A. MoneyA. Money The flow of income and moneyThe flow of income and money Money influences economic activityMoney influences economic activity Credit availability influences moneyCredit availability influences money Interest rates affect the price of moneyInterest rates affect the price of money

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B. FUNCTION OF MONEYB. FUNCTION OF MONEY

MEDIUM OF MEDIUM OF EXCHANGEEXCHANGE

MEASURE OF VALUE

STORE OF VALUE

STANDARD OF DEFERRED PAYMENTPage 20

C. What is MONEY (C. What is MONEY (M-1M-1)?)?

Anything ACCEPTABLE can operate as money. Anything ACCEPTABLE can operate as money.

The key is Acceptability.The key is Acceptability.

GOLD

COINS

CURRENCY

CHECKS

NOT backed by

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U S Currency of Money Supply U S Currency of Money Supply M-1M-1 22% = Coins and paper currency22% = Coins and paper currency

78% = Checks – Demand deposits78% = Checks – Demand deposits Tied to Tied to checking accountchecking account

Federal Reserve Note = I.O.U. of the Federal Reserve Bank.

Jan 1, 1975: U.S. citizens can legally buy/sell gold.U.S. no longer agrees to convert dollars held by foreigners into gold.

GOLD

Too much money = inflation

Too little money = recession

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B.B. HOW DO BANKS CREATE MONEYHOW DO BANKS CREATE MONEY

– Deposits 20% Hold for reserve LoansDeposits 20% Hold for reserve Loans

– BANK 1 $1,000 $200 $800BANK 1 $1,000 $200 $800– BANK 2 $800 $160 $640BANK 2 $800 $160 $640– BANK 3 $640 $128 $512BANK 3 $640 $128 $512– BANK 4 $512 $102.40 $409.60BANK 4 $512 $102.40 $409.60– TOGETHER TOGETHER $2,048 $2,048 $409.60$409.60 $1,638.40$1,638.40– TOTAL TOTAL $5,000$5,000 $1,000 $4,000 $1,000 $4,000

A DEPOSIT of $1,000 Creates $5,000

Other Definitions of MoneyOther Definitions of Money

M-1M-1– Currency + Checking accounts Currency + Checking accounts

M-2M-2– M-1 + Savings accounts + Small C.D.’s + M-1 + Savings accounts + Small C.D.’s +

Money Market accountsMoney Market accounts

M-3M-3– M-2 + large C.D.’sM-2 + large C.D.’s

FEDERAL RESERVE FEDERAL RESERVE SYSTEMSYSTEM

7 Governors7 Governors Board of Governors Board of Governors 14 yr. Appointment14 yr. Appointment

• 12 Regional Banks Regional Reserve Banks

Banks and Thrift Institutions

American Public

Federal Reserve System Federal Reserve System ToolsTools

Changes in money supply

Federal Reserve ToolsFederal Reserve Tools Change in the Change in the Discount RateDiscount Rate

– Local banks borrow from the Federal ReserveLocal banks borrow from the Federal Reserve– Discount Rate: Low interest rate is chargedDiscount Rate: Low interest rate is charged– Low rediscount rate: Increases money supplyLow rediscount rate: Increases money supply– High discount rate: Tightens the money supplyHigh discount rate: Tightens the money supply

Open marketOpen market OperationsOperations– Fed buys government securities (Fed buys government securities (bills,bills, notes notes and and bondsbonds) from ) from

the publicthe public– Increases the money supply by expanded depositsIncreases the money supply by expanded deposits– Increase in money means more funds for banks to lendIncrease in money means more funds for banks to lend

Changes in the Reserve RequirementsChanges in the Reserve Requirements– Fed increases the amount of reserves held on depositsFed increases the amount of reserves held on deposits– Decreases the money supplyDecreases the money supply

Federal Funds RateFederal Funds Rate– The rate one bank charges another for overnight use of excess The rate one bank charges another for overnight use of excess

reservesreserves Page 20

Government SecuritiesGovernment Securities (B)(B) (N)(N) (B)(B) The Fed Reserve sells securities to the The Fed Reserve sells securities to the publicpublic from time from time

to time.to time.– The more securities it sells the The more securities it sells the greatergreater money is money is

available in bank demand account reserves for loansavailable in bank demand account reserves for loans– Interest rates Interest rates increaseincrease and and fewerfewer loans are made. loans are made.– Interest rates decrease and greater loans are made.Interest rates decrease and greater loans are made.– Control Control creditcredit creating ability by manipulating amount creating ability by manipulating amount

of of cashcash kept as reserves kept as reserves– Influences interest rates or Influences interest rates or yieldyield

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Federal ReserveFederal Reserve

To decrease money supply.Increase reserve requirementsBuy bonds

Banks borrow money from Federal ReserveYou pay interest to the bank.Bank pays a discount to Federal ReserveChanges in discount rate affect money supplyDiscount and interest rates are in percent %Real Estate loans come from savings

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SAVINGS FLOW INTO MORTGAGE MARKETSAVINGS FLOW INTO MORTGAGE MARKET

SAVINGS

Institutional Lenders Commercial Banks

Thrift Institutions Insurance Companies Mutual Savings Banks

Non-Institutional Lenders Mortgage Companies Pension Funds

Trusts, Etc.

MORTGAGE

MARKET

$

$ $

$

Homes

Commercial

Industrial

Rural$$ Private Lenders $$

DISINTERMEDIATIONDISINTERMEDIATION

Savings

Thrift InstitutionsThrift Institutions Non-Mortgage Lenders or Borrowers

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DisintermediatedDisintermediated Savings Savings

List five things savers might spend their List five things savers might spend their savings on:savings on:

1.1. Consumer goodsConsumer goods

2.2. EntertainmentEntertainment

3.3. TravelTravel

4.4. Stocks/bonds/cd’s/mutual fundsStocks/bonds/cd’s/mutual funds

5.5. otherother

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? Money Rates ?? Money Rates ? Discount Rate = %Discount Rate = % Prime Rate = %Prime Rate = % Federal Funds Rate = %Federal Funds Rate = %

Mortgage RateMortgage Rate Real Estate Loan = %Real Estate Loan = %

– (owner occupied single family)(owner occupied single family)– 80% Loan80% Loan– 20% Down20% Down

Federal ReserveFederal Reserve

Impacts real estate activityImpacts real estate activity TightensTightens money supply and funds flow elsewhere money supply and funds flow elsewhere RaisesRaises mortgage interest rates mortgage interest rates Real estate activity Real estate activity declinesdeclines Easy money supply causesEasy money supply causes out flow out flow of fundsof funds This isThis is supply supply and and demanddemand of money of money Housing industry Housing industry sufferssuffers more than other sectors more than other sectors

from tightening of moneyfrom tightening of money

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