2. MONEY
• Task!
–What is money?
–What is the function of money?
–What has served as money
throughout history?
3. Money
• Money has Three Basic
Functions:
– 1. Medium of Exchange- enables
us to carry out trade and
commerce easily
– 2. Standard of Value- allows us to
measure and compare value using
one scale
– 3. Store of Value- it (usually) holds
its value over time
4. Money
• Money also has Six Main
Characteristics:
– 1. Acceptability- in order for you to buy something,
the seller must be willing to accept what you offer as
payment
– 2. Scarcity- needs to be scarce enough to be
valued by buyers and sellers
5. – 4. Durability- if money is
to serve as a store of
value, it must be durable
• 3. Portability- in order to
be convenient as a medium
of exchange it must be
portable
6. – 5. Divisibility- to be useful
as a medium of exchange,
money must be easily
divided into smaller
amounts
– 6. Uniformity- a dollar is a
dollar is a dollar. We take
for granted that each dollar
is the same as the next.
7. What Serves as Money?
– Throughout history, many items such as: salt,
shells, cattle, beads, fur, tobacco, gold, and silver
have served as money
– These are examples of commodity money– form of money that
has some intrinsic value or alternate use
• Gold and silver have generally been preferred because they hold many of
the characteristics of money
8. What about today?
• However, our money is no longer backed by precious
metals such as gold and silver
• Fiat money- paper money decreed as legal tender, but
not representing anything of intrinsic worth
– Rather, money is accepted solely
because we believe that it is worth
something, and is backed by the
“full faith and credit” of the United States
government
Trust me!
9. What is Currency and Money Supply?
• Currency- the bills and coins
currently in circulation in the
economy
• However, currency is only a
part of the total money
supply in the country
• Money Supply – total
amount of currency,
loans/credit, and other liquid
instruments available in the
economy at a given time
10. M1& M2 Money Supply
• M1 Money Supply is made
up of:
– Coins and bills (currency)
– Checkable deposits (liquid
assets)
– Travelers Checks
• M2 Money Supply is made
up of:
– All of M1
– Less liquid assets such as
savings deposits, money
market accounts, etc.
Discussion: Do we want a
larger or smaller total
money supply?
11. • So how is that money (M1 and M2)
transferred between people and managed?
– By banks!
12. The Regional Banks of the Federal
Reserve
• http://www.youtube.com/watch?v=8Hq5zw4Y
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• http://www.youtube.com/watch?v=M5drSk6E
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13. The Banking System in a Nutshell:
• Fractional Reserve Banking- a system
whereby banks keep a fraction of deposits in
reserves but loan out the rest to businesses
and consumers
• System allows our MONEY SUPPLY TO
EXPAND!
14. Federal Reserve Reading
• Pg. 282-285 – Read 14.4 “What Tools Does
Monetary Policy Use to Stabilize the
Economy”
• Complete Sections A-D of “The Federal
Reserve” Notes
15. Follow-Up Questions – Reread Pgs.
282-284
• What is the Federal Reserve System?
• What is monetary policy?
• Why does the Fed use…
– An easy-money policy?
– A tight-money policy?
16. Catch Me If You Can
• http://www.youtube.com/watch?v=DCOm4os
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• http://www.youtube.com/watch?v=dK2LZarp
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17. Monetary Policy- what is it?
• Monetary Policy-
central bank policy
aimed at regulating
interest rates and the
amount of money in
circulation to influence
the health and
direction of the
economy
18. The Federal Reserve (Fed)
• The Federal Reserve is America’s central bank,
established in 1913
• Congress gave the Fed enough power to act
independently in regards to monetary policy
19. Structure of the Fed
• 1. Board of Governors
– 7 member board that oversees the Fed from
Washington D.C.
