1 / 53

Chapter 2 of Cecchetti

Chapter 2 of Cecchetti. Money and the Payments System. Money. Money Money is an asset that is generally accepted as payment for goods and services or repayment of debt. 1. A means of payment. Transferability Information 2. A unit of account Allocation of resources Relative prices

preston-hays
Download Presentation

Chapter 2 of Cecchetti

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 2 of Cecchetti Money and the Payments System

  2. Money Money • Money is an asset that is generally accepted as payment for goods and services or repayment of debt. 1. A means of payment. • Transferability • Information 2. A unit of account • Allocation of resources • Relative prices 3. A store of value • Liquidity

  3. Example: Island Economy 1M florins Gold Miner Blacksmith 1M oz gold CENTRAL BANK Farmer Teacher “M”=million

  4. Example: Island Economy • Central bank declares it stands ready to redeem 1 florin for 1 ounce of gold from anyone at any time. Balance Sheet of Central Bank ASSETS LIABILITIES Gold: 1M fl Currency: 1M fl

  5. Example: Island Economy 1M florins Gold Miner Blacksmith gold florins 1M oz gold CENTRAL BANK florins florins food services lecture florins Farmer florins Teacher food “M”=million

  6. Example: Island economy • Assume no banking system • No bank deposits • Money supply is completely in the form of currency • Money supply = 1,000,000 fl

  7. Example: Island Economy Gold Miner Blacksmith Commercial Bank florins florins Farmer Teacher florins florins

  8. Commercial Bank • Initial Purpose: • Keep florins safe • Why not loan some of those florins out? Commercial Bank Balance Sheet ASSETS LIABILITIES Currency 1M fl Deposits 1M fl

  9. Example: Island Economy • Bank Reserves: liquid assets held by banks to meet demands for withdrawls from investors. • Central Bank mandates bank must hold some fraction of florins in vaults called reserves.

  10. Example: Island Economy • Reserve deposit ratio = currency/deposits • Assume required reserve deposit ratio = 20% • Commercial Bank loans out 80% of deposits • 800,000 fl • These are deposited back in the bank

  11. Example: Island Economy Commercial Bank Balance Sheet ASSETS LIABILITIES Currency 1,000,000 fl Deposits 1,800,000 fl Loans 800,000 fl ----------------------------- ----------------------------- Total 1,800,000 fl 1,800,000 fl • Reserve deposit ratio = 1/(1.8) = 60% • Only need .20 ´ 1,800,000 =360,000 fl • Can loan out 1,000,000 – 360,000 = 640,000 fl • Deposited back in bank

  12. Example: Island Economy Consolidated Balance Sheet of Banks ASSETS LIABILITIES Currency 1,000,000 fl Deposits 2,440,000 fl Loans 1,440,000 fl ----------------------------- ----------------------------- Total 2,440,000 fl 2,400,000 fl • Reserve deposit ratio = 1/(2.4) = 42% • Only need .20 ´ 2,440,000 =488,000 fl • Can loan out 1,000,000 – 488,000 = 512,000 fl • Does this just go on forever . . . . . ?

  13. Example: Island Economy • Equilibrium is achieved when Currency/deposits = 0.20 1,000,000/deposits = 0.20 1,000,000/0.20 = deposits 5,000,000 = deposits

  14. Example: Island Economy • Equilibrium ASSETS LIABILITIES Currency 1,000,000 fl Deposits 5,000,000 fl Loans 4,000,000 fl ----------------------------- ----------------------------- Total 5,000,000 fl 5,000,000 fl • Reserve deposit ratio = 1/5 = 20%

  15. Money Supply • Banks have effect on the money supply • Bank Deposits • Very liquid, can be used for transactions • Are counted as part of the money supply • In example, no cash is held by public • Money supply = total deposits • Risk of bank runs

  16. Measuring Money Different Definitions of money based upon degree of liquidity. Federal Reserve System defines monetary aggregates: measures of money

  17. Monetary Aggregates Link to Current Data

  18. Growth Rates in Monetary Aggregates

  19. 1960-1980 1990-2000 Money and Inflation M2 Growth Rate and CPI Inflation Rate 2 years later.

  20. Changes in Rates Chapter 6 of Cecchetti

  21. Fluctuations of 1-year T-bond Rate 1-month T-bill Rate: 1953-2007

  22. Bond Demand and Supply • From perspective of primary market • Market in which firms issue debt, sell to investors • Suppliers: Firms and Government • Demanders: Investors • Looking at secondary market, does not allow us to investigate firm behavior • Market in which investors buy and sell bonds among themselves

  23. Supply And Demand Curves Price Yield 5.3% 950 Supply Demand 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  24. Suppliers • We could actually have two supply curves • Government • Firms • Factors that impact one sector may not impact the other • Government and Corporate rates are connected.

