Money and Banks and Federal Reserve

1. Money and Banking

3. Characteristics of Money
 Medium of Exchange
 Unit of Account
 Store of Value
 Problem with Barter –
Need Coincidence of Wants

4. Is it money?
Criteria Credit Card Debit Card
Medium of
exchange?
Unit of
account?
Store of
value?

5. Substance used for money must
be
◦ Plentiful (but not too much) in supply
◦ Uniform & hard to duplicate
◦ Durable
◦ Portable
◦ Divisible

6. History of money
Cowrie
Shells
Metals
Paper
Money
Fiat
Money

7. Fiat money: Money by law
 No intrinsic value as opposed to
commodity money
 Traded because people BELIEVE in
its worth
 Our dollar bill printed by the US
Treasury

8. The Penny
 https://www.youtube.com/watch?v=_tyszHg96KI

9. What about checks?

10.  Or Tide,
 http://www.foxnews.com/us/2012/03/1
2/police-take-on-rising-wave-tide-
detergent-theft/?intcmp=obnetwork

11. History of Banks
 Safekeeping
◦ Temples
◦ Granaries
 Source of Loans
◦ Rich families
 Money-making venture
◦ Goldsmiths
◦ 1600s: development of checques, paper
money and state banks

12. Banks’ Role
 Place of Safe Deposit
 Place to borrow funds
 Money-making
◦ Savers earn interest
◦ Banks Profit
 Loan interest received (5%)
 - Savings interest paid (1.5%)
 Bank profits (3.5%)

13. Types of Banks
Full Reserves Fractional reserves
 100% of deposit on hand
 Fully redeemable for all
at anytime
 Bank as Guardian
 No policy role
 Portion on hand
 Partially redeemable for
some – Bank Run risk
 Bank as Business
 Policy role in money
creation

14. How loans create money
Reserve
@20% =
$100
Deposits
$500
Loans
$400

15. Money Creation
Bankers 20% required reserve Buyers
 +$1000 deposit
• Keep $200 + loan $800
 $800 deposit
◦ Keep $160 + loan $640
 $640 deposit
◦ Keep $130 + loan $510
 $510 deposit
 Etc, etc, etc
 $800 purchase
 $640 purchase
 $510 purchase
 Etc, etc,etc

16. What makes a good loan?
Lender
Why lend money?
Borrower
Why borrow money?
- Make a profit
- High interest rate
Urgent expense
Potential income gain
Cheaper than renting or leasing
Value of the asset
Lender owns until borrower pays
off
Value of the asset
Does it mean future greater
income?
Ability to repay
- Track record or Credit score
- Proof of income
- Other expenses/debts
Ability to repay
- Consider future income
- What else you may want to
spend money on. Avoid being
“house poor
- Length of loan
- (longer the loan lower the
interest rate but the more
interest collected)
- Length of loan
- (longer the loan the lower the
monthly payment but the more
interest paid)

17. Microlending
 PBS Pakistan,
http://www.youtube.com/watch?v=qI9G7yGJ-ds
 Grameen Bank (1976)
◦ Group-based Credit
◦ Trust-based
◦ Small deposits/small loans
◦ 97% of members are women
 2006 Nobel Prize
 KIVA

18. US Banking
 Local Banks
 National Bank
 1792-1811 Bank of the United States
 1907 Financial Panic and JP Morgan
 1913 The Federal Reserve System
◦ Decentralized-central bank
 1933 FDIC, Glass-Steagall Act, Gold
Standard ended
 1999 Glass-Steagall overturned

19. Federal Reserve
 System of 12 regional banks
 Politically independent
 Controls nation’s money supply
 Board of Governors & FOMC
 Banker’s Bank
 FDIC up to $250,000

20. Monetary Policy
 Open Market Operations by FOMC
 Discount Rate
 Reserve Requirement
◦ Quantitative easing from bank of England

21. Open Market Operations
 Action taken daily
 Buy or sell government debt
◦ Increases or decreases Money Supply
◦ Influences federal funds interest rate
 Benefits and Problems
 http://www.marketplace.org/topics/busine
ss/whiteboard/uncle-ben-goes-shopping

22. Discount Rate
 Action taken less than daily usu
monthly
 Changes the interest rate at which
banks can borrow from the Fed
 Benefits and Problems

23. Required Reserve Ratio
 Rarely Changed
 Adjusts the percentage of deposits
required to be kept by banks
 Benefits and Problems

25. How does the FOMC decide?
 Green book
◦ Forecasts aggregate demand and prices
 Blue book
◦ Presents policy options and impacts of
each
 Beige book
◦ Data and anecdotal information

26. Countering the Business Cycle
Expansionary Actions-
During recession
Contractionary Actions-
When fearing inflation during boom
 Monetary Policy
◦ Lower RR
◦ Lower Discount Rate
◦ Buy Bonds
◦ Find a way to get more
money into the economy
 Monetary Policy
◦ Raise RR
◦ Raise Discount Rate
◦ Sell Bonds
◦ Find a way to pull money
out of the economy

27. Expansionary – Money In
 Buy Bonds
lowers interest rate on bonds
encourages borrowing
Lower Discount Rate
encourages banks to lend more
Lower Required Reserve Ratio
increases money mulitplies

28. Expansionary Policy
PROS CONS
 Works within private
investment and
consumption patterns
 No change in US debt
 Banks may not lend
 People and firms may
not borrow
“Pushing on a string”
 Lags but shorter than
fiscal
 (3-12 months vs 1-3
years)

29. Contractionary – Money Out
 Sell Bonds
raises interest rate on bonds
discourages
borrowing
Raise Discount Rate
discourages banks from
lending
Raise Required Reserve Ratio
decreases money multiplier

30. Contractionary Policy
PROS CONS
 Works within private
investment and
consumption patterns
 No change in US debt
 Can work quickly
 Can over adjust
“Fool in the shower”
 Lags but shorter than
fiscal
 (3-12 months vs 1-3
years)