Post on 26-Dec-2015
Money and the Banking System
[Money] is a machine for doing quickly and
commodiously what would be done, though less quickly and commodiously, without it.
JOHN STUART MILL
● The Nature of Money● How the Quantity of Money is Measured● The Banking System● The Origins of the Money Supply● Banks and Money Creation● Why the Deposit Creation Formula Is
Oversimplified● The Need for Monetary Policy
● The Nature of Money● How the Quantity of Money is Measured● The Banking System● The Origins of the Money Supply● Banks and Money Creation● Why the Deposit Creation Formula Is
Oversimplified● The Need for Monetary Policy
ContentsContents
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● Barter versus Monetary Exchange♦ A barter system (with no money) would be
awkward and extremely inefficient.
♦ Money greases the wheels of exchange and, thus, makes the whole economy more productive.
● Barter versus Monetary Exchange♦ A barter system (with no money) would be
awkward and extremely inefficient.
♦ Money greases the wheels of exchange and, thus, makes the whole economy more productive.
The Nature of MoneyThe Nature of Money
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The Nature of MoneyThe Nature of Money
● The Conceptual Definition of Money♦ The functions of money:
■Medium of exchange■Unit of account■Store of value
♦ Money = whatever serves as the medium of exchange
● The Conceptual Definition of Money♦ The functions of money:
■Medium of exchange■Unit of account■Store of value
♦ Money = whatever serves as the medium of exchange
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What is Money?What is Money?
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● Commodity Money♦ Has intrinsic value based on the material from
which is made.
● Representative Money♦ Is backed by something tangible.
● Fiat Money♦ Is declared by the government and accepted by
citizens to have worth.
● Commodity Money♦ Has intrinsic value based on the material from
which is made.
● Representative Money♦ Is backed by something tangible.
● Fiat Money♦ Is declared by the government and accepted by
citizens to have worth.
Types of MoneyTypes of Money
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● What Serves as Money?♦ Societies have gradually moved from the use
of commodity monies to the use of money that has no commodity backing at all.
● What Serves as Money?♦ Societies have gradually moved from the use
of commodity monies to the use of money that has no commodity backing at all.
The Nature of MoneyThe Nature of Money
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Properties of MoneyProperties of Money
● Physical Properties♦ Durability
♦ Portability
♦ Divisibility
♦ Uniformity
● Physical Properties♦ Durability
♦ Portability
♦ Divisibility
♦ Uniformity
● Economic Properties♦ Stability of value
♦ Scarcity
♦ Acceptability
● Economic Properties♦ Stability of value
♦ Scarcity
♦ Acceptability
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● There is no single, obvious place to draw the line between “money” and “near money.”
● M1 = coins and paper money in circulation, plus checkable deposits
● M2 = M1 + money market deposit accounts, money market mutual funds, and savings accounts
● There is no single, obvious place to draw the line between “money” and “near money.”
● M1 = coins and paper money in circulation, plus checkable deposits
● M2 = M1 + money market deposit accounts, money market mutual funds, and savings accounts
How the Quantity of Money is MeasuredHow the Quantity of Money is Measured
FIGURE 28-2 Two Definitions of the Money Supply, February 2002
FIGURE 28-2 Two Definitions of the Money Supply, February 2002
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
M2 = $5500 billion
M1 = $1183 billion
Money market mutual funds $972 billion
Savings deposits
$3345 billion
M1 $1183 billion
Checking deposits in commercial banks $324 billion
Other checkable deposits $268 billion
Currency outside banks $591 billion
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● How Banking Began♦ Fractional reserve banking began when
goldsmiths realized they could profitably lend out a portion of the gold that had been deposited with them for safekeeping.
● How Banking Began♦ Fractional reserve banking began when
goldsmiths realized they could profitably lend out a portion of the gold that had been deposited with them for safekeeping.
The Banking SystemThe Banking System
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The Banking SystemThe Banking System
● How Banking Began♦ Three important features of the fractional
reserve banking system: ■Bank profitability■Banks discretion over the money supply■Exposure to bank runs
● How Banking Began♦ Three important features of the fractional
reserve banking system: ■Bank profitability■Banks discretion over the money supply■Exposure to bank runs
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Federal Reserve SystemFederal Reserve System
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The Banking SystemThe Banking System
● Principles of Bank Management: Profits versus Safety♦ To make a profit, a banker must take risks.
♦ But because the business is risky, the same banker must also emphasize safety.
♦ The heart of banking is to be torn between the two principles.
● Principles of Bank Management: Profits versus Safety♦ To make a profit, a banker must take risks.
♦ But because the business is risky, the same banker must also emphasize safety.
♦ The heart of banking is to be torn between the two principles.
FIGURE 28-1 Bank Failures in the United States, 1915-2000
FIGURE 28-1 Bank Failures in the United States, 1915-2000
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
'00 '95
'00 '95
Nu
mb
er o
f B
ank
Fai
lure
s
1985 1975 1965 1955 1945 1935
40
80
120
160
200
0
Great Depression begins
FDIC established
Nu
mb
er o
f B
ank
Fai
lure
s
Year
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0 1990 1985 1980 1975 1970 1965 1960 1955 1950 1945 1940 1935 1930 1925 1920 1915
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Banking SystemThe Banking System
● Bank Regulation♦ Deposit Insurance
■The Federal Deposit Insurance Corporation insures people’s deposits at banks.
♦ Bank Supervision ■Ensures banks take only sensible, defensible risks ■Controls the money supply
♦ Reserve Requirements ■Helps control the money supply
● Bank Regulation♦ Deposit Insurance
■The Federal Deposit Insurance Corporation insures people’s deposits at banks.
