I. Functions of money
A. Medium
of exchange: facilitate exchange eliminating barter which requires people
with mutually needs.
B. Standard of value: allows for
the pricing of heterogeneous goods.
C. Store of value: maintains
value and provides liquidity so extra spending power is available as needed.
D. Standard of deferred payment:
makes credit contracts possible so credit transactions are possible.
II. The supply and demand for money
A. Three categories of the
supply of money
1.
M1 = Currency, coins, and demand deposits (checking accounts).
2. M2 = M1 plus near
monies such as small time deposits (savings accounts) and short-term government
securities.
3. M3 = M2 plus large
time deposits (over $100,000)
B. What backs the dollar?
1.
It is a debt of the federal government.
2.
Backed by faith in the government's ability to control inflation.
3.
Value is determined by acceptability (it is legal tender and
scarce).
4.
It's fiat (by decree of the government) money.
5.
Coins have little intrinsic value (a small % of face value) so
they are called token money.
6.
Commodity money such as tobacco used as money in the Virginia colony has
intrinsic value of its own.
C.
The Demand for Money
1. Transaction D, Dt,
results because people hold money,
often in a money market account,
to use as a medium of exchange.
2. Asset Demand, Da,
results because people accumulate
money, often held in an investment account, to buy assets.
3. The demand for money Dm= D t
+ Da
4. Interest rates are set in
the money market.
5. For more information visit
Demand for money - Wikipedia, the free encyclopedia
III. Maintaining money's value requires
A. A sound fiscal
policy (a reasonable federal debt)
B. A sound monetary policy
(not using inflation to pay the federal debt)
IV. United States private banking system
A. Two kinds of banks
1.
Commercial banks offer demand deposits (checking accounts)
2.
Savings and loan associations used to specialize in time deposits (saving
accounts) and home mortgages.
Now, because of deregulation during the early 1980's, they are similar to
commercial banks.
B. Federal deregulation contributed to banking
difficulties in the 1980's.
C. Visit
History
provided
by the Federal Reserve Bank of St. Louis for a time line of the U.S.
banking System.
Be sure to point at each
date to see what happens during that period.
V. The Federal Reserve System
A.
Organization Chart
1. Board of Governors oversee the Federal Reserve System
a. Seven governors
b. Governors are appointed by the President and confirmed by the
Senate.
c. The
chair is appointed by the President for a four-year term.
1) To foster independence, the term does not coincide with the President's term.
2) Other board members are appointed to
14-year terms on a staggered basis to insure an experienced board.
2. Federal Open Market Committee
a. Membership consists of the Board of Governors and 5 of the 12 Federal Reserve bank
presidents with the
N.Y. president always a member because
N.Y. City
is the financial center for U.S. international trade.
b. The Committee tries to affect interest rates by affecting the supply of money by buying
and selling U.S. government
bonds (See Chapter 15).
3. Federal Advisory Council 12
prominent commercial bankers, one from each district, who
advise the Board of
Governors
4. Twelve Federal Reserve Banks
a. The United States is divided into 12 homogenous districts and each has
its own bank
b. Bank for the federal government
c. Bank for member banks
d. Graphic is complements of the Board of Governors of the Federal Reserve
System.
5.
Member commercial banks
6. Nonmember commercial banks and thrifts are regulated by
other government agencies
B.
Functions of the Federal Reserve
1.
Regulate the money supply
3.
Oversea the financial system
4.
Check collection and clearing
5.
Fiscal agent for the government
6.
Supervise (audit) member banks
7.
Hold reserves (deposits) for member banks
8.
Compile economic statistics such as the
Beige
book, which is
a quarterly summary of each districts'
recent economic activity.
9. Many Federal Reserve publications are free.
C.
The Federal Reserve System Purposes and Functions
D. Current Events Readings
1.
Philadelphia Reflections:
Whither, Federal Reserve?
is a well done, concise history of banking in the United States.
2.
