Download Chapter 27 - Money and Banking

PRINCIPLES OF ECONOMICS
Chapter 27 Money and Banking
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MONEY
Money is anything that is generally accepted as a
medium of payment.
Money is not income, and money is not wealth.
Income and wealth are measured in money.
Money has the following functions:
• Medium of payment
• Store of value
• Unit of account
MONEY: MEDIUM OF PAYMENT
Barter system: direct exchange of goods and
services for other goods and service
Barter system requires a double coincidence
of wants for trade to take place.
Money eliminates the barter problem and
facilitates market transactions.
MONEY: STORE OF VALUE
The value of money is the purchasing power
embodied in it. Why do we prefer a $100 bill to a
$1 bill?
Money is as an asset that can be used to
transport purchasing power from one time period
to another.
Money is easily portable across time and space.
MONEY: UNIT OF ACCOUNT
Money serves as a unit of account for
• quoting prices
• keeping books
• calculating debts
TYPES OF MONEY
Commodity Money: an item used as money that
also has intrinsic value in some other use (e.g.,
gold & silver).
Fiat or Token Money: money that is intrinsically
worthless (e.g., coins & bills).
Legal Tender: money that a government requires
to be accepted in settlement of debts (e.g., dollar
bills).
TOKEN MONEY
For centuries, the extremely durable cowrie shell was
used as a medium of exchange in various parts of the
world.
FIAT MONEY
Until 1958, silver certificates were commodity-backed
money—backed by silver, as indicated by the words
“Silver Certificate” printed on the bill. Today, U.S. bills are
backed by the faith of people on the US economic system.
SUPPLY OF MONEY
M1 or Transactions Money is money that can be
directly used in transactions.
M1 = currency held outside banks + checking
accounts + plus traveler’s checks + other
checkable deposits
Checking accounts are called “demand” deposits
SUPPLY OF MONEY
M2 or Broad Money includes near monies that
are close substitutes for transactions money.
M2 = M1 + savings accounts + money market
accounts + other near monies
Saving accounts are called “time” deposits
M1 AND M2
M1 = coins and currency in circulation + checkable
(demand) deposit + traveler’s checks.
M2 = M1 + savings deposits + money market funds +
certificates of deposit + other time deposits.
COMMERCIAL BANKING: BANK RESERVES
Total Reserves = Total deposits at a bank
Required Reserves: A fraction of Total
Reserves a bank must hold at its account in
the FED
Excess Reserves: The rest of Total Reserves
that a bank can use for loans
COMMERCIAL BANKING: MONEY CREATION
Banks use their Excess Reserves to make
loans.
COMMERCIAL BANKING: MONEY CREATION
Banks act as financial intermediaries because they
stand between savers and borrowers.
Savers place deposits with banks, and then receive
interest payments and withdraw money.
Borrowers receive loans from banks and repay the
loans with interest. In turn, banks return money to
savers in the form of withdrawals, which also include
interest payments from banks to savers.
COMMERCIAL BANKING: MONEY CREATION