♦ Bank Supervision ■Ensures banks take only sensible, defensible risks ■Controls the money supply
♦ Reserve Requirements ■Helps control the money supply
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● How Bankers Keep Books♦ Banks keep balance sheets
■Assets = liabilities + net worth
♦ Assets include: ■Reserves■Loans
♦ Liabilities include: ■Deposits owed to customers.
● How Bankers Keep Books♦ Banks keep balance sheets
■Assets = liabilities + net worth
♦ Assets include: ■Reserves■Loans
♦ Liabilities include: ■Deposits owed to customers.
The Origins of the Money SupplyThe Origins of the Money Supply
TABLE 28-1 Balance Sheet of Bank-a-mythica, Dec. 31, 2001
TABLE 28-1 Balance Sheet of Bank-a-mythica, Dec. 31, 2001
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Banks and Money CreationBanks and Money Creation
● The Limits to Money Creation by a Single Bank♦ Banks can lend money in their vault that is
above the minimum required reserve ratio.
♦ In doing so, they create new money.
● The Limits to Money Creation by a Single Bank♦ Banks can lend money in their vault that is
above the minimum required reserve ratio.
♦ In doing so, they create new money.
TABLE 28-2 Bank-a-mythica’s Balance Sheet, Jan. 2, 2002
TABLE 28-2 Bank-a-mythica’s Balance Sheet, Jan. 2, 2002
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TABLE 28-3 Bank-a-mythica’s Balance Sheet, Jan. 3-6, 2002
TABLE 28-3 Bank-a-mythica’s Balance Sheet, Jan. 3-6, 2002
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TABLE 28-4 Bank-a-mythica’s Balance Sheet, Jan. 2-6, 2002
TABLE 28-4 Bank-a-mythica’s Balance Sheet, Jan. 2-6, 2002
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Banks and Money CreationBanks and Money Creation
● Multiple Money Creation by a Series of Banks♦ When all banks make loans with funds they
have that are above the required reserve ratio, the society’s money supply expands.
● Multiple Money Creation by a Series of Banks♦ When all banks make loans with funds they
have that are above the required reserve ratio, the society’s money supply expands.
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Banks and Money CreationBanks and Money Creation
● Multiple Money Creation by a Series of Banks deposits = (1/m) x reserves
■Assumes banks keep the minimum reserve ratio, m■Assumes all new money held in the form of
deposits■Oversimplified deposit multiplier formula
● Multiple Money Creation by a Series of Banks deposits = (1/m) x reserves
■Assumes banks keep the minimum reserve ratio, m■Assumes all new money held in the form of
deposits■Oversimplified deposit multiplier formula
TABLE 28-5 Changes in First National Bank’s Balance Sheet
TABLE 28-5 Changes in First National Bank’s Balance Sheet
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TABLE 28-6 Changes in Second National Bank’s Balance Sheet
TABLE 28-6 Changes in Second National Bank’s Balance Sheet
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 28-3 The Chain of Multiple Deposit Creation
FIGURE 28-3 The Chain of Multiple Deposit Creation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
•
•
•
$400,000
$268,928
$236,160
$195,200
$144,000
(3)
$80,000
Loans
•
•
•
$100,000
•
•
•
$500,000
$336,160
$295,200
$244,000
$180,000
Running Sums
(2)
$100,000
Deposits
$67,232
$59,040
$48,800
$36,000
(1)
$20,000
Reserves
And so on . . .
$40,960 deposit
$32,768 lent out $8,192 on reserve
$51,200 deposit
$40,960 lent out $10,240 on reserve
$64,000 deposit
$51,200 lent out $12,800 on reserve
$80,000 deposit
$64,000 lent out $16,000 on reserve
$100,000 deposit
$80,000 lent out $20,000 on reserve
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Banks and Money CreationBanks and Money Creation
● The Process in Reverse: Multiple Contractions of the Money Supply♦ Deposits, and with them the money supply,
contract when reserves are reduced.■Banks reduce their loan commitments.■Calculation of the contraction in the money supply
utilizes the same formula as for money expansion.
● The Process in Reverse: Multiple Contractions of the Money Supply♦ Deposits, and with them the money supply,
contract when reserves are reduced.■Banks reduce their loan commitments.■Calculation of the contraction in the money supply
utilizes the same formula as for money expansion.
TABLE 28-7 Changes in Balance Sheet of Bank-a-mythica
TABLE 28-7 Changes in Balance Sheet of Bank-a-mythica
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TABLE 28-8 Changes, Balance Sheet of First National Bank
TABLE 28-8 Changes, Balance Sheet of First National Bank
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● Individuals hold some portion of additions to their money in the form of cash.
● Banks sometimes hold reserves above the required minimum.
● Individuals hold some portion of additions to their money in the form of cash.
● Banks sometimes hold reserves above the required minimum.
Why the Deposit Creation Formula Is OversimplifiedWhy the Deposit Creation Formula Is Oversimplified
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Need for Monetary PolicyThe Need for Monetary Policy
● Left uncontrolled, banks would: ♦ Reduce the money supply in a recession♦ Increase the money supply during boom
periods
● Changes in the money supply would exacerbate the business cycle.
● One reason for monetary policy, therefore, is to prevent this behavior on the part of banks.
● Left uncontrolled, banks would: ♦ Reduce the money supply in a recession♦ Increase the money supply during boom
periods
● Changes in the money supply would exacerbate the business cycle.
● One reason for monetary policy, therefore, is to prevent this behavior on the part of banks.