Chapter 13 Money and Our Banking System. Copyright © 2005 Pearson Addison-Wesley. All rights...
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Transcript of Chapter 13 Money and Our Banking System. Copyright © 2005 Pearson Addison-Wesley. All rights...
![Page 1: Chapter 13 Money and Our Banking System. Copyright © 2005 Pearson Addison-Wesley. All rights reserved.13-2 Learning Objectives List the functions of money.](https://reader035.fdocuments.in/reader035/viewer/2022081513/56649e865503460f94b8882e/html5/thumbnails/1.jpg)
Chapter 13
Money and Our Banking System
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-2
Learning Objectives
• List the functions of money.
• Explain the difference between the narrowest definition of money, M1, and the next broadest definition, M2.
• List four of the most important functions of the Federal Reserve System (Fed).
• Explain how the Fed can increase the money supply.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-3
Money
• Money is whatever people accept as money.
• Money’s principal functions are to serve as:
1. a medium of exchange, and
2. a unit of accounting.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-4
Medium of Exchange
• To say that money is a medium of exchange simply means that a seller will accept it as a means of payment for a good or service.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-5
Barter
• Without money, people would have to barter—exchange goods and services for other goods and services.
• Barter requires a double coincidence of wants, that is, each party to a transaction must want exactly what the other person has to offer.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-6
Money and Transaction Costs
• Money facilitates exchange by reducing the transaction costs associated with means-of-payment uncertainty.
• Individuals no longer have to hold a diverse collection of goods as an exchange inventory for bartering.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-7
Money and Specialization
• As a medium of exchange, money allows individuals to specialize in any area in which they have a competitive advantage, and to receive money payments for their labor.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-8
Money as a Unit of Accounting
• Money is the yardstick that allows people to compare the values of goods and services in relation to one another.
• By using money prices, people can determine whether one item is a better bargain than another.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-9
Liquidity
• An asset is liquid when it can easily be acquired or disposed of without high transaction costs and with relative certainty as to its value.
• Money is the most liquid asset.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-10
What Backs Money?
• In a fiduciary monetary system, the value of the payments in the form of currency and checks rests on the public’s confidence that such payments can be exchanged for goods and services.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-11
Fiat Money
• It is any form of money that is not backed by anything other than faith in its universal acceptance in trade.
• The U.S. dollar is fiat money. It has no intrinsic value.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-12
Depository Institutions
• These are financial institutions that accept money from savers, which is then lent out with interest.
• In addition to banks, there are thrift institutions–savings and loan associations, savings banks, and credit unions.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-13
Defining Money Supply as M1
• Money Supply is the amount of money in circulation.
• M1 includes all currency (bills and coins), all checkable deposits, plus traveler’s checks. M1 is the narrowest definition of money supply.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-14
Checkable Deposits
• These are deposit accounts against which a check can be written out.
• Checks are a way of transferring the ownership of deposits in financial institutions. They are normally accepted as a medium of exchange.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-15
Credit Cards are not part of the Money Supply
• Using a credit card is borrowing funds from the credit card issuer for a period of several days to a period of several months.
• The credit car company pays for the borrower’s transaction.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-16
M2: A Broader Definition of Money Supply
• M2 is equal to M1 plus the following near moneys:– Savings deposits and money market
deposit accounts,
– Small-denomination time deposits, and
– Funds held by individuals in money market mutual funds.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-17
Savings and Money Market Deposit Accounts
• Savings deposits are interest-bearing deposit accounts without set maturities.
• Money market deposit accounts are savings accounts with limited check-writing privileges.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-18
Time Deposits
• Time deposits have set maturities, meaning that the holder must keep the funds on deposit for a fixed length of time to be guaranteed a negotiated interest return.
• Small-denomination time deposits are accounts with balances under $100,000.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-19
Money Market Mutual Funds
• They are pools of funds from savers that managing firms use to purchase short-term financial assets, such as Treasury bills and large CDs issued by depository financial institutions.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-20
The Federal Reserve System
• The Federal Reserve System, also known as the Fed, is the most important regulatory agency in the United States’ monetary system.
• The Fed is considered the monetary authority–our central bank.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-21
Functions of the Fed
• Among its many functions, the Fed:– regulates the money supply,
– supplies the economy with paper currency and coins,
– provides for check collection and clearing, and
– holds reserves for the nation’s depository institutions.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-22
Fractional Reserve Banking
• Depository institutions do not keep 100 percent of their deposits on hand.
• They keep only a fraction of those deposits on hand as reserves.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-23
Required Reserves
• Since its creation in 1913, the Fed has set specific reserve requirements for many banks.
• Banks must hold a set percentage of their total deposits either as cash in their own vaults or as deposits in their Federal Reserve district bank.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-24
Expansion of the Money Supply
• A large portion of the money supply consists of funds that the Fed and customers deposit in banks.
• Because banks are not required to keep 100 percent of their deposits in reserve, they can use any new excess reserves to create new money.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-25
The Money Multiplier
• The money multiplier gives the change in the money supply per one dollar change in the banking system’s reserves.
1Potential money multiplier =
required reserve ratio
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-26
Factors that reduce the Money Multiplier
• The potential money multiplier will not be realized if:– Banks keep excess reserves.
– There are currency leakages out of the system. For instance, if a loan is taken out as currency.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-27
E-Money
• One of the most important recent technological innovations in the banking system is the smart card.
• Each time a cardholder uses a smart card, the amount of a purchase is deducted automatically from the cardholder’s balance and credited to a retailer.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-28
Digital Cash
• Digital cash, also called e-cash, consists of funds contained on computer software stored on microchips and other computer devices.
• Its use will reduce the nation’s costs of transferring funds because people can store and instantaneously transmit digital cash along preexisting electronic networks.
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-29
Key Terms and Concepts
• barter
• checkable deposits
• depository institutions
• digital cash
• Fed
• fiduciary monetary system
• fractional reserve
• liquidity
• medium of exchange
• money market deposit accounts
• money market mutual funds
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Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 13-30
Key Terms and Concepts (cont.)
• money multiplier
• money supply
• near moneys
• reserve requirements
• reserves
• savings deposits
• small-denomination time deposits
• smart cards
• thrift institutions
• unit of accounting