– Appointed by the president and confirmed by the
Senate for one 14 year term in office
– President selects one governor to serve as
chairman for 4 years
– Responsible for the overall direction of monetary
policy
20. Structure of the Fed
• 2. Regional Federal
Reserve Banks
– 12 regional banks
– Carry out many of
the day-to-day
duties
– Each regional bank
overseen by a
president
21. Structure of the Fed
• 3. Federal Open Market
Committee (FOMC)
– Consists of:
• All 7 governors from the Board
of Governors
• 5 rotating regional fed
presidents
– **But always New York’s
president
– FOMC is the policymaking body
of the Fed
– Study economic information
and decide what changes (if
any) to make to monetary
policy
22. Policies followed by Fed
• Easy Money Policy (Expansionary)
– Fed expands the money supply trying to cause cheaper lending
to stimulate economic growth
– Interest rates lower but too much easy money policy leads to
INFLATION
• Tight Money Policy (Contractionary)
– Fed shrinks the money supply trying to cause lending to be
more expensive to slow the economy
– Interest rates rise but too much tight money policy leads to a
RECESSION
23. Federal Reserve Reading
• Pg. 286-288 – Read the rest of14.4 “What
Tools Does Monetary Policy Use to Stabilize
the Economy”
• Complete Section E & F of “The Federal
Reserve” Notes
24. Follow-Up Questions
• What are open-market operations?
• What is the reserve requirement?
• What is the discount rate?
• What is the purpose of these tools?
25. 3 Main Tools of the Fed
• 1. Open Market Operations-
the buying and selling of
government securities in the
bond market (most used tool)
– Easy-Money Policy:
• Fed bond traders BUY
government securities, which
increases the money supply
– Tight-Money Policy:
• Fed bond traders SELL
government securities, which
decreases the money supply
26. • 2. Reserve requirement- the
minimum percentage of
deposits that banks must
keep in reserve at all times
(least used tool)
– Easy-Money Policy:
• Fed LOWERS REQUIREMENT,
which increases the money
supply
– Tight-Money Policy:
• Fed INCREASES
REQUIREMENT, which
decreases the money supply
27. • 3. The Discount Rate- the interest rate
the Fed charges on loans to private banks
(last tool in their toolbox)
– This tool leads to the Fed being known as the
“lender of last resort”
– Controlled by the Board of Governors
– Easy-Money Policy:
• Fed LOWERS rate, which increases the money supply
– Tight-Money Policy:
• Fed RAISES rate, which decreases the money supply
28. The Fourth “Tool”
• 4. Federal Funds Rate- the interest rate that banks
charge one another for quick (overnight) loans
• Banks set this rate, so this is NOT a monetary policy
tool
• HOWEVER, the Fed sets a target rate based on its view
of the economy & uses OMO to nudge the rate
towards the target!
– The Federal Funds Rate affects the interest rate on
everything: credit cards, mortgages, savings accounts,
bonds, etc.
31. UNIT #5 Fed REVIEW:
• Define monetary policy in your own words.
• If the Fed wanted to increase the money supply using the discount rate, what
would they do? Would the Fed be attempting to stimulate or slow down the
economy?
• If the Fed wanted to decrease the money supply using reserve requirement,
what would they do? What would happen to interest rates?
• If the Fed wanted to increase the money supply using open market
operations, what would they do? Would this be considered easy or tight
money policy?
• What is the relationship between interest rates and the amount of credit
demanded?
32. How much do banks need to keep on
reserves?
Pat’s $1000
Deposited
Pat’s $1000 -
$200 in reserve
LOAN
Kim’s $800 for
School books
Pat’s $1000 –
$200 in reserve
PSU deposits
$800 –
$160 in reserve
LOAN
Dave’s $640 for
New TV
**In a sense, as banks continuously lend
money that is not in reserves, they are
“creating money” in the money supply. This
lending is increasing the flow of money that
ordinarily wouldn’t be able to happen!**
Editor's Notes
THE BANKS OF BANKS!
