice cream etc.
+ Dollars help you figure out exactly what you're missing.
3. Store of Value
+ Any commodity/token can be held and exchanged later for foods/services called store of value.
+ Money acts as store of value, more stable the value of commodity/token, te better it can be as a
store of value and better use as money.
Money Today
are Fiat Money
+ Latin word = decreeorder.
+ Today's Fiat Money:
1. Currnecy
- notes (dollar bills) and coins.
+ governments declares notes to be money.
2. Deposits - at banks, credit card unions, savings banks, savings and loan associations are also
money. Can be used to make payments. Don’t need to use currency, write a check/use debit card to
tell bank to move money over.
Currency Inside the Banks Is Not Money
- currency and bank deposits are money, currency inside banks are not money.
+ Currency inside is not available as means of payment.
+ Getting cash from ATM, convert bank deposit to currency, change in form of money, not quantity
of money owned.
Measures of Counting Money M1 and M2
+ M1 - currency in circulation and checkable bank deposits (bank acc. on which people can write
checks)
+ Money Supply - total value of finanfial assets - cash, public holds, amount of deposits in
checkeable accounts.
M2 - NEAR MONEY - ifnancial assets hat can’t be directly used as a medium of exhcange but can
readily be converted into checks or checkable bank deposits.
Not all M2 are means of payment (savings deposits, time deposits, money market funds)
All M1 means of payment.
Checks, Credit Cards, Debit Cards, and Mobile Wallets
Check - not money, instruction to bank to make payment. Money is your bank deposit, not value of
checks you've written.
Credit Card - not money. Special type of ID to get you an instant loan. You haven't paid for the
book yet (even if you take it home), you took loan from bank that issued your credit card. Credit
card issuer pays the bookstore, and you then get your credit card bill which you use to pay with
money.
Debit Card - paper check, but faster. Not money. Bank deposits are money and debit card is the
took that causes money to move over.
Mobile wallets - electronic version of physical wallet, not money.
E-CASH
+ Portable, untraceable, anonymous.
18.2 The Banking System
- Banks are financial intermediaries that use liquid assets (in the form of bank deposits) to
finance illiquid investments of borrowers.
- MONETARY ROLE OF BANKS: T-account - tool for analyzing a businesse’s financial
position by showing business’s assets and liabilitlities:
Bank Reserves - currrency that bank hold in their valuts plus their deposits at the Fed
Reserve.
THE RESERVE RATIO- fraction of bank deposits that a bank holds as reserves. (reserves/
deposites)
Assets: ;oan 1,200,000 reserves 100,000
liabilities deposits: 1,000,000
HOW BANKS CREATE MONEY
+ bridge lender and borrower
+ accept deposit, make loans, make money and also CREATE money (M1)
FRACTIONAL RESERVE BANKING SYSTEM: - put money in to bank account, bank is
required to hold a part of it in its vault as cash....
PROBLEM OF BANK RUNS: banks hold only a fraction of deposits on reserve (rest is used
to make loan) - from time to time people get worried about banks losing money. Contagious
BANK REG!
1. Deposit insurance - a guarantee of up to 250,000 will be paid back.
2. Capital requirements - requirement that owners of banks hold more assets than value of
bank deposits (bank buildings)
3. Reserve requirement - rules set by federal reserve that determine how much money banks
must keep (at least 10%)
4. The discount window - an arrangement in which Fed Reserve stands ready to lend money
to banks in trouble. (last resort)
HOW BANKS CREATE MONEY
+ silas has shoebox of cash under bed, deposits cash at the bank, what happens to 1,000
1. initial:
assets: loans - no change
reserves + 1,000
loabilities: checkable deposits: 1,000
Banks make loans from 90% of deposits, rest must be on reserve
assets - loans 900
assets - reserves - 900
liabilities - no change
----
+ Bank lends to 900 to Maya,, pays anne, who deposits it at her bank, cycle starts all over.
+ 1000 --> 900 --> 810 --> keep going.
How much money can be created? - Use Money Multiplier:
1,000/rr -->
Money multiploer = 1/reserve ratio.
Take money deposited to bank, multiple by money multiplier: 1,000 dollars X 1/.10 = 10,000
--------
MONETARY BASE - bank reserves + currency in circulation (physical money)
MONEY SUPPLY - checkable bank deposits + currency in circulation, not enough reserves to
cover these deposits.
WHAT IF A BANK CANNOT MEET THE FED’S RESERVE REQUIREMENT
BORROWS - FROM FEDERAL. FUNDS MARKET ( INTER-BANK LOANS, ONLY
BANKS WORKING THERE) - allows banks that (INTEREST RATE AT WHICH BANKS
LOANTO EACH OTHER DETERMINED BY FEDERAL FUND MARKET)
- is what central bank targets with its monetary policy.
- FEDERAL FUND RATE - IS THE INTEREST RATE DETERMINED BY THE FEDERAL
FUNDS MARKET
- FEDERAL FUNDS MAKRET -ALLOWS BANKS TO BORROW FUNDS FROM BANKS
THAT HAVE EXCESS RESERVES.
