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Learning Objectives
1.Define money and discuss its three basicfunctions.
2.Distinguish between commodity money and fiatmoney, giving examples of each.
3.Define what is meant by the money supply andtell what is included in the Federal ReserveSystem’s two definitions of it (M1 and M2).
•Money is anything that serves as amedium of exchange.
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•A medium of exchange is anything thatis widely accepted as a means of payment.
•To Barter an individual exchanges goodsdirectly for other goods.
•A unit of account is a consistent means ofmeasuring the value of things.
•A store of value is an item that holdsvalue over time.
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•Commodity money is money that has value apartfrom its use as money.
–E.g. Mackerel in federal prisons, gold, and silver
•Fiat money is money that some authority, generallya government, has ordered to be accepted as amedium of exchange.
–E.g. paper money and coins in the U.S. “this noteis legal tender for all debts public and private”
•Currency is paper money and coins.
•Checkable deposits are balances in checkingaccounts.
•A check is a written order to a bank to transferownership of a checkable deposit.
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•Money supply refers to the total quantityof money in the economy at any one time.
•Liquidity is the ease with which an assetcan be converted into currency.
•M1 is the narrowest of the Fed’s moneysupply definitions that includes currency incirculation, checkable deposits, andtraveler’s checks.
•M2 is a broader measure of the moneysupply than M1 that includes M1 and otherdeposits.
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Learning Objectives
1.Explain what banks are, what their balancesheets look like, and what is meant by afractional reserve banking system.
2.Describe the process of money creation(destruction), using the concept of the depositmultiplier.
3.Describe how and why banks are regulated andinsured.
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•A financial intermediary is an institutionthat amasses funds from one group andmakes them available to another.
•A bank is a financial intermediary thataccepts deposits, makes loans, and offerschecking accounts.
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•A balance sheet is a financial statementshowing assets, liabilities, and net worth.
•Assets are anything of value.
•Liabilities are obligations to other parties.
•Net worth refers to assets less liabilities.
•Reserves are bank assets held as cash invaults and in deposits with the FederalReserve.
•A fractional reserve banking system is asystem in which banks hold reserves whosevalue is less than the sum of claimsoutstanding on those reserves.
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Assets
Liabilities and Net Worth
Reserves
$300.0
Checkable deposits
$604.5
Other assets
1,357.8
Other deposits
6,306.7
Loans
6,903.4
Borrowings
2,322.1
Securities
2,466.9
Other liabilities
6,576.6
Total assets
$11,928.1
Total Liabilities
9,890.9
Net worth
1,137.2
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•Required reserves are the quantity ofreserves banks are required to hold.
•The required reserve ratio is the ratio ofreserves to checkable deposits a bank mustmaintain.
•Excess reserves are reserves in excess ofthe required level.
•A bank is said to be loaned up when itsexcess reserves equal zero.
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ACME Bank
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Liabilities
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$1,000
Deposits
$10,000
Loans
$9,000
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•A deposit multiplier is the ratio of themaximum possible change in checkabledeposits (ΔD) to the change in reserves (ΔR).
EQUATION 2.1
EQUATION 2.2
EQUATION 2.3
EQUATION 2.4
EQUATION 2.5
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•Deposit insurance
–In the U.S. if a commercial bank fails, theFDIC guarantees to reimburse depositorsup to at least $100,000 per account.
•Regulation to Prevent Bank Failure
–The FDIC audits banks to ensure they areoperating safely (i.e. not makinginvestments deemed too risky andmaintaining a minimum level of net worthas a fraction of total assets)
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Learning Objectives
1.Explain the primary functions of central banks.
2.Describe how the Federal Reserve System isstructured and governed.
3.Identify and explain the tools of monetary policy.
4.Describe how the Fed creates and destroys moneywhen it buys and sells federal government bonds.
•A central bank is a bank that acts as a banker tothe central government, acts as a banker to banks,acts as a regulator of banks, conducts monetarypolicy, and supports the stability of the financialsystem.
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•Reserve requirements
•The discount window and other creditfacilities
–The discount rate is the interest ratechanged by the Fed when it lends reserves tobanks.
–The federal funds market is a market inwhich banks lend reserves to one another.
–A federal funds rate is the interest ratecharged when one bank lends reserves toanother.
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•Open market operations
–A bond is a promise by the issuer of the bond to paythe owner of the bond a payment or a series ofpayments on a specific date or dates.
–Open market operations are the buying and sellingof federal government bonds by the Fed.
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The Fed
The Fed
Banks
Banks
The Public
The Public
Reserves
Deposits
Loans
