Eco 202 ch 30 the monetary system
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Transcript of Eco 202 ch 30 the monetary system
Chapter 30 !
The Monetary System
Key Termsmoney medium of exchange unit of account store of value liquidity commodity money fiat money currency demand deposits central bank money supply monetary policy
reserves fractional-reserve banking reserve ratio money multiplier bank capital leverage leverage ratio capital requirement open-market operations discount rate reserve requirements !
Two Choices
Make
or
Trade
Barter
Direct trade - stuff for stuff
No money
Double coincidence of wants
Both sides have to want what the other side has
Double coincidence of wants
Both must want what the other has at the
same time
Double coincidence of wants
Money makes trade easier
What is money?
Money
Something people use to trade with
Why would you accept a cigarette if you didn’t smoke?
Functions of Money
Medium of exchange
Unit of account
Store of value
Medium of Exchange
Buyers give to sellers
Sellers accept from buyers
Unit of Account
Measurement
Prices
Debts
Store of ValueTrading time for time
Today for tomorrow
Tomorrow for today
Earn - Save - Spend
LiquidityHow easy is it to convert
something to money
Kinds of MoneyCommodity
Fiat
Commodity MoneyIntrinsic value
Easy to carry
Easy to measure
Easy to verify
Hard to copy
=
Gold Standard
Central Bank will convert paper money to gold at a fixed rate
Fiat Money
No intrinsic value
Declared money by government decree
Fiat Money
Why do people accept fiat money?
Trust that someone else will also accept it
Money
Trust inscribed
If people lose trust, money loses it value
Coins
Currency
Checks
Card Type Payment
Credit Defer
Debit Instant
Why credit and debit cards are not money
Not a method of payment, but a method of
making payment
Debit card is like a check
Takes money out of your bank account
Credit Card
Defer the payment
Demand Deposits
Bank account that you can access by writing a check or using a debit
card
Saudi Arabia Monetary Agency
The Central Bank of Saudi Arabia
SAMA sama.gov.sa
Central Bank
The bank that oversees the banking system and
regulates the money supply in a country
Dr. Fahad Al Mubarak !
Chairman of the Board Governor
!
Saudi Arabia Monetary Agency SAMA
Six Functions• Issues national currency, the Saudi Riyal.
• Acts as a banker to the government.
• Supervises commercial banks.
• Manages Kingdom’s foreign exchange reserves.
• Conducts monetary policy for promoting price and exchange rate stability.
• Promotes the growth and ensures the soundness of the financial system.
Source: sama.gov.sa
Money Supply
The quantity of money available in a country.
Monetary Policy
Setting the money supply by the central bank policymakers
Two Types of Banks
100 Percent Reserve
Fractional Reserve
100-Percent Reserve Bank
All the deposits are kept in a safe vault.
No loans
Fractional-Reserve Bank
Bank only holds a fraction of the deposits
as reserves
Loans out the remainder
Reserve Ratio
The fraction of deposits that banks hold as
reserves
Fractional-Reserve Banking
Creates money
Bank DepositReserve
10%Loan
Remainder
1000 100 900
900 90 810
810 81 729
• • • •
• • • •
• • • •
Total 10,000
How does 1000 become 10,000?
Reserve Ratio
Fraction Reciprocal Money Multiplier
100% 1 1÷1 1
50% 0.5 1 ÷ 0.50 2
25% 0.25 1 ÷ 0.25 4
10% 0.1 1 ÷ 0.10 10
5% 0.05 1 ÷ 0.05 20
1% 0.01 1 ÷ 0.01 100
Money multiplier is the reciprocal of the reserve ratio
Bank Capital
The money the bank’s shareholders have put in
to the bank
Leverage
OPM
Using other people’s money
Leverage1. I have 10
2. I borrow 90 from you
3. I buy something for 100
4. I resell the item for 150
5. I pay back your 90
6. I keep the 60
7. I earned 50 profit on my 10
Leverage Ratio
The ratio of assets to bank capital
Assets Bank Capital
Bank Balance Sheet
AssetsLiabilities and Owner Equity
Reserves 200 Deposits 800
Loans 700 Debt 150
Securities 100 Capital 50
Total 1000 Total 1000
Totals must balance or be equal
What is the leverage ratio?
AssetsLiabilities and Owner Equity
Reserves 200 Deposits 950
Loans 800 Capital 50
Total 1000 Total 1000
Assets ÷ Capital1000 ÷ 50 = 20
Leverage Ratio of 20
Owners put up 1
Depositors put up 19
Leverage is Risky!If leverage ratio is 20,
5% increase in asset value = 100% return to owners
5% decrease in asset value = 100% loss to owners
Capital Requirement
Government rule on minimum amount of
bank capital
Insolvent
Liabilities are more than the assets
You owe more than you own
Three Tools of Central Banks
Open-Market Operations
Discount Rate
Reserve Ratio
Open-Market Operations
Purchase and sale of government bonds
Buy bonds increases supply
Sell bonds decreases supply
Banks now have
more cash to loan
Central Bank
Public Banks
Increase Money Supply?Buy bonds for cash
Banks now have less cash to loan
Central Bank
Public Banks
Decrease Money Supply?Sell bonds for cash
Discount RateThe rate the central bank charges to make loans to
member banks
Called the Official Repo Rate or ORR rate in Saudi Arabia
Official Repurchase Rate or Discount Rate
2.0%
Dropped from 2.5% on January 19, 2009
SAMA Official Repo Rate
Dropped from 5.5% October 2008
to 2.0% by January 2009 3 month period of
global financial crisis Rate increased
as economy heated up
Reserve Ratio
Increase reserve ratio will reduce money multiplier
Decrease reserve ratio will increase money multiplier
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 4 6 8 10 12 14 16 18 20
Reserve Ratio
Money Multiplier
The Power of the Reserve Ratio to Multiply Money
Reserve RatioNot changed very often
What is the current reserve ratio in Saudi Arabia? 7%
What is the Money Multiplier?
1÷7% = 14.28
Bank Deposit Insurance
Protects against bank runs
Moral Hazard to take more risk because government
will pick up losses
The Meaning of Money Three Functions of Money
Medium of Exchange Unit of Account Store of Value
Two Kinds of Money Commodity Fiat
Money in the Economy Currency Demand Deposits
Central Banks SAMA
Banks and the Money Supply 100-Percent Reserve Banking Fractional-Reserve Banking Reserve Ratio Money Multiplier Leverage Capital Requirement
Tools of Monetary Control Open-Market Operations Discount Rate - ORR Reserve Ratio Bank Runs and Deposit Insurance