Handout_7a_9-9-2011

Handout_7a_9-9-2011 - BASIC MONEY AND BANKING AND MONETARY...

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1 1 BASIC MONEY AND BANKING AND MONETARY POLICY Economy without Money i) Barter ii) Double coincidence of wants iii) N(N-1)/2 Relative Prices Functions of Money i) Medium of Exchange ii) Unit of Account iii) Store of Value 2 Types of Money i) Fiat Money: money that has no intrinsic value. Money by government decree ii) Commodity Money: Money that has intrinsic value. a. For example, gold. When people use paper money that is redeemable for gold, the economy is said to be on a gold standard. iii) Bank money: checks 3 Measures of Money: i) High-Powered Money (source base) = Total Reserves + Currency ii) Monetary Base = Total Reserves + Currency + Reserve Adjustment Magnitude iii) M1 = Currency outside the Treasury, Federal Reserve banks and vault cash + demand deposits + traveler checks + other checkable deposits (e.g. NOW and ATS accounts, and Credit share drafts). iv) M2: M1 + retail MMMF + saving deposits (including MMDA) + small denomination time deposits + overnight Repos + overnight Eurodollars 4 Fractional Reserve Banking Bank Balance Sheet Asset Liabilities Reserves Deposits Loans Borrowings Physical AssetsNet Worth Implication of Fractional Reserve Requirements Process of Loan Creation and Money Creation
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2 5 MONEY SUPPLY PROCESS Four Players: Federal Reserve, Banks, Depositors and Borrowers. Money supply is endogenous, not exogenous as we have assumed. Federal Reserve 1. Federal Reserve Act of 1913 2. 12 Regional Banks 3. Board of Governors--7 member, 14 year terms 4. FOMC - 12 members, meet about 8 times per year, issues directives (explains how open market operations should be conducted over the next month) to the "Open Market Desk" at the New York Fed CENTRAL BANK INDEPENDENCE 6 MONEY SUPPLY AND MONEY STOCK DETERMINATION Equilibrium in the money market M s = M d Simple Model a. No Currency b. Base = Total Reserves rr = required reserve ratio a. 3% for banks with deposits < 50 million b. 10% for all other banks M s = Δ Reserves*(1/rr) (1/rr) is the simple money multiplier 7 High-Powered Money (H) = Total Reserves (TR) + Currency (C) = Source Base Monetary Base (B) = Total Reserves + Currency + Reserve adjustment Magnitude (RAM). C = Currency held by the nonbank public. Does not include bank vault cash. TR = Reserves of financial institutions held at the Fed and vault cash. M = M1 = C + DD + OCD 8 DD = demand deposits and traveler checks OCD = other checkable deposits (e.g. NOWs, ATS) M2 = M1+ Saving Deposits + Small TD + MMMF (retail) + MMDA + Overnight REPOs + Overnight Eurodollars. Fractional Reserve Banking and Money Creation
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3 9 Balance Sheet Assets Liabilities Reserves (TR) Deposits (DD) Loans (L) Borrowings Reserves (BR) Securities (B) Physical Assets Net Worth L = includes regular loans B = holdings of government securities. Assume that the bank earns a rate of interest i
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Handout_7a_9-9-2011 - BASIC MONEY AND BANKING AND MONETARY...

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