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Bitcoin Ted Talk 14 - 3 What Is Money? Anything widely used and freely accepted as payment for goods and services 14 - 4 The Functions of Money Medium of Exchange Store of Value Unit of Account/ Measure of Value 14 - 5 What Is Money? Portability Divisibility Durability Recognizable Relative scarcity 14 - 6 The Cost of Producing U.S. Coins Golden Dollar 10.03 cents Half Dollar 9.93 cents Quarter 4.29 cents Dime 1.88 cents Nickel 3.13 cents Penny .81 cents Source: http://www.usmint.gov/faqs/circulating_coins 14 - 7 Kinds of Money Commodity – money with intrinsic value Representative – convertible or commodity-backed money Fiat – value derived from official status, acceptability 14 - 8 Just How Much Is a Ton of Money Worth? The Time Value of Money Dollar Bills $908,000 Quarters $40,000 Pennies $3,632 Source: State of Michigan Office of Financial and Insurance Services, www.cis.state.mi.us/ofic/consumer/kids/ton_money 14 - 9 The Money Supply M1: Spendable Currency Demand deposits M2: Spendable plus Convertible (M1 + near money) Time deposits Money market mutual funds Savings deposit 14 - 10 The Monetary Role of Banks More than half of the M1 is currency The rest is demand deposits 14 - 11 What Banks Do •Financial Intermediary •Bank Reserves •T - Account Assets & Liabilities •Reserve Ratio •Required Reserve Ratio 14 - 12 The Problem of Bank Runs •Customer Deposits > Bank Reserves •Why does this usually work? •Bank Run •Why? •Bank Failure 14 - 13 Bank Regulation •Deposit Insurance •FDIC •Capital Requirements •Reserve Requirements •The Discount Window 14 - 14 Money Supply Growth 5.4 5.0 Money Supply (trillions) 4.4 4.0 3.4 M-2 3.0 2.4 2.0 1.4 1.0 M-1 0.4 0 1964 1969 1974 1984 1984 1989 1994 2001 14 - 15 Determining the Money Supply 14 - 16 How Banks Create Money 14 - 17 Reserves, Bank Deposits, and the Money Multiplier •“Leaks” •Excess Reserves •rr = reserve ratio •Loan Expansion = Excess Reserves / rr MM = 1/rr 14 - 18 The Money Multiplier in Reality •Monetary Base •Money Multiplier Each dollar of bank reserves backs several dollars of bank deposits, making the money supply larger than the monetary base. 14 - 19 Assumes a reserve ration of 10% Table 25.1 How Banks Create Money Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers 14 - 20 Figure 25.3 Effect on the Money Supply of Turning Cash into a Checkable Deposit at First Street Bank Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers 14 - 21 Insert Federal Reserve here 14 - 22 The Money Market (Supply and Demand for Money) 23 Demand for Money Transactions Demand – medium of exchange demand; directly related to changes in nominal GDP 14 - 24 Demand for Money cont. Asset Demand – store of value demand; inversely related to the interest rate 14 - 25 Demand for Money cont. Total Money Demand – transaction + asset directly related to nominal GDP 14 - 26 The Demand for Money At any given time, people demand a certain amount of liquid assets (money) for everyday purchases The Demand for money shows an inverse relationship between nominal interest rates and the quantity of money demanded 1. What happens to the quantity demanded of money when interest rates increase? Quantity demanded falls because individuals would prefer to have interest earning assets instead 2. What happens to the quantity demanded when interest rates decrease? Quantity demanded increases. There is no incentive to convert cash into interest earning assets 27 The Demand for Money Inverse relationship between interest rates and the quantity of money demanded Nominal Interest Rate (ir) 20% 5% 2% 0 DMoney Quantity of Money (billions of dollars) 28 The Demand for Money What happens if price level increase? Money Demand Shifters 1. Changes in price level Nominal 2. Changes in income Interest Rate 3. Changes in taxation (ir) 20% that affects personal investment 5% 2% 0 DMoney1 DMoney Quantity of Money (billions of dollars) 29 The Demand for Money At any given time, people demand a certain amount of liquid assets (money) for everyday purchases The Demand for money shows an inverse relationship between nominal interest rates and the quantity of money demanded 1. What happens to the quantity demanded of money when interest rates increase? Quantity demanded falls because individuals would prefer to have interest earning assets instead 2. What happens to the quantity demanded when interest rates decrease? Quantity demanded increases. There is no incentive to convert cash into interest earning assets 30 The Supply for Money The U.S. Money Supply is set by the Board of Governors of the Federal Reserve System (FED) Interest Rate (ir) 20% The FED is a nonpartisan government office that sets and adjusts the money supply to adjust the economy 5% This is called Monetary Policy. SMoney 2% DMoney 200 Quantity of Money (billions of dollars) 31 32 Why are there so many interest rates? 33