Download Federal Reserve

Macroeconomics
CHAPTER 14
Money, Banking, and
the Federal Reserve System
PowerPoint® Slides
by Can Erbil
© 2006 Worth Publishers, all rights reserved
What you will learn in this chapter:
The various roles money plays and the many forms it takes in
the economy.
How the actions of private banks and the Federal Reserve
determine the money supply.
How the Federal Reserve uses open-market operations to
change the monetary base.
2
The Meaning of Money
Money
is any asset that can easily be used to purchase goods
and services.
Currency
in circulation is cash held by the public.
Checkable
bank deposits are bank accounts on which people
can write checks.
The
money supply is the total value of financial assets in the
economy that are considered money.
3
Roles of Money
A medium of exchange is an asset that individuals acquire for
the purpose of trading rather than for their own consumption.
A store of value is a means of holding purchasing power over
time.
A unit of account is a measure used to set prices and make
economic calculations.
4
Types of Money
Commodity money is a good used as a medium of exchange
that has other uses.
A commodity-backed money is a medium of exchange with
no intrinsic value whose ultimate value is guaranteed by a
promise that it can be converted into valuable goods.
Fiat money is a medium of exchange whose value derives
entirely from its official status as a means of payment.
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Measuring the Money Supply
A monetary aggregate is an overall measure of the money
supply.
Near-moneys are financial assets that can’t be directly used as
a medium of exchange but can readily be converted into cash or
checkable bank deposits.
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Monetary Aggregates
The Federal Reserve uses three definitions of the money supply:
M1, M2, and M3.
M1 = $1,368.4 (billions of dollars), June 2005
M1 is equally split between
currency in circulation and
checkable bank deposits.
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Monetary Aggregates
The Federal Reserve uses three definitions of the money supply:
M1, M2, and M3.
M2 = $6,510.0 (billions of dollars), June 2005
M2 has a much broader
definition: it includes M1,
plus a range of other
deposits and deposit-like
assets, making it about three
times as large.
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The Monetary Role of Banks
A bank is a financial intermediary that uses liquid assets in
the form of bank deposits to finance the illiquid investments of
borrowers.
Bank reserves are the currency banks hold in their vaults plus
their deposits at the Federal Reserve.
The reserve ratio is the fraction of bank deposits that a bank
holds as reserves.
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Assets and Liabilities of First Street
Bank
A T-account summarizes a bank’s financial position. The bank’s
assets, $900,000 in outstanding loans to borrowers and reserves
of $100,000, are entered on the left side. Its liabilities, $1,000,000
in bank deposits held for depositors, are entered on the right side.
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The Problem of Bank Runs
A
bank run is a phenomenon in which many of a bank’s
depositors try to withdraw their funds due to fears of a bank
failure.
Historically,
they have often proved contagious, with a run on one
bank leading to a loss of faith in other banks, causing additional
bank runs.
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Bank Regulations
Deposit Insurance - guarantees that a bank’s depositors will
be paid even if the bank can’t come up with the funds, up to a
maximum amount per account. The FDIC currently guarantees the
first $100,000 of each account.
12
Bank Regulations
Capital Requirements - regulators require that the owners of
banks hold substantially more assets than the value of bank
deposits. In practice, banks’ capital is equal to 7% or more of
their assets.
13
Bank Regulations
Reserve Requirements - rules set by the Federal Reserve that
determine the minimum reserve ratio for a bank. For example, in
the United States, the minimum reserve ratio for checkable bank
deposits is 10%.
14
Determining the Money Supply
Effect on the Money Supply of a Deposit at First Street
Bank - Initial Effect Before Bank Makes New Loans
15
Determining the Money Supply
Effect on the Money Supply of a Deposit at First Street
Bank - Effect After Bank Makes New Loans
16
How Banks Create Money
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Reserves, Bank Deposits, and the
Money Multiplier
Excess reserves are bank reserves over and above its required
reserves.
Increase in bank deposits from $1,000 in excess reserves =
$1,000 + $1,000 × (1 − rr) + $1,000 × (1 − rr)2 +
$1,000 × (1 − rr)3 + . . .
this can be simplified to: Increase in bank deposits from $1,000
in excess reserves = $1,000/rr
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The Money Multiplier in Reality
The
monetary base is the sum of currency in circulation and
bank reserves.
The
money multiplier is the ratio of the money supply to the
monetary base.
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The Federal Reserve System
A
central bank is an institution that oversees and regulates the
banking system and controls the monetary base.