The Real Threat to Fed Independence
Henry Kaufman, Wall Street Journal. The financial giant cuts the industry
no slack.
3. The
Current Events Internet Library
has many
up-to-date economic articles.
VI. Recent Developments
A. Banks and thrifts are the only
institutions whose checking accounts are not restricted as to check size and
number
1. A
liberalized of banking laws,
Financial Institutions Reform, Recovery and
Enforcement Act of 1989,
has caused a declined in their importance although
reforms resulting from the Great Recession beginning in 2007 cold change this.
2.
Consolidation has caused their numbers to decline and their size to increase.
3. Many
bank/thrift services are now performed by insurance companies, pension, and
securities companies.
B. Globalization of financial
markets.
C. Some politicians think the Federal
Reserve system is too independent.
1.
Congress Is Politicizing the Fed Jan 25, 2010
2. Central bank independence versus inflation. This often cited
[49] research published by Alesina and Summers (1993)[50]
is used to show why it is important for a nation's central bank (i.e.-monetary
authority) to have a high level of independence. This chart shows a clear
trend towards a lower inflation rate as the independence of the central bank
increases. The generally agreed upon reason independence leads to lower
inflation is that politicians have a tendency to create too much money if
given the opportunity to do it.[50]
The Federal Reserve System in the United States is generally regarded as one
of the more independent central banks. |
 |
VII. The fractional reserve system and the creation of money
A. Commercial banks are
required to keep a reserve (cash) of about 12% of their demand deposits
(checking accounts)
at their bank or on
deposit
with the Federal Reserve (required reserves). The remainder, (Excess
Reserves) may
be loaned out even though they support deposits.
B. Money is created by these loans as long as the
demand deposits (DD) created by them stay within the banking system,
that is,
the money loaned is redeposit as a DD into a
bank within the system. The banks owe the demand deposits created
by the loans
to each other. These inter-brain debts are canceled with a
bookkeeping entry. It should be pointed out that the
demand deposits created by such loans are spent, and goods transferred,
just as if the
transaction involved currency.
C. Example: Bank A has $50,000 in
demand deposits. A reserve requirement of 10% would yield required reserves of
.10 x $50,000 = $5,000. If Bank A had $7,000 in
reserve, it could loan up to $2,000 in the form of demand deposits.
Suppose Bank
B does exactly the same with both banks' customers
depositing their DD in the other bank. Banks would
owe cashed checks to each
other, would cancel interbank debts, and money has been created.
D. The system works in reverse
with money destroyed if reserves leave the system.
E. Required reserves, reserves
not loaned, and loans of cash (reserves) represent a leakage which
eventually stops money
supply growth.
VII. The monetary multiplier
A. An infusion of
reserves into the system by the Treasury as directed by the Federal Reserve can
be loaned a number of times
by the commercial banking system. For
example, the Federal Reserve may buy a $100 Treasury bond from Ms. A who
deposits
the Federal Reserve check (reserves) into Bank A.
B. Bank A's new DD of $100
requires them to keep $10 (10%) in reserve leaving $90 excess to loan to Mr. B
who
deposits it in Bank B.
C. Bank B needs to keep
only $9 ($90 x .1) in reserve and may loan out $81.
D. This process continues and as long as the
demand deposits being created by the loans stay within the commercial
banking
system, interbank debts are canceled and
money has been created
E. Monetary multiplier (M)
sets the upper limit of the expansion
1. R = reserve
requirement = 10% = .1
2. M = 1/R =
1/.1 = 10
F. In the above example the total
amount of DD created beginning with Bank A's $90 in excess reserves would
equal
Excess Reserves
x M = $90 x 10 = $900. If the $100 infusion by the Federal Reserve
is included, the increase is
10 x 100 = $1,000.
G. For more Information visit
The Banking System and the Money Multiplier
from Jay Kaplan of the University of Colorado at Boulder.
VIII. Additional reading
1.
Money creation
- Wikipedia
2.
Banks Create
Money
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