Money and Banking

1. 12 Money and Banking

2. Chapter Objectives • The Functions of Money and the Components of the U.S. Money Supply • What “Backs” the Money Supply, Making Us Willing to Accept It? • The Makeup of the Federal Reserve and the U.S. Banking System • The Functions and Responsibilities of the Federal Reserve

3. Money Defined • The Functions of Money • Medium of Exchange • Unit of Account • Store of Value • Components of the Money Supply • Currency • Checkable Deposits • Other Liquid Savings Deposits

4. Before money… • Barter system used • Problem? • Difficulty finding two people who have what each other wants

5. Functions – Accepted by everyone in society b/c: • Medium of Exchange – • It’s a method of exchange for goods & services • Unit of account– • Determines economic worth of goods & services • Store of Value – • Holds its value over time

6. Components of the Money Supply • Societies have many items as money (commodities, representative currency, fiat money) • In US, money defined as M1, M2, M3

7. Money Defined • Currency • Coins and Paper Money • Token Money • Federal Reserve Notes • Checkable Deposits • Commercial Banks • Thrift Institutions • A Qualification • Government, Federal Reserve, and Banks Excluded from M1

8. Money Defined • M1: • Currency-bills and token money • Checkable Deposits • M2 = M1 plus: • Near-Monies • Savings Deposits Including Money Market Deposit Accounts (MMDA) – interest-bearing account containing a variety of interest-bearing short-term securities • Small Time Deposits • Money Market Mutual Funds (MMMF) – offered by mutual fund company and invested into a combo of short-term credit instruments

9. Money Defined M1 M2 February 2006 + Currency 54% M1 + Checkable Deposits 20% 46% + Small Time Deposits 15% Money Market Mutual Funds Held By Individuals (MMMF) 11% + Savings Deposits Including Money Market Deposit Accounts (MMDA) 54% + Totals $1,375 Billion $6,758 Billion

10. Money Defined • Money Definition MZM • Money Zero Maturity • Immediately Available • From M2 Subtract Small Time Deposits • Add Back Money Market Mutual Funds Owned by Businesses (MMMF) • Slightly Larger than M2 • February 2005 M2 was $6,758 Billion and MZM was $6,934 Billion

11. MZM • Money zero maturity – focuses on monetary balances that are immediately available, for household and business transactions • M2 adjusted by • -subtracting small time deposits • Adding MMMF balances owned by businesses

12. Money Supply • Are Credit Cards Money? • What “Backs” the Money Supply? • Stable Value of Money • Money as Debt • Acceptability • Legal Tender • Relative Scarcity

13. Are Credit Cards Money? • Read p. 232 Consider This and discuss

14. What “backs” the money supply? • US currency is backed by the governments ability to keep its value relatively stable---NOTHING ELSE!!!

15. Money as Debt • Major components of money supply are debts, or promises to pay • Currency and checkable deposits have no intrinsic value • Not backed by precious metal, but “managed” by government

16. Value of Money • 3 economic characteristics ensure value of money • 1. acceptability • 2. legal tender – valid and legal means of payment of debt • 3. relative scarcity – value depends on S and D

17. Money Supply • Money and Prices • Purchasing Power of the Dollar $V = 1/P • Inflation and Acceptability • Stabilizing Money’s Purchasing Power • Intelligent Management of the Money Supply – Monetary Policy • Appropriate Fiscal Policy

18. Purchasing Power of the Dollar • Amt a dollar buys varies inversely with price level • When CPI increases, value of dollar goes down and vice versa • See equation of previous slide • To find value of dollar $V, divide 1 by the price level in hundredths

19. Inflation and Acceptability • Over issuance of currency can make it worthless and unacceptable in exchange • Ex. Post WWI Germany, • In extreme cases, a nation may adopt another country’s currency to counter hyperinflation

20. Stabilizing Money’s Purchasing Power • Hyperinflation and erosion or purchasing power result from economic policies • Nation must use fiscal and monetary policies appropriately

21. Federal Reserve System • The Federal Reserve and the Banking System • Historical Background • Board of Governors • Federal Open Market Committee (FOMC) • Open Market Operations

22. 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)

23. The Federal Reserve and the banking system • The Fed – US monetary authorities • Includes Board of Governors and 12 Federal Reserve Banks

24. Board of Governors • Seven members • Appointed by President, approved by Senate • Experienced membership, independent from political pressures

