Class9

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Class9

  1. 1. Economics for Journalists Week 9: The Banking System Jeffrey TimmermansMonday, 26 March, 12
  2. 2. Review: Monetary PolicyMonday, 26 March, 12
  3. 3. Monetary policy ✤ Now, typically the domain of central banks ✤ In most developed countries, central banks control interest rates and money supply independently ✤ Both interest rates and money supply are closely linkedMonday, 26 March, 12
  4. 4. Central banks & money supply ✤ Central banks have three main ways to influence the supply of money in an economy ✤ Directly increasing/decreasing money supply by selling/buying government bonds (U.S., Europe, Japan) ✤ Raising/lowering deposit & lending rates (China) ✤ Changing commercial banks’ reserve ratio (China)Monday, 26 March, 12
  5. 5. Interest rates ✤ Most countries have a “base” interest rate, upon which all other domestic rates (deposit rates, mortgage rates) depend ✤ Typically, these are target rates for overnight loans between banks ✤ Fed funds target rate in U.S. (zero-0.25%) ✤ Overnight call rate in Japan (0.10%)Monday, 26 March, 12
  6. 6. Impact of interest rate adjustments/open-market ops Open-market Money supply All interest rates PURCHASES UP DOWN Open-market Money supply All interest rates SALES DOWN UPMonday, 26 March, 12
  7. 7. Money SupplyMonday, 26 March, 12
  8. 8. Measuring the money supply ✤ M1: Currency + Demand Deposits + Traveler’s Checks + Other Checkable Deposits ✤ M2: M1 + Savings Deposits + Retail Money Market Mutual FundsMonday, 26 March, 12
  9. 9. U.S. Money Supply February 2010 (provisional) billions of 9,000 U.S. dollars Money Mkt Funds Time Deposits 6,750 Savings 4,500 Deposits 2,250 M1 Currency 0 M1 M2 Source: U.S. Federal ReserveMonday, 26 March, 12
  10. 10. The Banking SystemMonday, 26 March, 12
  11. 11. Role of the banking system ✤ To channel individuals’ savings to others who want to borrow money ✤ To serve as a financial intermediaryMonday, 26 March, 12
  12. 12. The Banking System Prime rate Home/car Commercial Bank Loans Interbank Commercial rate Bank Interbank Commercial market Bank Deposits Commercial Deposit rate Home/car Bank Loans Finance Open- Discount Business Company Market window loans Ops Discount rate Commercial lending rate Money Central Market Fund Commercial Bank PaperMonday, 26 March, 12
  13. 13. Key interest rates ✤ Interbank rates Low ✤ Overnight, 1-wk, 1-mth, 3-mth ✤ Deposit rates ✤ Overnight, 1-wk, 1-mth, 3-mth ✤ Commercial lending rate High ✤ Prime (lending) rateMonday, 26 March, 12
  14. 14. Structure of the Banking System ✤ The central bank sets a target rate for overnight lending by banks ✤ Commercial banks borrow from each other to meet short-term needs in the interbank market ✤ Commercial banks take deposits from individuals and lend out some of those deposits ✤ Corporations issue short-term debt in form of commercial paper, which is purchased by banks & money-market fundsMonday, 26 March, 12
  15. 15. The “Shadow Banking System” ✤ Any non-bank financial institution that is subject to less oversight than traditional lenders like commercial banks ✤ Finance companies ✤ Money-market funds ✤ Hedge fundsMonday, 26 March, 12
  16. 16. Interbank rates ✤ H.K.: Hong Kong Interbank Offer Rate (Hibor) ✤ U.K.: London Interbank Offer Rate (Libor) ✤ Fed sets Fed Funds target rate; supply/demand determine Hibor & Libor ✤ Banks’ other lending rates often based on local interbank rateMonday, 26 March, 12
  17. 17. Commercial Banks ✤ Take deposits ✤ Make loans ✤ Deposits are banks’ liabilities ✤ Loans (& reserves) are assets ✤ Pay depositors interest (deposit rate) ✤ Banks keep some reserves, lend out the rest ✤ Earn interest from borrowersMonday, 26 March, 12
  18. 18. Reserve Ratio ✤ Typically set by the central bank ✤ Indicates the percentage of deposits a bank must keep as reserves ✤ In U.S., reserve ratio is now 10% for deposits above $55.2 million ✤ An increase in the reserve ratio forces banks to curtail lending, a decrease leads to more lending and an expansion of the money supplyMonday, 26 March, 12
  19. 19. Jeff’s Bank (100% reserve ratio) Assets Liabilities Reserves $100 Deposits $100Monday, 26 March, 12
  20. 20. Jeff’s Bank (10% reserve ratio) Assets Liabilities Reserves $10 Deposits $100 Loans $90Monday, 26 March, 12
  21. 21. The Money Multiplier 1 reserve ratioMonday, 26 March, 12
  22. 22. How the multiplier works Original deposit $100 Jeff’s Bank lending $90 (.9 x $100) Masato’s Bank lending $81 (.9 x $90) Wylie’s Bank lending $72.90 (.9 x $81) etc. etc. Total money supply $1,000Monday, 26 March, 12

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