The document discusses key concepts related to the monetary system and central banking. It defines money's three functions as a medium of exchange, unit of account, and store of value. It explains liquidity and different types of money like commodity and fiat money. It also discusses the role of central banks like the Federal Reserve in issuing currency, controlling the money supply through tools like open market operations, setting interest rates, and regulating reserve ratios that impact the money multiplier.

1. Macroeconomics
Lecture 15
The Monetary System

2. Questions

3. 1. What are the three functions of money?
2. What is the difference between good money and bad money?
3. What is liquidity?
4. What is more liquid, a share of Apple stock, or a house?
5. What is the difference between commodity and fiat money?
6. What is an example of commodity money?
7. Who issues the U.S. Currency?
8. What is a gold standard?
9. Are any countries on a gold standard?
10. What is one word that describes money?
11. Are credit cards considered money?
12. What is a central bank.
13. Does every country have a central bank?
14. What is the central bank in the U.S.?
15. When was the FED established?
16. How many board members does the FED have?
17. How long do FED board members serve?
18. Who is the current FED chairman?
19. How many regional FED banks are there?
20. What is the FMOC?
medium of exchange, unit of account, store of value
fails in one of the functions
convert to cash
Apple stock
Commodity has other use, fiat is declared by government
gold
Federal Reseve Bank
Convert currency to gold
no
Trust
no
an institution that oversees the baking system and money supply
Yes
Federal Reseve Bank
1913
7
14 years
Janet Yellen
12
Sets monetary policy

5. Fed Functions
• Issues national currency
• Clearing of checks
• The bank of banks - lender of last resort
• Control the money supply

6. Federal Open Market Committee
FMOC
7 board governors
12 regional banks
5 of the regionals vote
always NY Fed

7. Money Supply
The quantity of money
available in a country.

8. Monetary Policy
Setting the money
supply by the central
bank policymakers

9. Two Types of Banks
100 Percent Reserve
Fractional Reserve

10. 100-Percent Reserve Bank
All the deposits are kept
in a safe vault.
No loans

12. Fractional-Reserve Bank
Bank only holds a
fraction of the deposits
as reserves
Loans out the remainder

13. Reserve Ratio
The fraction of deposits
that banks hold as
reserves

14. Fractional-Reserve Banking
Creates money

15. Bank Deposit
Reserve
10%
Loan
Remainder
1000 100 900
900 90 810
810 81 729
• • • •
• • • •
• • • •
Total 10,000
How does 1000 become 10,000?

16. 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

17. Bank Capital
The money the bank’s
shareholders have put in
to the bank

18. Leverage
OPM
Using other people’s
money

19. 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

20. Leverage Ratio
The ratio of assets to
bank capital
Assets
Bank Capital

21. 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

22. 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

23. 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

24. Capital Requirement
Government rule on
minimum amount of
bank capital

25. Three Tools
of Central Banks
Open-Market Operations
Discount Rate
Reserve Ratio

26. Open-Market Operations
Purchase and sale of
government bonds
Buy bonds increases supply
Sell bonds decreases supply

27. Banks
now have
more cash to
loan
Central Bank
Public Banks
Increase Money Supply?
Buy bonds for cash

28. Banks
now have less
cash to loan
Central Bank
Public Banks
Decrease Money Supply?
Sell bonds for cash

29. Two Rates
Discount Rate
Federal Funds Rate

30. Discount Rate
The rate the FED charges to
make loans to member banks
Today is 1.0%

31. Federal Funds Rate
The rate banks
charge each other
Today is 0.5%

32. Remember
Discount Rate:
What the FED charges banks
Federal Funds Rate:
What banks charge other
banks

34. Reserve Ratio
Increase reserve ratio will
reduce money multiplier
Decrease reserve ratio will
increase money multiplier

35. 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

36. Reserve Ratio
Not changed very often
What is the current reserve
ratio in the U.S.? 3% to 10%
What is the Money Multiplier?
1÷3% = 33.33 1÷10% = 10

37. Bank Deposit Insurance
Protects against bank runs
Moral Hazard to take more
risk because government
will pick up losses

39. Bank Run
Customers all want their
money at the same time
Many banks runs at once
Bank Panic