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Money, banking, and financial institutions

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  • 1. 34 Money, Banking, and Financial Institutions McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2012 McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2012 by Theby The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. 13 - 1 •Money In a World War II Prisoner of War Camp During World War II, cigarettes were used as money in some prisoner-ofwar camps. 2 of 37
  • 3. Functions of Money • Medium of exchange • Used to buy/sell goods • Unit of account • Goods valued in dollars • Store of value • Hold some wealth in money form • Money allows us to transfer purchasing power • LO1 from present to future Money is liquid • It is the most liquid (spendable) of all assets, a convenient way to store wealth.
  • 4. What Is Money and Why Do We Need It? What Can Serve As Money? What makes a good suitable to use as a medium of exchange? There are five criteria: The good must be acceptable to/usable by most traders. It should be of standardized quality, so that any two units are identical. It should be durable, so that value is not lost by spoilage. It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported. The medium of exchange should be divisible because different goods are valued differently. 4 of 37
  • 5. 13 - 2 •Money without a Government? The Strange Case of the Iraqi Dinar Many Iraqis continued to use currency with Saddam’s picture on it, even after he was forced from power. 5 of 37
  • 6. Money Definition M1  Currency  Checkable deposits Institutions offering checkable deposits: • Commercial banks • Savings & loan assoc. • Mutual savings banks • Credit unions Note: Currency & checkable deposits held by the federal govt, Federal Reserve, or other financial institutions are not included in M1. LO1 M2 M1 plus near-monies  Savings deposits including money market deposit accounts (MMDA)  Small-denominated time deposits  Money market mutual funds (MMMF) balances, which can be redeemed by phone calls, checks, or through the Internet
  • 7. Money Definition Narrow definition of money, M1 includes: •Currency (coins + paper money) held by public. a. Is “token” money, which means its intrinsic value is less than actual value. The metal in a dime is worth less than 10¢. a. All paper currency consists of Federal Reserve Notes issued by the Federal Reserve • Checkable Deposits can be spent almost as readily as currency and can easily be changed into currency.
  • 8. Money Definition M1 January 2008 Currency Checkable Deposits Small Time Deposits Money Market Mutual Funds Held By Individuals Savings Deposits, Including Money Market Deposit Accounts Source: Federal Reserve System Totals + + + M2 56% M1 44% 18% 16% 14% + 52% + $1,365 Billion $7,499 Billion
  • 9. How Do We Measure Money Today? M1: The Narrowest Definition of the Money Supply 13 - 1 Measuring the Money Supply, September 2005 9 of 37
  • 10. What “Backs” the Money Supply? • Guaranteed by government’s ability to keep value stable • Money as debt • Why is money valuable? •Acceptability •Legal tender •Relative scarcity LO2
  • 11. WHAT GIVES MONEY ITS VALUE? • Acceptability money is accepted as payment for goods and services. It is accepted as is serves the function as medium of exchange • Legal Tender Money is also accepted as payment for debts. Govt mandates through law that debt can be settled with paper money. (checks are not mandate as money but demand deposits do) • Relative Scarcity Money must be relatively scarce. Its value or purchasing power is determined by supply of money controlled by the Federal Reserve System
  • 12. What “Backs” the Money Supply? • • • LO2 Prices affect purchasing power of money Hyperinflation renders money unacceptable Stabilizing money’s purchasing power • Intelligent management of the money supply – monetary policy • Appropriate fiscal policy
  • 13. What Backs the Money Supply? Stable Value! through... 1. Appropriate Fiscal Policy 2. Intelligent Management of the Money Supply – Monetary Policy
  • 14. Stabilizing Money’s Purchasing Power through... 1. Appropriate Fiscal Policy government needs to be prudent in its spending and taxing actions to that it does not reduce the value of money by running large budget deficits when economy is at full employment 2. Monetary policy used to control money supply . If too much money is available the value of money for a given level of production of goods and services it can lead to inflation and value of money
  • 15. MONEY SUPPLY Two key points about the money supply to keep in mind are: 1. The MS consists of both currency and balances in checking accounts. 2. Because balances in checking accounts are included in the MS, banks play an important role in the process by which the MS increases and decreases.
  • 16. WHAT ABOUT CREDIT CARDS? • Credit cards are not money, but their use involves short‑ term loans; • It represent the ability to get instant loan for exchange of goods and services. • At one point the loan must be paid with money. • their convenience allows you to keep M1 balances low because you need less for daily purchases.
