392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the...

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1 Money

Transcript of 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the...

Page 1: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Money

Page 2: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

2What is Money?

• Money is any commodity or token that is generally acceptable as the means of payment.

• A means of payment is a method of settling a debt.

Page 3: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

3What is Money?

• Other functions of Money

1) Medium of exchange

2) Unit of account

3) Store of value

Page 4: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

4What is Money?

• Medium of Exchange

• A medium of exchange is an object that is generally accepted in exchange for goods and services.• Without money, people would have to exchange

goods for goods, or barter.

Page 5: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

5What is Money?

• Unit of Account

• A unit of account is an agreed measure for stating the prices of goods and services.• This simplifies value comparisons and purchase

decision making if all prices are expressed using a uniform measure.

Page 6: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

6 The Unit of Account Functions of Money Simplifies Price Comparisons

Movie $6.00 each 2 six-packs of soda

Soda $3.00 per six-pack 2 ice-cream cones

Ice cream $1.50 per cone 3 packs of jelly beans

Jelly beans $0.50 per pack 2 cups of coffee

Coffee $0.25 per cup 1 local phone call

Price in Price in unitsGood money units of another good

Page 7: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

7What is Money?

• Store of Value

• A store of value is any commodity or token that can be held and exchanged later for goods and services.

Page 8: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

8What is Money?

• Money in the United States Today

• Money in the U.S. consists of:• Currency

• Deposits at banks and other financial institutions

Page 9: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

9What is Money?

• Money in the United States Today

• Currency is the bills and coins that we use.

• Deposits are also money because they can be converted into currency and are used to settle debts.

Page 10: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

10What is Money?

• Official Measures of Money

1) M1 consists of currency and traveler’s checks plus checking deposits.

• Includes accounts held by individuals and businesses, but does not include currency held by banks, or currency and checking deposits owned by the U.S. government

Page 11: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

11What is Money?

• Official Measures of Money

2) M2 consists of M1 plus saving deposits and time deposits

Page 12: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

12What is Money?

• Official Measures of Money

3) M3 consists of M2 plus large-scale time deposits and term deposits

Page 13: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

13 Two Measures of Money

Page 14: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

14What is Money?

• Are M1 and M2 Really Money?

• The test of whether an asset is money is whether it serves as a means of payment.• Currency does so

• Checking deposits are money because they can be transferred by writing a check.

• M1 is money

Page 15: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

15What is Money?

• Are M1 and M2 Really Money

• Some savings deposits are readily accessible and can be used as a means of payment.

• Other deposits are less liquid.• Liquidity is the property of being instantly

convertible into a means of payment with little loss in value.

• M2 is money

Page 16: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

16What is Money?

• Other Points Regarding Money

1) Deposits are money but checks are not.

2) Credit cards are not money.

Page 17: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

17Financial Intermediaries

• Financial intermediaries are firms that take deposits from households and firms and makes loans to other households and firms.

Page 18: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

18Financial Intermediaries

• Four Types of Financial Intermediaries

1) Commercial banks

2) Savings and loan associations

3) Savings banks and credit unions

4) Money market mutual funds

Page 19: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

19Financial Intermediaries

• Commercial Banks

• A commercial bank is a firm, licensed by the Comptroller of the Currency or by a state agency to receive deposits and make loans.

Page 20: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

20Financial Intermediaries

• Commercial Banks

• Their balance sheet lists their assets, liabilities, and net worth.• The assets are what the bank owns

• The liabilities are what the bank owes

• These include deposits

• Net worth is the difference between assets and liabilities.

Page 21: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

21Financial Intermediaries

• Commercial Banks

• Their balance sheet is described by the following formula:

Liabilities + Net Worth = Assets

Page 22: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

22Financial Intermediaries

• Profit and Prudence: A Balancing Act

• Banks attempt to maximize the net worth of their stockholders• They earn profit by lending at a higher interest rate

than they borrows

• Lending is risky

• Banks must be prudent in how they uses their deposits

Page 23: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

23Financial Intermediaries

• Reserves and Loans

• Banks divide their funds into two parts:• Reserves are cash in a bank’s vault plus its deposits

at Federal Reserve banks

• Loans

Page 24: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

24Financial Intermediaries

• Three Types of Assets Held by Banks

1) Liquid assets are U.S. government Treasury bills and commercial bills

2) Investment securities are longer-term U.S. government bonds and other bonds

3) Loans are commitments of fixed amounts of money for agreed- upon periods of time

Page 25: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

25Financial Intermediaries

• Savings and Loan Associations

• A savings and loan association is a financial intermediary that receives checking deposits and savings deposits and that makes personal, commercial, and home-purchase loans.

