Eco 202 ch 30 the monetary system

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Eco 202 ch 30 the monetary system

  1. 1. Chapter 30 ! The Monetary System
  2. 2. Key Terms money medium of exchange unit of account store of value liquidity commodity money fiat money currency demand deposits central bank money supply monetary policy reserves fractional-reserve banking reserve ratio money multiplier bank capital leverage leverage ratio capital requirement open-market operations discount rate reserve requirements !
  3. 3. Two Choices Make or Trade
  4. 4. Barter Direct trade - stuff for stuff No money Double coincidence of wants
  5. 5. Both sides have to want what the other side has Double coincidence of wants
  6. 6. Both must want what the other has at the same time Double coincidence of wants
  7. 7. Money makes trade easier
  8. 8. What is money?
  9. 9. Money Something people use to trade with
  10. 10. Why would you accept a cigarette if you didn’t smoke?
  11. 11. Functions of Money Medium of exchange Unit of account Store of value
  12. 12. Medium of Exchange Buyers give to sellers Sellers accept from buyers
  13. 13. Unit of Account Measurement Prices Debts
  14. 14. Store ofValue Trading time for time Today for tomorrow Tomorrow for today Earn - Save - Spend
  15. 15. Liquidity How 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 carry Easy to measure Easy to verify Hard to copy
  19. 19. = Gold Standard Central Bank will convert paper money to gold at a fixed rate
  20. 20. Fiat Money No intrinsic value Declared money by government decree
  21. 21. Fiat Money Why do people accept fiat money? Trust that someone else will also accept it
  22. 22. Money Trust inscribed If people lose trust, money loses it value
  23. 23. Coins Currency Checks
  24. 24. Card Type Payment Credit Defer Debit Instant
  25. 25. Why credit and debit cards are not money Not a method of payment, but a method of making payment
  26. 26. Debit card is like a check Takes money out of your bank account
  27. 27. Credit Card Defer the payment
  28. 28. Demand Deposits Bank account that you can access by writing a check or using a debit card
  29. 29. Saudi Arabia Monetary Agency The Central Bank of Saudi Arabia SAMA sama.gov.sa
  30. 30. Central Bank The bank that oversees the banking system and regulates the money supply in a country
  31. 31. Dr. Fahad Al Mubarak ! Chairman of the Board Governor ! Saudi 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 Supply The quantity of money available in a country.
  35. 35. Monetary Policy Setting the money supply by the central bank policymakers
  36. 36. Two Types of Banks 100 Percent Reserve Fractional 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 a fraction of the deposits as reserves Loans out the remainder
  39. 39. Reserve Ratio The fraction of deposits that banks hold as reserves
  40. 40. Fractional-Reserve Banking Creates money
  41. 41. Bank Deposit Reserve 10% Loan Remainder 1000 100 900 900 90 810 810 81 729 • • • • • • • • • • • • Total 10,000 How does 1000 become 10,000?
  42. 42. Reserve Ratio Fraction Reciprocal Money Multiplier 100% 1 1÷1 1 50% 0.5 1 ÷ 0.50 2 25% 0.25 1 ÷ 0.25 4 10% 0.1 1 ÷ 0.10 10 5% 0.05 1 ÷ 0.05 20 1% 0.01 1 ÷ 0.01 100 Money multiplier is the reciprocal of the reserve ratio
  43. 43. Bank Capital The money the bank’s shareholders have put in to the bank
  44. 44. Leverage OPM Using other people’s money
  45. 45. Leverage 1. I have 10 2. I borrow 90 from you 3. I buy something for 100 4. I resell the item for 150 5. I pay back your 90 6. I keep the 60 7. I earned 50 profit on my 10
  46. 46. Leverage Ratio The ratio of assets to bank capital Assets Bank Capital
  47. 47. Bank Balance Sheet Assets Liabilities and Owner Equity Reserves 200 Deposits 800 Loans 700 Debt 150 Securities 100 Capital 50 Total 1000 Total 1000 Totals must balance or be equal
  48. 48. What is the leverage ratio? Assets Liabilities and Owner Equity Reserves 200 Deposits 950 Loans 800 Capital 50 Total 1000 Total 1000 Assets ÷ Capital 1000 ÷ 50 = 20
  49. 49. Leverage Ratio of 20 Owners put up 1 Depositors put up 19
  50. 50. Leverage is Risky! If leverage ratio is 20, 5% increase in asset value = 100% return to owners 5% decrease in asset value = 100% loss to owners
  51. 51. Capital Requirement Government rule on minimum amount of bank capital
  52. 52. Insolvent Liabilities are more than the assets You owe more than you own
  53. 53. Three Tools of Central Banks Open-Market Operations Discount Rate Reserve Ratio
  54. 54. Open-Market Operations Purchase and sale of government bonds Buy bonds increases supply Sell bonds decreases supply
  55. 55. Banks now have more cash to loan Central Bank Public Banks Increase Money Supply? Buy bonds for cash
  56. 56. Banks now have less cash to loan Central Bank Public Banks Decrease Money Supply? Sell bonds for cash
  57. 57. Discount Rate The rate the central bank charges to make loans to member banks Called the Official Repo Rate or 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. SAMA Official Repo Rate Dropped from 5.5% October 2008 to 2.0% by January 2009 3 month period of global financial crisis Rate increased as economy heated up
  60. 60. Reserve Ratio Increase reserve ratio will reduce money multiplier Decrease reserve ratio will increase money multiplier
  61. 61. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1 2 4 6 8 10 12 14 16 18 20 Reserve Ratio Money Multiplier The Power of the Reserve Ratio to Multiply Money
  62. 62. Reserve Ratio Not changed very often What is the current reserve ratio in Saudi Arabia? 7% What is the Money Multiplier? 1÷7% = 14.28
  63. 63. Bank Deposit Insurance Protects against bank runs Moral Hazard to take more risk because government will pick up losses
  64. 64. The Meaning of Money Three Functions of Money Medium of Exchange Unit of Account Store ofValue Two Kinds of Money Commodity Fiat Money in the Economy Currency Demand Deposits Central Banks SAMA Banks and the Money Supply 100-Percent Reserve Banking Fractional-Reserve Banking Reserve Ratio Money Multiplier Leverage Capital Requirement Tools of Monetary Control Open-Market Operations Discount Rate - ORR Reserve Ratio Bank Runs and Deposit Insurance

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