The
Federal Reserve is a central bank—an institution that
oversees and regulates the banking system, and controls the
monetary base.
The
Federal Reserve system consists of the Board of Governors
in Washington, D.C., plus regional Federal Reserve Banks, each
serving its district; of the 12 Federal Reserve districts:
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The Federal Reserve System
21
What the Fed Does: Reserve Requirements and the Discount
Rate
The
federal funds market allows banks that fall short of the
reserve requirement to borrow funds from banks with excess
reserves.
The
federal funds rate is the interest rate determined in the
federal funds market.
The
discount rate is the rate of interest the Fed charges on
loans to banks.
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Open-Market Operations
Open-market operations by the Fed are the principal tool of
monetary policy: the Fed can increase or reduce the monetary
base by buying government debt from banks or selling
government debt to banks.
The Federal Reserve’s Assets and Liabilities:
23
Open-Market Operations by the Federal Reserve
An Open-Market Purchase of $100 Million
24
Open-Market Operations by the Federal Reserve
An Open-Market Sale of $100 Million
25
The End of Chapter 14
coming attraction:
Chapter 15:
Monetary Policy
26
Macroeconomics
CHAPTER 15
Monetary Policy
PowerPoint® Slides
by Can Erbil
© 2006 Worth Publishers, all rights reserved
What you will learn in this chapter:
What the money demand curve is
Why the liquidity preference model determines the interest rate
in the short run
How the Federal Reserve can move interest rates
How monetary policy affects aggregate output in the short run
A deeper understanding of the adjustment process behind the
savings–investment spending identity
Why economists believe in monetary neutrality—that monetary
policy affects only the price level, not aggregate output, in the
long run
28
The Demand for Money
The Opportunity Cost of Holding Money
Short-term interest rates are the interest rates on financial
assets that mature within six months or less.
Long-term interest rates are interest rates on financial assets
that mature a number of years in the future.
29
The Demand for Money
The Opportunity Cost of Holding Money
30
The Money Demand Curve
The money demand curve shows the relationship between the
quantity of money demanded and the interest rate.
The Liquidity Preference Model of the Interest Rate
31
Prices and the Demand for Money
The real quantity of money is the nominal quantity of money
divided by the aggregate price level.
32
Prices and the Demand for Money
The Aggregate Price Level and Money Demand
33
The Real Demand for Money
The real money demand curve shows the relationship between
the real quantity of money demanded and the interest rate.
34
Shifts of the Real Money Demand Curve
Changes in Real Aggregate Spending
Changes in Technology
Changes in Institutions
35
The Velocity Approach to Money Demand
The velocity of money is nominal GDP divided by the nominal
quantity of money.
According to the velocity of money approach to money
demand, the real quantity of money demanded is proportional to
real aggregate spending.
36
The Velocity Approach to Money Demand
The real demand for money, M/P, is proportional to real GDP, Y,
where the constant of proportionality is 1/V.
37
Money and Interest Rates
According to the liquidity preference model of the interest
rate, the interest rate is determined by the supply and demand for
money.
The money supply curve shows how the nominal quantity of
money supplied varies with the interest rate.
38
Equilibrium in the Money Market
39
The Effect of an Increase in the Money Supply on the Interest Rate
40
Setting the Federal Funds Rate
- Pushing the Interest Rate Down to the Target Rate
The target federal
funds rate is the Federal
Reserve’s desired federal
funds rate.
41
Setting the Federal Funds Rate
- Pushing the Interest Rate Up to the Target Rate
42
The Fed Moves Interest Rates
43
Monetary Policy and Aggregate Demand
Expansionary
monetary policy is monetary policy that
increases aggregate demand.
Contractionary
monetary policy is monetary policy that
reduces aggregate demand.
44
Expansionary Monetary Policy to Fight a Recessionary Gap
45
Contractionary Monetary Policy to Fight an Inflationary Gap
46
Monetary Policy and the Multiplier
47
The Short-Run Determination of the Interest Rate
48
Federal Reserve Policy and the Business Cycle
49
Money, Output, and Prices in the Long Run
The Short-Run and Long-Run Effects of an Increase in the Money
Supply
50
Monetary Neutrality
In
the long run, changes in the money supply affect the
aggregate price level but not real GDP or the interest rate.
In
fact, there is monetary neutrality: changes in the money
supply have no real effect on the economy. So monetary policy is
ineffectual in the long run.
51
The Long-Run Determination of the Interest Rate
52
The Long-Run Relationship Between Money and Inflation
53
The End of Chapter 15
54