Download Burton and Lambra: Chapter One

The Financial System and the
Economy:
Principles of Money and Banking, 2e
by
Burton and Lombra
© 2000 South-Western College Publishing
1
Chapter 1
Introduction and Overview
© 2000 South-Western College Publishing
2
Economics
The study of how society decides
•what gets produced
•how it gets produced
•who gets what
3
Microeconomics
The branch of economics that
studies the behavior of
individual decision-making
units such as households and
business firms
4
Macroeconomics
The branch of economics that
studies the aggregate or total
behavior of all households
and firms
5
Finance
The study of how the financial
system coordinates and channels the
flow of funds from lenders to
borrowers - and vice versa - and how
new funds are created by financial
intermediaries in the borrowing
process
6
Deregulation
The removing or phasing out
of existing regulations
7
Money is
Something acceptable and
generally used as payment for
goods and services
8
Saving is
Income not spent on
consumption
9
Surplus spending units (SSUs)
Spending units such as
households and firms
with income that exceeds
spending
10
Deficit spending units (DSUs)
Spending units such as
households and firms where
spending exceeds income
11
Exhibit 1-1
Income
Spending
Spending
Income
Income greater than
spending
SSUs
Spending greater
than income
DSUs
12
Exhibit 1-2
Total Saving
Household Saving
(Income not spent on consumption)
Investment
Surplus Funds
+
+
Business Saving
(Income not distributed to the owners of the business firms)
Investment
Surplus Funds
=
=
INVESTMENT
PLUS
SURPLUS FUNDS
13
Financial Markets
Markets in which
spending units trade
financial claims
14
Direct finance is...
When SSUs lend their funds
directly to DSUs
15
Financial Intermediaries
Financial institutions that
borrow form SSUs for the
purpose of lending to DSUs
16
Indirect Finance
When DSUs borrow from
financial intermediaries that
have acquired the funds to
lend from SSUs
17
The Financial System
Exhibit 1-3
DIRECT FINANCE
Surplus
Spending
Units
Financial
Markets
Deficit
Spending
Units
INDIRECT FINANCE
Financial
Intermediaries
Purchasing Power flows one way
Legal obligations flow back
18
Transaction Costs are...
The costs associated with
borrowing and lending or
making other exchanges
19
Liquidity
The ease with which a
financial claim can be
converted to cash without loss
of value
20
Depository Institutions
Financial intermediaries that
issue checkable deposits
21
Checkable Deposits
Deposits that are subject to
withdrawal by writing a
check
22
FINANCIAL INTERMEDIARIES
Depository Institutions
Commercial Banks
Savings and Loans
Credit Unions
Mutual Savings Banks
Issue Checkable Deposits
Exhibit 1-4
Other Intermediaries
Life and Casualty
Insurance Companies
Pension Funds
Mutual Funds
Market Mutual Funds
Finance Companies
Issue Other Financial Claims
23
The Federal Reserve (Fed)
The central bank of the
United States that regulates
the banking system and
determines monetary policy
24
Monetary Policy
The Fed’s efforts to promote
the overall health and stability
of the economy
25
The Federal
Reserve
Financial System
Economic behavior
of households,
businesses, governments,
and foreigners
Overall performance
of health of the economy:
•Inflation
•Unemployment
•Growth
Exhibit 1-5
26
Business Cycle
Short-run fluctuations in the
level of economic activity as
measured by the output of
goods and services in the
economy
27
Expansion is
The phase of the business
cycle during which
economic activity increases
and unemployment falls
28
Recession is
The phase of the business
cycle during which economic
activity falls and
unemployment rises
29
Fiscal Policy
Government spending and
taxing decisions to speed up
or slow down the level of
economic activity
30
Peak
Long-Term
Trend
Trough
Expansion
(Recovery)
Recession
(Contraction)
Year
Exhibit 1-6
31
Laissez-Faire
The view that government
should pursue a hands-off
policy with regard to the
economy
32
Average Inflation, Unemployment,
and Growth During Recent Decades
Inflation
Unemployment
Growth
(Output)
1960s
2.4%
4.75%
4.4%
1970s
7.0
6.25
3.2
1980s
5.5
8.25
2.8
1990 - 1998*
2.8
5.9
2.5
*Through 3rd quarter 1998 only
Exhibit 1-7
33