Eco 202 ch 30 the monetary system

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Eco 202 ch 30 the monetary system

  1. 1. Chapter 30The Monetary System
  2. 2. Key Termsmoney reservesmedium of exchange fractional-reserve bankingunit of account reserve ratiostore of value money multiplierliquidity bank capitalcommodity money leveragefiat money leverage ratiocurrency capital requirementdemand deposits open-market operationscentral bank discount ratemoney supply reserve requirementsmonetary policy
  3. 3. Two Choices Make or Trade
  4. 4. BarterDirect trade - stuff for stuff No money Double coincidence of wants
  5. 5. Double coincidence of wantsBoth sides have to want what the other side has
  6. 6. Money makes trade easier
  7. 7. Double coincidence of wantsBoth must want what the other has at the same time
  8. 8. What is money?
  9. 9. MoneySomething people use to trade with
  10. 10. Why would you accept acigarette if you didn’t smoke?
  11. 11. Functions of Moneymedium of exchange unit of account store of value
  12. 12. Medium of Exchange Buyers give to sellersSellers accept from buyers
  13. 13. Unit of Account Measurement Prices Debts
  14. 14. Store of ValueTrading time for timeToday for tomorrowTomorrow for todayEarn - Save - Spend
  15. 15. LiquidityHow easy is it to convert something to money
  16. 16. Kinds of Money Commodity Fiat
  17. 17. Commodity Money Intrinsic value
  18. 18. Easy to carryEasy to measureEasy to verifyHard to copy
  19. 19. Gold Standard =Central Bank will convert paper money to gold at a fixed rate
  20. 20. Fiat MoneyNo intrinsic valueDeclared money bygovernment decree
  21. 21. Fiat MoneyWhy do people accept fiat money? Trust that someone else will also accept it
  22. 22. Money Trust inscribedIf people lose trust,money loses it value
  23. 23. CoinsCurrencyChecks
  24. 24. Card Type Payment Credit Defer Debit Instant
  25. 25. Why credit and debit cards are not money Not a method ofpayment, but a method of making payment
  26. 26. Debit card is like a checkTakes money out of your bank account
  27. 27. Credit CardDefer the payment
  28. 28. Demand DepositsBank account that youcan access by writing acheck or using a debit card
  29. 29. Saudi Arabia Monetary Agency The Central Bank of Saudi Arabia SAMA sama.gov.sa
  30. 30. Central BankThe bank that overseesthe banking system and regulates the money supply in a country
  31. 31. Dr. Fahad Al MubarakChairman of the Board GovernorSaudi Arabia Monetary Agency SAMA
  32. 32. Six Functions• Issues national currency, the Saudi Riyal.• Acts as a banker to the government. • Supervises commercial banks.• Manages Kingdom’s foreign exchange reserves.• Conducts monetary policy for promoting price and exchange rate stability.• Promotes the growth and ensures the soundness of the financial system.
  33. 33. Source: sama.gov.sa
  34. 34. Money SupplyThe quantity of moneyavailable in a country.
  35. 35. Monetary Policy Setting the moneysupply by the central bank policymakers
  36. 36. Two Types of Banks100 Percent ReserveFractional Reserve
  37. 37. 100-Percent Reserve Bank All the deposits are kept in a safe vault. No loans
  38. 38. Fractional-Reserve Bank Bank only holds afraction of the deposits as reservesLoans out the remainder
  39. 39. Reserve RatioThe fraction of deposits that banks hold as reserves
  40. 40. Fractional-Reserve Banking Creates money
  41. 41. How does 1000 become 10,000? Reserve Loan Bank Deposit 10% Remainder 1000 100 900 900 90 810 810 81 729 • • • • • • • • • • • • Total 10,000
  42. 42. Money multiplier is thereciprocal of the reserve ratioReserve Money Fraction Reciprocal Ratio Multiplier 100% 1 1÷1 1 50% 0.50 1 ÷ 0.50 2 25% 0.25 1 ÷ 0.25 4 10% 0.10 1 ÷ 0.10 10 5% 0.05 1 ÷ 0.05 20 1% 0.01 1 ÷ 0.01 100
  43. 43. Bank Capital The money the bank’sshareholders have put in to the bank
  44. 44. Leverage OPMUsing other people’s money
  45. 45. Leverage1. I have 102. I borrow 90 from you3. I buy something for 1004. I resell the item for 1505. I pay back your 906. I keep the 607. I earned 50 profit on my 10
  46. 46. Leverage RatioThe ratio of assets to bank capital Assets Bank Capital
  47. 47. Bank Balance Sheet Liabilities and Assets Owner EquityReserves 200 Deposits 800Loans 700 Debt 150Securities 100 Capital 50Total 1000 Total 1000 Totals must balance or be equal
  48. 48. What is the leverage ratio? Liabilities and Assets Owner EquityReserves 200 Deposits 950Loans 800 Capital 50Total 1000 Total 1000 Assets ÷ Capital 1000 ÷ 50 = 20
  49. 49. Leverage Ratio of 20 Owners put up 1Depositors put up 19
  50. 50. Leverage is Risky! If leverage ratio is 20,5% increase in asset value= 100% return to owners5% decrease in asset value = 100% loss to owners
  51. 51. Capital RequirementGovernment rule onminimum amount of bank capital
  52. 52. InsolventLiabilities are more than the assets You owe more than you own
  53. 53. Three Tools of Central BanksOpen-Market Operations Discount Rate Reserve Ratio
  54. 54. Open-Market Operations Purchase and sale of government bondsBuy bonds increases supplySell bonds decreases supply
  55. 55. Increase Money Supply? Buy bonds for cashCentral Bank Banks now have more cash to loanPublic Banks
  56. 56. Decrease Money Supply? Sell bonds for cashCentral Bank Banks now have less cash to loanPublic Banks
  57. 57. Discount Rate The rate the central bank charges to make loans to member banksCalled the Official Repo Rateor ORR rate in Saudi Arabia
  58. 58. Official Repurchase Rate or Discount Rate 2.0% Dropped from 2.5% on January 19, 2009
  59. 59. Dropped from 5.5% October 2008 to 2.0% by January 2009Rate increased 3 month period of as economy global financial crisis heated upSAMA Official Repo Rate
  60. 60. Reserve RatioIncrease reserve ratio will reduce money multiplierDecrease reserve ratio willincrease money multiplier
  61. 61. The Power of the Reserve Ratio to Multiply Money 100% 90% 80% 70%Reserve 60% Ratio 50% 40% 30% 20% 10% 0% 1 2 4 6 8 10 12 14 16 18 20 Money Multiplier
  62. 62. Reserve Ratio Not changed very oftenWhat is the current reserveratio in Saudi Arabia? 7%What is the Money Multiplier? 1÷7% = 14.28
  63. 63. Bank Deposit InsuranceProtects against bank runsMoral Hazard to take more risk because government will pick up losses

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