Why so many banks – no one bank could be all-powerful, regional structure more responsive to local needs
1913: Congress decides that there is a need to create The Fed
Lacking the money to create The Fed, Congress asks banks in each district to contribute money to est. the institution (so member banks –banks belonging to the Fed – own it), they get stock in Fed back (Fed pays dividends to member banks)
As a result, the private banks own the Fed and elect a board of directors to run in
CONGRESS DOES NOT APPROPRIATE FUNDS (Fed is SELF-SUFFICIENT)
FOMC – 8 meetings a year where they release their feelings/projections about economy & set the target fed funds rate (rate banks charge each other for overnight loans of reserve balances to each other)
Prime Rate – set by banks, lowest interest rate charged to best customers
Board of Governors – Elects a chairman for 4 years (this person reports to Congress twice a year)
The Fed is an independent monetary authority, but it comes under political pressure to raise or lower interest rates.
The president and Congress can affect the Board of Governors by appointing new members when governors’ terms expire.
GOAL IS TO INCREASE MONEY SUPPLY FAST ENOUGH TO KEEP UP WITH GROWTH BUT NO FASTER!
Easy money – consumers spend too much, increase in demand causes demand-pull inflation
Tight money – deflation results with low levels of investment & spending
THREE TOOLS ARE USED TO INFLUENCE THE TARGET FEDERAL FUNDS RATE!
RR – change requirement for savings & checking accounts, powerful tool but very rarely used to influence monetary policy (CHANGED BY GOVERNORS)
DR (rate charged by individual banks for loans obtained from the Fed Central Banks (set by Fed at anytime)– why getting loan from Fed.
1. Reserves could have dropped which shrinks excess reserves = less loans
2. Banks could face seasonal demand for loans (bank in agricultural area might have high loan demand during planting)
3. many withdrawals
Banks shy away from borrowing from Fed because usually means they are in trouble, instead they borrow from fellow banks
DR has been as high as 7.0% to low of 0.75% from 1990-2008
If lower rate then “opens window” for lending (LOOSE MONETARY POLICY)
If high then “closes” window for lending (TIGHT MONETARY POLICY)
OMO
Want to increase money supply
Fed buys gov’t securities from dealer who specializes in large volume transactions
Fed writes a check to pay for it
Dealer deposits check in his/her bank
Bank forwards check to Fed & Fed “pays” check by increasing the bank’s reserves
RESULT – Any time the Fed writes a check, reserves are pumped into banks (therefore more loans can be given)
Shrink money supply
Instructs Fed bond traders to Sell billions of $ of securities to dealers
Dealers pay for securities with checks withdrawing from bank
Fed processes checks by reducing reserves from bank
Fewer reserves = less money to loan = less money supply
Required to get quick loans if they don’t have enough reserves
Why this rate? = easiest rate to change using OMO, affects interest rates for mortgages/credit cards/savings accounts/bonds
The FOMC Policy Decision
"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability."
Again, the FOMC opted for no change in the target federal funds rate, essentially repeating the March policy statement. 'The fed funds rate can't be used effectively to help the member banks, who borrow reserves at the fed funds rate from other member banks. With the target so low, monetary policy, especially open market operations, is not an effective stimulatory tool.
The demand for money consists of consumers borrowing for such items as cars and homes, firms borrowing for such items as factories and equipment, and the government borrowing to finance the national debt. The supply of money is set by the Federal Reserve Board of Governors, the central banking system for the United States. The supply and demand for money determine the interest rate that must be paid for the use of borrowed money. So if the Federal Reserve increases the money supply, interest rates will fall, making it less expensive to borrow money. In that case, those wishing to borrow money will be more likely to do so-- and be more likely to spend that money on products. If the Federal Reserve reduces the money supply, interest rates will rise, so less will be borrowed and spent (because of the higher cost of borrowing).
With every deposit, there is an increase in the lending power of the bank
Thus, the monetary value of one deposit will have lending power well beyond its value