25. 12 Federal Reserve Banks • Blend public and private control • Serve as central bank and bankers’ banks • Central bank – most nations have single central bank • Quasi-public banks – each district bank is owned by private commercial banks in its district • Not motivated by profit, do not compete with commercial banks • Bankers’ banks – accept deposits and make loans to regional banks, issue currency

26. Federal Reserve System The 12 Federal Reserve Banks Source: Federal Reserve Bulletin

27. FOMC (Federal Open Market Committee) • Aids BOG in conducting monetary policy • 12 members, includes the 7 members of the BOG plus 5 other Fed district bank presidents • Meet regularly to conduct open-market operations

28. Commercial Banks and Thrifts • About 7600 commercial banks, many state chartered • 11,400 thrift institutions (many are credit unions)

29. Historical Background • 1913 – Federal Reserve Act of 1913 – Congress decided centralization and public control of banking were needed for an efficient system

30. Federal Reserve System The 12 Federal Reserve Banks • Private and Public Control • Central Bank • Quasi-Public Banks • Banker’s Banks • Commercial Banks and Thrifts

31. Federal Reserve System Fed Functions and the Money Supply • Issuing Currency • Setting Reserve Requirements and Holding Reserves • Lending Money to Banks and Thrifts • Discount Rate • Check Collection • Fiscal Agent for U.S. • Supervising Banks • Controlling the Money Supply

32. Federal Reserve System Fed Functions and the Money Supply • Federal Reserve Independence • Recent Developments • Relative Decline of Banks and Thrifts • Consolidation Among Banks and Thrifts • Convergence of Services Provided by Financial Institutions • Globalization of Financial Markets • Electronic Payments

33. Fed Functions and the Money Supply • 1. Issuing paper currency • 2. setting reserve requirements and holding reserves – fractions of checking account balances that banks must maintain as currency reserves • 3. lending money to banks and thrifts • 4. providing for check collection • 5. acting as a fiscal agent –for the federal gov

34. Fed Functions and the Money Supply • 6. Supervising banks – periodic examinations and assessments • 7. controlling the money supply – most important responsibility of the Fed (detailed in Ch. 14)

35. Federal Reserve Independence • Independent gov agency • Protected from political Congressional and executive pressures

36. Recent Developments • Relative decline of banks and thrifts – See 12.1 • Consolidation among banks and thrifts – mergers b/w major banks • Convergence of services provided by financial institutions – “financial supermarkets” • Globalization of Financial markets • Electronic payments

37. GLOBAL PERSPECTIVE Financial Institutions • Barclays (U.K.) • UBS (Switzerland) • Citigroup (U.S.) • ING Group (Netherland) • Mizuho Financial (Japan) • Allianz Worldwide (Germany) • Bank of America (U.S.) • HSBC Group (U.K.) • BNP Paribus (France) • JPMorgan Chase (U.S.) • Deutsche Bank Group (Germany) • Royal Bank of Scotland (U.K.) World’s Largest Financial Institutions 2005 Assets (Millions of U.S. Dollars) $1,587,061 1,519,399 1,494,037 1,369,546 1,325,227 1,300,648 1,291,795 1,274,219 1,227,951 1,198,942 1,134,826 1,119,901 Source: Forbes Global 2000

38. Financial Institutions Major U.S. Financial Institutions • Commercial Banks • Thrifts • Insurance Companies • Mutual Fund Companies • Pension Funds • Securities Firms

39. The Global Greenback Last Word • U.S. Currency Circulating Abroad • Russians $40 Billion • Argentineans $7 Billion • Polish $6 Billion • U.S. Profits from Dollars Leaving • Black Markets and Illegal Activities • Seeking Stable Purchasing Power • Soviet Union Collapse • Brazil Inflation Issues • Asian Market Exchanges

40. The Global Greenback Last Word • Financial Risks • Exchange-Rate Risk • Upside Opportunity • Global Greenback a Positive Economic Force • Results in Increased Output and Income Globally

41. medium of exchange unit of account store of value M1 token money Federal Reserve Notes checkable deposits commercial banks thrift institutions near-monies M2 savings account money market deposit account (MMDA) time deposits money market mutual fund (MMMF) MZM legal tender Federal Reserve System Board of Governors Federal Reserve Banks Federal Open Market Committee (FOMC) financial services industry electronic payments Key Terms

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