Professional Documents
Culture Documents
What is Money?
Unit of account
Store of value
What is Money?
Medium of Exchange
A medium of exchange is an object that is generally
accepted in exchange for goods and services.
In the absence of money, people would need to exchange
goods and services directly, which is called barter.
Barter requires a double coincidence of wants, which is
rare, so barter is costly.
Unit of Account:
A unit of account is an agreed measure for stating the
prices of goods and services.
By this method we can easily compare the price of one
commodity with the price of another commodity.
It is simpler to express prices.
What is Money?
Store of Value
As a store of value, money can be held for a time and later
exchanged for goods and services.
What is Money?
Official Measures of Money
The two main official measures of money in the United
States are M1 and M2.
M1 consists of currency and travelers checks and
checking deposits owned by individuals and businesses.
M2 consists of M1 plus time, saving deposits, money
market mutual funds, and other deposits.
What is Money?
Composition of money
in the USA:
Figure 25.1 illustrates
the composition of M1
and M2 in June 2005
and shows the relative
magnitudes of their
components.
What is Money?
Are M1 and M2 Really Money?
All the items in M1 are means of payment.
Some saving deposits in M2 are not means of payments
they are called liquid assets.
Liquidity is the property of being instantly convertible into
a means of payment with little loss of value.
Deposits are money, but checks are nota check is an
instruction to a bank to transfer money.
Credit cards are not money. A credit card enables the
holder to obtain a loan quickly, but the loan must be repaid
with money.
Depository Institutions
A depository institution is a firm that takes deposits from
households and firms and makes loans to other
households and firms.
Depository Institutions
Commercial Banks
A commercial bank is a private firm that is licensed by the
Comptroller of the Currency or by a state agency to
receive deposits and make loans.
Depository Institutions
Reserves and Loans
To achieve security for its depositors, a bank divides its
funds into two parts: reserves and loans.
A banks reserves are the (1) cash in its vault and (2) its
deposits at the Federal Reserve (central bank).
A bank keeps only a small percentage of deposits as
reserves and lends the rest.
TERMS:
Reserves on deposit deposit accounts at the
central bank, owned by banks.
Vault cash reserves held as cash in bank vaults
rather than being on deposit at the central bank.
Borrowed reserves bank reserves that were
obtained by borrowing from the central bank.
Non-borrowed reserves bank reserves that were
not obtained by borrowing from the central bank.
Required reserves the amount of reserves that
banks are required to hold, determined by the central
bank as a function of a bank's deposit liabilities.
TERMS CONT.
Excess reserves - bank reserves in excess of the
reserve requirement. A portion of excess reserves
(or even all of them) may be desired reserves.
Free reserves - the amount by which excess
reserves exceed borrowed reserves. (Vogel
2001:421)
Total reserves all bank reserves: vault cash plus
reserves on deposit at the central bank, also
borrowed plus non-borrowed, also required plus
excess.
Depository Institutions
A bank has three types of assets:
1. Liquid assetsU.S. government Treasury bills (T-Bills)
and commercial bills
Depository Institutions
Thrift Institutions
Saving and loan associations
Saving banks
Credit unions
A savings and loan association (S&L) is a depository institution that
accepts checking and savings deposits and that make personal,
commercial, and home-purchase loans.
A savings bank is a depository institution owned by its depositors that
accepts savings deposits and makes mainly mortgage loans.
A credit union is a depository institution owned by its depositors that
accepts savings deposits and makes consumer loans.
Depository Institutions
Money Market Mutual Fund
A money market fund is a fund operated by a financial
institution that sells shares in the fund and uses the
proceeds to buy liquid assets such as U.S. Treasury bills.
Depository Institutions
The Economic Functions of Banks
Depository institutions make a profit from the spread
between the interest rate they pay on their deposits and
the interest rate they charge on their loans.
This spread exists because depository institutions
Create liquidity
Depository Institutions
Financial Innovation
The aim of financial innovationthe development of new
financial products is to lower the cost of deposits or to
increase the return from lending.
Financial innovation occurred for three reasons:
The economic environment
Technological change
Avoid regulation
Monetary Policy
The Fed and the FOMC shall maintain long-term growth of
the monetary and credit aggregates commensurate with
the economys long-run potential to increase production,
so as to promote effectively the goals of maximum
employment, stable prices, and moderate long-term
interest rates.
Desired reserves
Desired currency holding
V = PY M
The equation of exchange states that
MV = PY
The equation of exchange becomes the quantity theory of
money if M does not influence V or Y.
So in the long run, the change in P is proportional the the
change in M.
Inflation rate +
Real GDP growth
Rearranging:
Inflation rate = Money growth rate + Rate of velocity change
Real GDP growth
THE END