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Banking & Finance Chapter 3

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  1. 1. 3 MONEY AND INTEREST 3.1 The Money Supply 3.2 Money Creation and Circulation 3.3 Interest and Interest RatesSlide 1 © South-Western Publishing
  2. 2. Lesson 3.1 THE MONEY SUPPLY GOALS Define money supply, and explain how it is measured Describe two types of money, and explain the fractional-reserve systemSlide 2 © South-Western Publishing
  3. 3. WHAT IS THE MONEY SUPPLY? The money supply is defined as the liquid assets held by banks and individuals. The flow of money—and the amount of it flowing—has a direct effect on how the economy performs.Slide 3 © South-Western Publishing
  4. 4. MEASURING THE MONEY Liquidity is a measure of how quickly things may be converted to something of value like cash. Liquidity is variable, depending on the nature of the asset or liability.More Liquid Less Liquid A certificate of depositChange in your pocket Your savings account that matures next JuneSlide 4 © South-Western Publishing
  5. 5. AGGREGATE MEASURES OF THE MONEY SUPPLY M1 Money that can be spent immediately M2 All the money in M1 plus short-term investments M3 All the money in M1 and M2 plus large deposits MZM Money at zero maturitySlide 5 © South-Western Publishing
  6. 6. NATURE OF MONEY Two types of money Commodity money is based on some item of value, for example, gold or precious stones. Fiat money is money that is deemed legal tender by the government, and it is not based on or convertible into a commodity. The fractional-reserve systemSlide 6 © South-Western Publishing
  7. 7. Lesson 3.2 MONEY CREATION AND CIRCULATION GOALS Describe how money is created by bank activities Explain how money circulates in the United StatesSlide 7 © South-Western Publishing
  8. 8. HOW MONEY IS CREATED Printing currency and creating money are two different things. Money is actually created by the interaction of the demand for it, banks’ use of it, and the Federal Reserve’s supply and control of it.Slide 8 © South-Western Publishing
  9. 9. DEPOSITS AND RESERVES Primary reserves Secondary reservesSlide 9 © South-Western Publishing
  10. 10. THE MULTIPLIER EFFECT Money on deposit, minus the reserve requirement, can be loaned to customers. When it is, it creates new deposits, which also go out to customers as loans and create more deposits, thus expanding the amount of money in the system.Slide 10 © South-Western Publishing
  11. 11. HOW MONEY CIRCULATES Transfers and circulation The Fed and fiat money Money as an IOUSlide 11 © South-Western Publishing
  12. 12. Lesson 3.3 INTEREST AND INTEREST RATES GOALS List factors that affect interest rates Explain which factors the Federal Reserve affectsSlide 12 © South-Western Publishing
  13. 13. INTEREST RATES AND BUSINESS The money supply and the economy are linked closely to interest rates. Generally, when rates are high, money is said to be “tight” and business tends to slow because it costs more to acquire capital. When rates drop, more credit is accessible, and the economy tends to gather speed.Slide 13 © South-Western Publishing
  14. 14. FACTORS AFFECTING INTEREST RATES The federal funds rate is the amount of interest charged for short-term, interbank loans. The discount rate is the interest rate that the Federal Reserve sets and charges for loans to member banks. The prime rate is the rate that banks charge their best and most reliable customers.Slide 14 © South-Western Publishing
  15. 15. MONETARY POLICY AND INTEREST RATES The Federal Reserve sets the discount rate. The Federal Reserve only influences the federal funds rate.Slide 15 © South-Western Publishing