---
BANKS CAN ALSO BORROW FROM FED:
DISCOUNT RATE - ABOUT 1 PERCENTAGE HIGHERRATE OF THE FED CHARGES
TO BANK
OPEN MARKET OPERATION - WHEN FED BUYS ANYTHING (EVEN APPLES),
RESERVES INCREASE.
GOVERNMENT - IF FED BUYS ANYTHING ,RESERVES INCREASE. FED GUYS
GOVERNMENT BOND, SELL ON OPEN GOVERNMENT..... FED BUYS U.S DEBT.
VERY STABLE. EASY TO SELL ON OPEN MARKET, GOVERNMENT BONDS ARE
FOREVER.
+ FED USUALLY BUYS/SELLS SHORT-TERN BONDS CALLED TREASURY BILS, T-
BILLS.
OPEN MARKET OPERATION
-- Fed does not buy bonds directly from government, (that would be priting out money) -
usually buy from ank.
-- Fed is not the government. It is independent. Chair chosen by government, they are
independent institution.
-- Fed has own reserves
basically - fed can influence monetayr base by buying/selling bonds
+ example:
+ fed makes 100 million purchase of buying/selling bonds
fed
asset; treasury bills: 100 million // liabilities; monetary base: 100 million
commercial banks
assets; treasury bills: -100 million
[CHECK!!!]
Fed wants to increase money supply -
pay for t bills --> fed electronically buys reserves of the seller --> more reserves, bank increase
loans --> money supply increase.
buy t bills, create money, decrease? - sell loans, reserves and loans go down, money supply is
decreased.
+ Contains Federal Reserve and banks and other institutions that accept deposits and provide
services to enable people/business to make/receive payments.
+ Three types of financial institutions that accept deposit that are pat of nation's money:
1. Commercial Banks
- Firm chartered by Comptroller of the Currency in the U.S Treasury to accept deposits and make
cans.
+ 2016 - 5,260 banks, 15,000 in 1980s, lots shut down after financial crisis caused failure.
Bank Deposits
- Commercial banks accepts:
- checkable deposit
savings deposits
- time deposits
+ Bank pays low interest rate on checkable deposits, highest on time deposits.
Profit and Risk: A Balancing Act
+ Commercial banks try to maximize stockholder wealth by lending for long term at high interest
rates and borrowing from depositors and others.
+ Lending is risky, if depositors see bank is incurring loss, massive withdrawal and might create a
crisis.
+ Must balance security for depositor and stockholder against risky returns. Trade off between risk
and profit makes bank divide its assets in to four parts:
1a. Reserves
+ Used to meet its depositor's withdrawals. Bank must replenish currency in its ATM when you raid
for crash for pizza.
1b. Liquid Assets
- Short term Treasury bills and overnight loans to other banks.
+ Interest rate are low but they are low-risk assets.
+ IR on interbank loans (federal funds rate) is central target of the Feds monetary policy actions.
1c. Security and Loans
+ Securities - bonds issues by the U.S government and other organizations.
+ Some bonds have low interests rates and are some.
+ Some bonds high IR and risky (i.e mortgage-backed securities)
+ Loans - provisions of funds to businesses and individuals. Loans earn the bank a high IR, are
risky. Highest IR on unpaid credit card balances aka loans to credit card holders.
1d. Bank Assets and Liabilities: The Relative Magnitudes
2. Thrift Institutions
+ Main types:
2a. Savings and loan associations - financial institutions that accepts checkable deposits and
savings deposits and makes personal/commercial/home purchase loans.
2b Savings bank - financial institutions that accepts savings/deposit and makes mostly
consumer/home purchase loans. Depositor own some savings banks.
3c. Credit union - financial institution owned by a social or economic group such as a firm's
employees, that accepts savings deposit and makes mostly consumer loans.
+ Like commercial banks, thrift institutions hold reserves + must meed minimum reserve
ratios set by the Fed.
3. Money Market Funds
- financial institutions that obtains funds by selling shares and uses funds to buy assets such as u.s
treasury bills.
+ acts like bank deposit (money market fund), shareholder write check on mmf
Federal Reserve
- central bank of the united states.
+ provides banking services to banks/governments ,regulates financial institutions and markets.
+ only customers: bank of America, citibank, and us. government
+ main task: regulate interest rate and quantity of money to achieve low and predictable inflation
and sustained economic expansion.
Structure of Fed. Reserve
1. Chair of Board of Gov:
fe'd chief executive, public face, center of power.
2. Board of Governors - seven members, including chair, app. but u.s confirmed by senate, 14 years.
3. Regional Federal Reserve Banks
- 12 regional fed. reserve banks. each have nine directors, 2 of whenwhe app. by board of governors
and six of whom elected by the commercial banks in the federal reserve district.
Federal Open Market committee
THE FED'S POLICY TOOLS:
+ need to influence interest rate, regulate amount of money circulating in the united states.