  25. Supply – A Closer Look • Three agents in economy • Government • Business • Households Increased Gov Borrowing Initial Situation

  26. Shift in SupplyIncrease in Government Borrowing Price Yield 5.3% 950 Government Bond Supply Curve 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  27. Changes in Government Borrowing • An increase in Government borrowing • The supply curve shifts to the right • Prices to decrease • Yields to increase • A decrease in Government borrowing • The supply curve shifts to the left • Prices to increase • Yields to decrease

  28. Shift in SupplyDeclining Business Conditions Price Yield 5.3% 950 11.1% 900 Corporate Bond Supply Curve 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  29. Changes in Business Conditions • An improvement in business conditions • The supply curve to shift to the right • Prices to decrease • Yields to increase • A decline in business conditions • The supply curve to shift to the left • Prices to increase • Yields to decrease

  30. Shift in SupplyIncrease in Corp. Tax Subsidies Price Yield 5.3% 950 Corporate Bond Supply Curve 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  31. Changes in Corp.Tax Subsidies • An increase in Corp. Tax Subsidies • The supply curve to shift to the right • Prices to decrease • Yields to increase • A decrease in Corp. Tax Subsidies • The supply curve to shift to the left • Prices to increase • Yields to decrease

  32. Shift in SupplyIncrease in Expected Inflation Price Yield Corporate/Government Bond Supply Curve 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  33. Changes in Expected Inflation • An Increase in Expected Inflation • The supply curve to shift to the right • Prices to decrease • Nominal Yields to increase • A decrease in Expected Inflation • The supply curve to shift to the left • Prices to increase • Nominal Yields to decrease

  34. Demand – A Closer Look • Three agents in economy • Government • Business • Households Increased Household Saving Initial Situation

  35. Shift in DemandIncreased Household Wealth Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  36. Changes in Household Wealth • An Increase in Household Wealth • The demand curve to shift to the right • Prices to increase • Yields to decrease • A decrease in Household Wealth • The demand curve to shift to the left • Prices to decrease • Yields to increase

  37. Shift in DemandIncrease in Expected Stock Return Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  38. Changes in ExpectedRelative Bond Returns • An Increase in Bond Yield – Return Alt. • The demand curve to shift to the right • Prices to increase • Yields to decrease • A decrease in Bond Yield – Return Alt. • The demand curve to shift to the left • Prices to decrease • Yields to increase

  39. Shift in DemandDecrease in Relative Risk of Bonds Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  40. Changes in Relative Bond Risk • A decrease in Bond Risk – Risk Alt. • The demand curve to shift to the right • Prices to increase • Yields to decrease • An increase in Bond Risk – Risk Alt. • The demand curve to shift to the left • Prices to decrease • Yields to increase

  41. Example: Crowding Out • Increased government borrowing “crowds out” firms from borrowing Yield Price Yield Price Primary Market for Government Bonds Primary Market for Corporate Bonds

  42. Shift in DemandIncrease in Relative Bonds Liquidity Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  43. Changes in Relative Bond Liquidity • An Increase in Bond Liq. – Liq. Alt. • The demand curve to shift to the right • Prices to increase • Yields to decrease • A decrease in Bond Liq. – Liq. Alt. • The demand curve to shift to the left • Prices to decrease • Yields to increase

  44. Shift in DemandIncrease in Expected Inflation Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  45. Changes in Expected Inflation • A Decrease in Expected Inflation • The demand curve to shift to the right • Prices to increase • Yields to decrease • An increase in Expected Inflation • The demand curve to shift to the left • Prices to decrease • Yields to increase

  46. Expected Inflation • Expected inflation shifts both curves • Consider a decrease in expected inflation

  47. Decrease in Expected Inflation Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

  48. Decrease in Expected Inflation • A decrease in expected inflation unambiguously causes bond prices to rise and yields to fall.

  49. Business Cycles • Business Cycles can shift both curves • Consider what happens when economy emerges from a recession. • Jobs are created, household wealth increases • Business conditions improve

  50. Economy Emerges from Recession Price Yield 5.3% 950 11.1% 900 850 17.6% 800 25.0% 750 33.0% 100 200 300 400 500 Quantity of Bonds ($ billions)

More Related