{ Banking: Basic Operation and Money Modules 25 & 26.
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Transcript of { Banking: Basic Operation and Money Modules 25 & 26.
{
Banking: Basic Operation and Money
Modules 25 & 26
Banks are a financial intermediary Two jobs
Take deposits Provide loans (liquidity) to finance
illiquid investments by borrowers Role of the Federal Reserve is
different “Dual Mandate” – full employment,
low inflation Banks cannot lend ALL their money
Banking
Banks must keep substantial quantities of liquid reserves on hand (post Depression) Currency or deposits in the Federal
Reserve Money in the bank vault
Banks must have sufficient assets to cover their financial liabilities PLUS depositor withdraws
Banking
T-accounts Summarize a business’s financial position
STANDARD BUSINESS>
BANK>
Banks are different from standard businesses in T-accounts Must have some money set aside with the
Fed by law (assets column) Required Reserve Ratio – required
amount of deposits a bank must hold (usually 10%) Bank runs and subsequent bank failure “Fractional Reserve Banking” – when central
banks require reserves
Banking
Money creation Through their activity, banks actual CREATE money
Banking
Paper money is obsolete and should be removed from circulation all together.
Four-Corner Debate
Just a reminder:
M1 = measures money in circulation and demand deposits (checking)
Monetary Base Sum of currency in circulation AND
reserves held by banks. DIFFERENT- Bank reserves are NOT
considered part of the money supply, but ARE part of the monetary base!
Checkable bank deposits, part of money supply aren’t part of
monetary base
Money multiplier Ratio of money supply to the monetary
base Tells us the total number of dollars
created in the banking system by each $1 addition to the monetary base Simple money multiplier:
$1/rr**** rr = Reserve rate
Banking
SO: If the reserve rate is 10% and the
Fed adds $100 to the monetary base, then the money supply will increase BY:
1/.10 = 1010x$100 = $1000
Assume money lent out is spent and will end up back in another bank Some may keep cash in our wallet
(leakage) Assumptions
Not worried about leakage Banks lend out ALL their money (save Req.
Reserve Rate) What if a bank keeps too much in reserves?
– excess reserves What happens if rr falls?
Banking Regulations Deposit Insurance Capital Requirements Reserve Requirements Discount Window
The Federal Reserve One of the most important,
controversial elements of the US economy Many conspiracy theories about the
founding of the bank, the role of the bank, and its propensity to create debt burdens.
Little government oversight, but not a private entity Oversight through appointment
The Federal Reserve
Historic Analysis Various “national banks” in our history Panic of 1907
JP Morgan’s role VERY similar to today (8% unemp)
Trusts speculating on the stock market (Knickerbocker Trust)
United Copper Company’s stock Currency supply issues, credit markets
frozen Progressives feared Morgan’s power, and
tried to limit his influence
Jekyll Island gathering Wealthiest men in America, politicians
gathered in secret to plan and organize a new national bank.
1913- Federal Reserve Act instituted a new national bank,
regulated, and set basic requirements for lending and currency involvement.
Unanimously passed in Congress
Dual mandate of the Fed Keep unemployment low and keep
prices (inflation) stable This is achieved through open market
operations Effectiveness?
1930s issues Crisis in the 1980s 2008 Recession
The Fed
The Federal Reserve System and Function Two parts to the Fed
Board of Governors (US Gov, appointed) 12 Regional Fed Banks (Private)
Functions Provide Financial Services
“bank for banks” Supervise and Regulate Banks Maintain stability of financial system Conduct monetary policyThe Fed: Banking
Functions
Fed Functions and Market Performances What if a bank has insufficient funds?
Federal funds market Borrow reserves from banks with excess! Overnight loan, w/interest Federal funds rate
Fed can adjust RR to alter money supply (last time: 1992)
The Fed: Banking Functions
Discount Rate Banks in need of RR funds can borrow
directly from the fed using the “discount window” Discount rate- usually 1% above the FFR
to encourage banks to borrow from each other
Fed can adjust to also alter money supply (ex- 2008 it was 0.25% interest!!) Cost of being short reserves falls,
encouraging banks to lend!The Fed: Banking Functions
Open-Market operations Mainly short-term (1 year) US
Treasury bill purchases Purchased through commercial banks
(financial market banks) BAD idea to buy directly from government
(historically terrible) Pays banks for bills by crediting
reserve accounts of commercial banks
The Fed: Banking Functions
Fed creates the money to purchase the bills “Click of the mouse,” created at the
Fed’s own discretion Does not directly enter the money
supply, BUT, sets the money multiplier in motion Increases reserves, commercial banks
then lend out excess reserves easier, which increases money supply.The Fed: Banking
Functions
The Federal Reserve should be ended because it has too much
control over the economy.
Four-Corner Debate