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The Nature and Creation of Money Read Chapter 9 pages 184 – 200. I What is Money?

The Nature and Creation of Money Read Chapter 9 pages 184 – 200. I What is Money? Money is anything that serves as a medium of exchange. B) Three Functions of Money. A medium of exchange is anything that is widely accepted as a means of payment.

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The Nature and Creation of Money Read Chapter 9 pages 184 – 200. I What is Money?

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  1. The Nature and Creation of Money Read Chapter 9 pages 184 – 200. I What is Money? • Money is anything that serves as a medium of exchange.

  2. B) Three Functions of Money. • A medium of exchange is anything that is widely accepted as a means of payment. Barter occurs when goods are exchanged directly for other goods. • A unit of account is a consistent means of measuring the value of things. 3) A store of value is an item that holds value over time.

  3. Types of Money • Commodity money is money that has value apart from its use as money. • Fiat money is money that some authority has ordered to be accepted as a medium of exchange. Examples: a) Currency is paper money and coins. b) Checkable deposits are balances in checking accounts. A check is a written order to a bank to transfer ownership of a checkable deposit.

  4. Measuring Money • The total quantity of money in the economy at any one time is called the money supply. • Economists refer to the ease with which an asset can be converted into currency as the asset’s liquidity. • M1 consists of currency in circulation, checkable deposits and travelers checks. 4) M2 is M1 plus small time deposits.

  5. II The Banking System and Money Creation • Banks and other Financial Intermediaries • A financial intermediary is an institution that amasses funds from one group and makes them available to another. • A bank is a type of financial intermediary which accepts deposits, makes loans, and offers checking accounts.

  6. Bank Finance and a Fractional Reserve System • A balance sheet is a financial statement showing assets, liabilities and net worth. 2) Assets are anything of value. 3) Liabilities are obligations to other parties. 4) Net worth equals assets less liabilities. 5) Banks keep only a fraction of their deposits as cash in their vaults and in deposits with the Fed called reserves.

  7. 6) A system in which banks hold reserves whose value is less than the sum of claims outstanding on those reserves is called a fractional reserve banking system.

  8. C) Money Creation • The quantity of reserves banks are required to hold is called required reserves. 2) The reserve requirement is the ratio of reserves to checkable deposits. 3) Excess reserves are reserves that a bank holds in excess of the required level. 4) Excess reserves plus required reserves equal total reserves. 5) When a banks excess reserves are zero, it is loaned up.

  9. D) Money Creation Illustration • Bank (Acme Bank) is initially loaned up. • Next they receive a deposit of $1,000 • The bank has excess reserves of $900. • So they make a loan for $900 increasing their loans and deposits by $900. • The person who receives the loan buys a stereo and writes a check for $900 to someone with an account at Bellville Bank. 6) Now the steps repeat.

  10. E) The Deposit Multiplier • The deposit multiplier equals the ratio of the maximum possible change in checkable deposits to the change in reserves. • Md = Change in deposits/Change in reserves. • Md = 1/reserve ratio. example: reserve ratio of .1 implies deposit multiplier of 10.

  11. F) The regulation of banks. • Deposits Insurance provided by the FDIC • Regulated to maintain a minimum level of net worth as a fraction of total assets.

  12. III The Federal Reserve system • A central Bank performs four primary functions: 1) acts as a banker to the government, 2) acts as a banker to banks, 3) acts as a regulator of banks, 4) sets monetary policy.

  13. B) Structure of the Fed 1) 12 regional branches. 2) 7 members of the Board of Governors located in Washington. 3) Federal Open Market committee consists of the 7 BOG members plus 5 regional bank presidents who serve on a rotating basis. 4) Fed decides policy independent of political demands.

  14. C) Powers of the Fed • Set Reserve Requirements. 2) Sets the discount rate which is the interest rate that banks can borrow from the Fed at on overnight loans. 3) Targets the Federal Funds rate which is the interest rate that banks can borrow from the other banks on overnight loans.

  15. D) Implementation of Monetary policy • Carried out by the New York Fed President who is a permanent member of the FOMC. • Done using open market operations which occur when the Fed buys and sells federal government bonds on the open market. E) Impact on the Money Supply.

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