+ Adjusts reserves of banking system, also stand ready to make loans to banks:
+ Policy tools:
REQUIRED RESERVE RATIOS
- Banks hold reserves currency/deposits at fed reserve, red requires banks/thrifts to hold minimum
percentage. Fed determines requires reserve ratio for each type of deposit: checkable, deposits in
access etc)
DISCOUNT RATE - interest rate at which fed stands ready to lend reserves to commercial banks.
+ change in discount rate begins with a proposal to FOMC by at least one of 12 fed reserve banks.
OPEN MARKET OPERATIONS:
+ when fed conducts open market operation, makes transaction with a bank or some other business
but it does not transact with the federal government. new York conducts fed open market
operations.
EXTRAORDINARY CRISIS MEASURES
HOW DOES FED POLICY TOOLS WORK
- changes either demand for or supply of monetary base, which changes interest rate.
+ monetary baseL sum of coins ,Federal Reserve notes, and banks' reserves at the Fed.
+ by increasing required reserve ratio, fed can force banks to hold larger quant of monetary base.
+ by raising discount rte, fed can make it more costly for banks to borrow reserves/monetary base.
+ by selling securities in open market, fed can decrease monetary base.
ALL CAN LEAD TO RISEI N INTEREST RATE.
18.3 REGULATING THE QUANTITY OF MONEY
+ Most money is deposits, not currency - banks create deposits by making loans.
CREATING DEPOSITS BY MAKING LOANS
+ Guy buyers car from Chevron with Citibank card. Chevron clerk brings credit card sale slips to
bank. Citibank gives some money to Chevron takes a little bit as well.
+ This create bank deposit and a loan. andy has increases size of his loan (credit card balance) and
Chevron has increase size of its bank deposit.
+ Deposits = money, Citibank has created money.
+ If andy swiped card - quant of money would increase by amount of his purchase - bank
commission.
THE MONETARY BASE - sum of coins + fed reserve notes + bank deposits at fed
+ Size of monetary base limits total quant of money banking sysem can create because banks have a
desired level of reserves and households/firms have desired level of currency holding and both
desired holdings of monetary base depend on quant of money.
DESIRED RESERVES
+ Banks desired reserves are reserves bank chooses to hold.
+ Desired reserve ratio - ratio of reserves to deposits a bank wants to hold.
+ this ratio exceeds required reserve ration by an amount that banks determine.
+ actual reserve ratio - changes when customers make a deposit or withdrawal. Deposit -reservices
and deposits increase same amount so bank reserve ratio increases. If bank costumer makes
withdrawal, reserve and deposits decrease by the same amount, so the banks reserve ratio decreases.
withdrawal = opposite.
+ Excess reserves:
+ excess = bank can create money by making new loans.
+ When bank has whole short of reserve, banks must destroy money, decrease quant of loan.
DESIRED CURRENCY HOLDING
HOW OPEN MARKET OPERATIONS CHANGE THE MONETARY BASE
+ When fed buys securities in open market op, pays for them with newly created bank reserves and
money.
+ more reserves in banking system, supply of interbank loans increase, demand for interbank loan
decrease, fed funds rate (i.r in interbank loan market) falls.
Fed buys Securities
+ Let's say Fed buys 100 million of u.s government securities on open market )could be from
person or business that is not commercial bank)
THE FED SELLS SECURITIES
THE MULTIPLIER EFFECT OF AN OPEN MARKET OPERATION
+ open market purchase that increases bank reserves also increases the monetary base by the
amount of the open market purchase and the banks have excess reserves that they then lend.:
+ process ends when no excess reserves.
+ situation arises when increase in monetary base from open market operation is willingly held,
when increase in desired reserves + increase in desired currency holding equals the increase in
monetary base.
THE MONEY MULTIPLIER
+ Ratio of change in quant of money to change in monetary base.
+ magnitude of money multiplier depends on desired reserve ratio and currency drain ratio.
+ smaller the two ratios, larger the money multiplier.
18.4
MONEY, PRICE LEVEL, AND INFLATION
+ Fed controls quant if money, how does quant o money influence price level and inflation rate.
QUANTITY THEORY OF MONEY -
THE VELOCITY OF CIRCULATION AND EQUATION OF EXCHANGE
+
+ Average number of times each dollar of money is used during a year to buy final goods and
services.
+ value of final goods/services is nominal gdp, (real gdp y multiplied by price level)....
THE QUANTITY THEORY PREDICTION
+ when inflation rate > 50 percent a month, called hyperinflation - which translates to 12,875 per
year.
+hyper inflation - occurs when quantity of money grows at a rapid pace to pay for government
expenditures that exceeds what government can collect in tax revenue or borrow.
TYPES OF MONEY
Commodity money - used as a medium of exchange that has intrinsic value in other uses (cigs)
COMMODITY- BACKED MONEY - a medium of exchange has no intrinsic value whose ultimate
value is guarantee by a promise that it can be converted to valuable goods (dollar backed by silver
before)
FIAT MONEY - nothing real backing it. Has value because government says it has value.
