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13
Money and Banking
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FUNCTIONS OF MONEY
1. Unit of Account
•
Measurement of value of goods and
services
•
Standard unit for stating prices
•
Basis for comparing market prices
of goods, services, and resources
2. Store of Value
•
Enables people to transfer
purchasing power from the
present to the future
•
In order to buy things
later, people store some of
their wealth as money
•
The money you place in a
safe or checking account
will be available to you in a
few weeks, months or
years from now.
•
Other means of storing
wealth with art, jewelry,
stocks
3. Medium of Exchange
• Fundamental use in paying for goods and
services in market economy
• It is readily acceptable as payment.
• Money allows society to escape from the
complications of barter.
The Components of the
Money Supply
MONEY, M1 = CURRENCY + CHECKABLE DEPOSITS
1.
CURRENCY
-
(coins and paper money) in the hands of the public*
Government and government agencies supply coins and
paper money. All coins in circulation in the U.S. are token
money (the value of the metal contained in
the coin itself
is less than the face value of the
coin). Most currency
is paper money (Federal Reserve
Notes) issued by the
Federal Reserve System.
2.
CHECKABLE DEPOSITS
- All checkable deposits (all deposits in commercial
banks and “thrift” or savings institutions on which
checks of any size can be drawn). Commercial banks
and savings institutions (thrifts) provide checkable
deposits.
*To avoid double counting, currency resting in banks are excluded
by M1.
Money Definition M2
MONEY, M2 =
M1 + near-monies: savings
deposits, including MMDAs
small time (less than $100,000)
deposits + MMMFs held by
individuals
1.
SAVINGS DEPOSITS including MMDAs (money
market deposit accounts)
2.
SMALL (less than $100,000) TIME DEPOSITS
(funds become available at their maturity)
3.
MONEY MARKET MUTUAL FUNDS (MMMF)
held by individuals
Money Definition MZM
MZM (money zero maturity) focuses
exclusively on monetary balances that are
immediately available, at zero cost, for
household and business transactions.
Economists make two (2) adjustments
to M2 to obtain MZM:
1.
2.
Subtract small time deposits because the maturity (time until
repayment) is 6 mos., 1 year or some other length beyond instant
maturity. Withdrawal prior to maturity require substantial financial
penalty.
Add MMMF (money market mutual fund) balances owned by
businesses. These are immediately available for purchases.
Money MZM
Money MZM = M2 – small ($100,000 or less)
time deposits + MMMFs held
by businesses. It is slightly larger
than M2.
Advantages of MZM: includes currency,
checkable deposits, MMDAs, and MMMFs. Used on a daily
basis to buy goods, services and resources.
What Backs The Money Supply?
Essentially, the money supply in the U.S. is backed by
(guaranteed) by the ability of the government to keep the
value of money relatively stable. Following are four (4)
ways in which the money supply is guaranteed:
1. Money as Debt
• Paper money (just a piece of paper) is the circulating debt of
the Federal Reserve Banks.
• Checkable deposits (merely a bookkeeping entry) are the
debts of commercial banks and thrift institutions.
The government has chosen to “manage” the money supply in an
attempt to provide enough money for business activity that will
promote full employment, price-level stability and economic growth.
What Backs The Money Supply
2.
Value of Money – why are currency and checkable
deposits money?
•
Acceptability – Currency and checkable deposits are
money because people accept them as money. They
are confident it can be exchanged for real goods and
services.
Legal Tender – The government has designate currency
as “legal tender”; look at your paper money and read
the statement “This note is legal tender for all debts,
public and private.” Private firms and government may
refuse to accept cash for debt and specify payment in
noncash forms such as checks, cashier’s checks,
money orders or credit cards.
•
What Backs The Money Supply, Cont’d.
• Relative scarcity – The value of money depends upon
supply and demand. Money derives it value from its
scarcity relative to its utility (want-satisfying power).
• The demand for money depends upon the total dollar
volume of transactions plus the amount of money
individuals and businesses want to hold for future
transactions.
• As long as there is a reasonable constant demand for
money, the supply of money will determine the domestic
value or purchasing power of the monetary unit.
Federal Deposit Insurance Corporation (FDIC)
• What Does FDIC Cover?
•
Let’s begin by saying what FDIC does not cover. FDIC does not cover
money placed in stocks, bonds, mutual funds, life insurance, annuities, U.S.
Treasury obligations, or uninsured bank deposits. FDIC does cover up to
$250,000 in deposits for one owner at one insured bank.
•
There are different categories of owners that may allow one to increase
coverage. For example, joint accounts are covered up to $500,000. The
FDIC coverage is per bank, meaning if one owner has $250,000 deposited
at ten different banks all deposits would be covered.
