Section 5 - Section 5 Money Banking and the Federal Reserve...

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Section 5 Money, Banking and the Federal Reserve System
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This chapter is all about introducing the interest rate to our model Key Point There are lots of different interest rates → Interest rate paid on savings account → Interest rate charged on borrowing → 30-year mortgage rate → Interest rate paid on 30-year US T-bill → Interest charged on credit card payments → Etc.
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Q: When do we encounter interest rates? A: In two general situations → When we save money → When we borrow money Q: Why is there interest paid when we save? → Banks want to encourage us to save so that they will have funds available to loan out (i.e. an inducement to save)
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Q: Why do we have to pay interest to borrow? Q: Why do we borrow money? A: To buy things that we could otherwise not afford → We borrow money to enable us to get things that we could not otherwise get → Many of these things are valuable enough to us (high enough MU) that we are willing to pay a little extra to get the extra funds needed to buy them
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Banks take advantage of the fact that many people are willing to pay a little extra to borrow money to get more stuff → Remember, banks are in business and aim to maximize profits → They make profit by charging interest to people who would like to borrow funds → To do so, they have to have funds on hand (i.e. charge interest) (i.e. they need to have people who save money with them)
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Key Point : In our economy there are two types of people (1) Those who spend less than they make (2) Those who spend more than they make → Financial markets bring these people together → The interest rate is the tool that is used to do so Savers Borrowers
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Key Point: We are going to boil all of these together and talk about one single value Important Note : There are two ways to think about the interest rate (1) Reward for savings (2) Cost of borrowing r - interest rate
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We will always talk about “the interest rate” However, to understand how changes in the interest rate affect the economy we will have to be careful to distinguish between the two different ways that “the interest rate” can affect economic transactors Namely, ”the interest rate” affects two things (1) The decision to save money (2) The decision to borrow money
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If we are interested in how “the interest rate” affects the decision to save money → We need to think of the interest rate as the reward for saving money If we are interested in how “the interest rate” affects the decision to borrow money → We need to think of the interest rate as the cost of borrowing money From experience, this often gets confusing, so be forewarned and try to get used to it!
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What is money? → By definition, anything is considered money that meets the following (1) Medium of Exchange (2) Store of Value (3) Unit of Account
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So, money can be many things → Salt in Roman times → Cigarettes in Prison → Wampum for Native Americans → Stones for South Pacific tribes → American Greenbacks Hence, we must be careful in the way we think about money It is not just the greenback bills with the pictures of the presidents
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Section 5 - Section 5 Money Banking and the Federal Reserve...

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