  • 17. Federal Reserve - Banking System • • • Historical background Board of Governors 12 Federal Reserve Banks • Serve as the U.S. central bank • Quasi-public banks • Banker’s bank
  • 18. Federal Reserve – Banking System 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)
  • 19. Federal Reserve – Banking System The 12 Federal Reserve Banks LO3
  • 20. Federal Reserve – Banking System • Federal Open Market Committee • Aids Board of Governors in setting monetary policy • Conducts open market operations • Commercial banks and thrifts • 6,800 commercial banks • 8,700 thrifts
  • 21. Federal Reserve Functions • Issuing Currency • Setting Reserve Requirements & Holding Reserves • Lending Money to Banks & Thrifts •Discount Rate • Providing for Check Collection service for banks • Acting as Fiscal Agent • Supervising Banks • Controlling the Money Supply-Monetary Policy
  • 22. Federal Reserve Independence • Established by U.S. Congress as an independent agency • Protects the Fed from political pressures • Enables the Fed to take actions to increase interest rates in order to stem inflation as needed
  • 23. Financial Institutions World’s 12 Largest Financial Institutions, 2009 0 Assets (Trillions of U.S. Dollars) 1.5 2.5 3.5 Royal Bank of Scotland (UK) Barclays (UK) Deutsche Bank (Germany) BNP Paribas (France) HSBC Holdings (UK) JPMorgan Chase (US) Credit Agricole (France) Citigroup (US) Mitsubishi UFJ (Japan) UBS (Switzerland) ING Group (Netherlands) Bank of America (US) Source: Forbes Global 2000, www.forbes.com
  • 24. The Financial Crisis of 2007 and 2008 • U.S. Mortgage Default Crisis. Many causes • Government programs that encouraged home ownership • Declining real estate values • Bad incentives provided by mortgage-backed bonds • Securitization: the process of slicing up and bundling groups of loans into new securities.As loans defaulted, the system collapsed • “Underwater” homeowners abandoned homes and mortgages LO5
  • 25. Recent Developments Globalization of Financial markets Significant integration of world financial markets is occurring and recent advances in computer and communications technology. Electronic transactions: Internet buying and selling, electronic cash, and “smart cards”. . Unlike currency, E‑cash is “issued” by private firms rather than by government. To control the money supply the Fed will need to find ways to control the total amount of E‑cash, including that created through Internet loans.
  • 26. medium of exchange unit of account store of value M1, M2, M3 token money Federal Reserve Notes checkable deposits commercial banks thrift institutions near-monies savings account money market deposit account (MMDA) time deposits Copyright McGraw-Hill/Irwin, Inc. 2005 money market mutual fund (MMMF) legal tender transactions demand asset demand total demand for money money market Federal Reserve System Board of Governors Federal Open Market Committee (FOMC) Federal Reserve Banks financial services industry electronic transactions BACK END
  • 27. Checklist:  After completing this chapter, students should be able to  List and explain the three functions of money.  Define the money supply, M1 and near‑monies, M2, and M3.  State three reasons why currency and checkable deposits are money and why they have value.  Identify two types of demand for money and the main determinant of each.  Describe the relationship between GDP and the interest rate and each type of money demand.  Explain what is meant by equilibrium in the money market and the equilibrium rate of interest.  Explain the relationship between bond prices & the money market.  Describe seven functions of the Federal Reserve System and point out which role is the most important.
  • 28. Coming up next... How Banks and Thrifts Create Money
  • 29. MONEY AND PRICES PURC HAS ING POWER OF MONEY •The amount a dollar will buy varie s inve rs e ly with the pric e le ve l: •D= 1/ Pric e Le ve l •The re is a re c iproc al re lations hip be twe e n the pric e le ve l and the purc has ing powe r of the dollar •Whe n C PI or ‘c os t of living’ ris e the value of dollar goe s down, vic e ve rs a •Highe r pric e lowe r value of dollar as we ne e d more to buy a partic ular amount of goods , s e rvic e s of re s ourc e •Eg If pric e double s , the dollar value falls by one half. Value of the dollar $V $V=1/P Expressed as index no in hundredths If P level = 1 then V=1 If P rise to 1.20, V falls to 1/1.20=0.833 Thus increase in price by 20 percent cause value of dollar to falls by 16.67 percent
  • 30. Inflation 1. Inflation may significantly depreciates the value of money between the time it is received and the time it is spent 2. Rapid decline if value of money makes it cease its function as medium of exchange. 3. Business and household refuse to accept paper money as of loss of value that will occur 4. Economy may go back to barter system 5. Alternatively more stable foreign currencies are use as mode of payment
  • 31. Inflation and Acceptability Other problems: 1.Money cannot be used as store of value due to serious inflation 2.Money cannot be used as unit of account when its purchasing power unstable. Thus price do not reflect to value of goods, services and resources. 3.Terms of trade are difficult to be determined

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