Money and Prices
Purchasing Power of the Dollar
When money loses its purchasing power, it loses its role as
money. A reciprocal relationship exists between the general PL
and the purchasing power of the dollar. A rising price index
means reduced purchasing power value of the dollar, vice versa.
$V
Value of the dollar
=
=
1/PL
1/P
(expressed as an index
number (in hundredths)
Example: If PL rose from 100 to 120 (20% inflation)
Value of the dollar
= .83 (100/120)
Inflation and Acceptability
If you think back to your history lessons, in the 1920’s,
Germany in the 1920’s had very rapid inflation. In 1919,
there were about 50 billion marks in circulation. Four
years later, there were 496,585,345,900 marks in
circulation!!! The result? The German mark was worth
an infinitesimal fraction of its 1919 value.
People will use money as a store of value only as long
as there is no sizable deterioration in the value of that
money because of inflation. When the value of the
dollar is declining rapidly, sellers will not know what to
charge and buyers will not know what to pay for goods
and services.
Whose job is it to stabilize money’s purchasing
power?
The Federal Reserve has a critical role in maintaining the
purchasing power of the dollar (2-3% annual inflation).
The President and Congress must apply fiscal policies to
support the efforts of the nation’s monetary authorities to
hold down inflation.
The Federal Reserve
The Federal Reserve System was created in
1913 as a result of an unusually acute banking
crisis in 1907.
Congress purposely established the Fed as an
independent agency so could be protected
from political pressures and could effectively
control the money supply and maintain price
stability.
Ben Bernanke,
Chairman
to 1/31/14 [1590 on SAT]
Federal Reserve System
Framework of the Federal Reserve
System and the Relationship to the Public
Board of Governors
Federal Open Market Committee
12 Federal Reserve Banks
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)
Structure of the Fed
• Board of Governors
– 7 members appointed by the President and
approved by the Senate for 14-year terms
– Regulatory and supervisory role
– Sets general policy for member banks
– Conducts monetary policy
– Annual report to Congress
Federal Reserve System
The 12 Federal Reserve Banks are
quasi-public banks, which blend private
ownership and public control.
Source: Federal Reserve Bulletin
The 12 Federal Reserve
Banks
Quasi-Public Banks
Each Federal Reserve Bank is owned by the private
commercial banks in its district. Despite their private
ownership, the Federal Reserve Banks are in practice
pubic institutions. They are not motivated by profit.
In general, they do not deal with the public, but rather
interact with the government an commercial banks and
thrifts.
The 12 Federal Reserve Banks
Bankers’ Banks
The Federal Reserve Banks are “bankers’ banks.” They
perform the same functions for banks and thrifts (i.e.,
credit unions) as those institutions perform for the
public. Just as banks and thrifts accepts deposits and
make loans to the public, the central banks accept the
deposits and make loans to banks and thrifts. Normally,
these loans average only about $150MM/day.
Lender of Last Resort
In emergency circumstances, the
Federal Reserve Banks become
the “Lender of Last Resort” to the
banking system and can lend out
as much as needed to ensure that
banks and thrifts meet their cash
obligations.
Federal Open Market Committee [FOMC]
-Fed’s main policy-making arm
-includes 7 Board of Governors, NY Fed
President who is vice chairman, & is the
second most important in the system
-The 4 other bank presidents rotate
among the other 11 every 3 years.
-other 7 bank presidents are
non-voting members
-they meet every 6 weeks or 8 times a year]
-The Fed has primarily used FOMC
operations thru 17 primary dealers.
The New York Fed publishes the list of
primary dealers on its website, along
with procedures to become a primary
dealer.
The FOMC Meeting Room in Washington DC
The FOMC meets around a 27-foot oval mahogany table in a
room with a 23-foot ceiling with a 1,000-pound chandelier.
Home of 7 Board of Governors
.
The entire committee [12 members + other
8 bank presidents] examine regional,
national and international economic info to
assess the strengths and weaknesses of the economy.
After discussing the economy, the voting members vote on
the direction of monetary policy. A policy directive describes the
committee’s assessment of the economy and the new target
fed funds rate. An announcement is made about 1:15 p.m.
The Fed issues currency
Congress has authorized the Federal Reserve Banks to
put into circulation Federal Reserve Notes, which
constitute the economy’s paper money supply.
Destroy/Issue paper notes
The Fed clears 40%;
Banks clear rest electronically.
• Store cash and coin
• Maintain currency’s
quality
• Detect counterfeits
The Fed
handles
billions of
electronic
transactions
FINALLY…the most important…
and…ultimate responsibility for the Fed
… is to control the money supply