Chapter 13 Money And Financial Institutions What is

Chapter 13 Money And Financial Institutions

What is Money? Stability Money is anything generally accepted as a medium of exchange, a store of value, and a measure Portability Durability Uniformity Divisibility Recognizability

Different kinds of Money The Money Supply M 1 M 2 M 3 Currency, travelers’ checks, demand deposits (checking accounts), other checkable deposits M 1 plus, small savings deposits, passbook/money market savings deposits, mutual fund money market accounts M 2 plus, institutional money market accounts, large savings deposits, eurodollars, other

What Banks Do • History lesson • Basic function of banks: – Collect funds from those that have no immediate need, pay interest on those funds, funnel them to borrowers • Accepting and holding deposits • Make loans (coordinate lenders and borrowers) • Collecting/transferring funds

Fractional Reserve Banking • How it started • It’s a wonderful life

Let’s make some money • Required reserves – Fixed portion of deposits that cannot be loaned • Reserve ratio – The percentage of reserves a bank is required to keep • Inverse relationship (teeter totter) between reserve ratio and the amount banks can lend

How does this create money? • Some of each deposit is kept (reserve ratio) • The total left is loaned to others – Is the money removed from the vault and given to borrowers? – Bank “creates” money by starting or adding to account • How much money will be created? – Deposit multiplier (100÷reserve ratio)

The FED • The federal reserve system – The nation’s central bank • Entities of the Fed – Federal Reserve Banks (12 districts) – Board of governors (7 members) • Nominated by Pres. Confirmed by Senate • 14 year term, one chairman (Greenspan) – Federal Open Market Committee FOMC • Increase/decrease reserves – Advisory Committees

What does the Fed do? • Issues currency • Processes checks/EFT • Hold reserves for banks – Required reserves (transferred nightly) • Banker to federal Government – Tax payments, treasury department, bonds and securities

Value of money changes • Inflation – A period of rising prices. – Purchasing power of dollar falls. – More money required to purchase same bundle of goods. • Deflation – A time when prices are falling. – Purchasing power of dollar rises. – Less money required to purchase same bundle of goods.

How inflation happens • Demand-pull inflation – Demand for goods/services increases faster than industry’s ability to produce more goods – Consumers bid up the price • Cost-push inflation – Prices rise due to increase in cost of production – Raw materials, wage-price (wages more than productivity), price-wage

Ouch! Inflation hurts • Fixed income – Cost of living goes up, income doesn’t • Savers – ROI must be more than inflation – Same money buys less • Lenders – Interest must be more than inflation – Same money buys less • Businesses – Increases production costs – Increases uncertainty

Inflation Make it hurt so good • Adjustable income – If increases are more than inflation rate • Borrowers – The money they repay is worth less – Interest less than inflation rate • Government – Income tax – Sales tax