Page 26: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

26Financial Intermediaries

• Savings Banks and Credit Unions

• A savings bank (mutual savings bank) is a financial intermediary owned by its depositors that accepts deposits and makes mostly home-purchase loans.

Page 27: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

27Financial Intermediaries

• Savings Banks and Credit Unions

• A credit union is a financial intermediary owned by its depositors that accepts savings deposits and makes mostly consumer loans.• The key difference between savings banks and

credit unions is that credit unions are owned by a social or economic group such as a firm’s employees.

Page 28: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

28Financial Intermediaries

• Money Market Mutual Funds

• A money market mutual fund is a financial institution that obtains funds by selling shares and uses these funds to buy highly liquid assets such as U.S. Treasury bills

Page 29: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

29Financial Intermediaries

• The Economic Functions of Financial Intermediaries

1) Creating Liquidity

2) Minimizing the cost of borrowing

Page 30: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

30Financial Intermediaries

• The Economic Functions of Financial Intermediaries

3) Minimizing the cost of monitoring borrowers

4) Pooling Risk

Page 31: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

31 Financial Regulation, Deregulation, and Innovation

• Financial Innovation

• Financial innovation is the development of new ways of borrowing and lending.• Primary aim is to increase the profit from financial

intermediation

Page 32: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

32 Financial Regulation, Deregulation, and Innovation

• The three main influences on financial innovation are:

1) Economic environment

2) Technology

3) Regulation

Page 33: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

33 Financial Regulation, Deregulation, and Innovation

• Financial Innovations

• Variable interest rate mortgages

• Widespread credit card usage

• Rise in the importance of the Eurodollar

• Paying interest on checkable deposits

Page 34: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

34How Banks Create Money

• Reserves: Actual and Required

• The reserve ratio is the fraction of a bank’s total deposits that are held in reserves.

• The required reserve ratio is the ratio of reserves to deposits that banks are required, by regulation, to hold.

• Excess reserves are actual reserves minus required reserves.

Page 35: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

35How Banks Create Money

• Creating Deposits by Making loans in a One-Bank Economy

Let’s see an example of howbanks create money.

Page 36: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Reserves $100 Deposits $400

Loans $300

Total $400 Total $400

Creating Money at theOne-and-Only Bank

Balance sheet on January 1

Assets(millions of dollars)

Liabilities(millions of dollars)

Page 37: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Reserves $101 Deposits $401

Loans $300

Total $401 Total $401

Creating Money at theOne-and-Only Bank

Balance sheet on January 2

Assets(millions of dollars)

Liabilities(millions of dollars)

Page 38: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Reserves $101 Deposits $404

Loans $303

Total $404 Total $404

Creating Money at theOne-and-Only Bank

Balance sheet on January 3

Assets(millions of dollars)

Liabilities(millions of dollars)

Page 39: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

39How Banks Create Money

• The Deposit Multiplier

reservesinChange

depositsinChangemultiplierDeposit

Page 40: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

40How Banks Create Money

• Creating Deposits by Making Loans with Many Banks

Let’s see how the

banking system creates money

Page 41: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

41The Multiple Creation

of Bank DepositsThe sequence The running tally

Deposit$100,000

Reserves Loans Deposits

$25,000

$75,000 $25,000

$75,000 $100,000Loan

$75,000

Deposit$75,000

Reserve$25,000

Loan$56,250

Reserve$18,750 $43,750 $131,250 $175,000

Page 42: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

42The Multiple Creation

of Bank DepositsThe sequence The running tally

Reserves Loans Deposits

Deposit$56,250

Loan$42,187

Reserve$14,063

Deposit$42,187

$43,750 $131,250 $175,000

$57,813 $173,437 $231,250

Page 43: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

43The Multiple Creation

of Bank DepositsThe sequence The running tally

Reserves Loans Deposits

$68,360 $205,077 $273,437

Loan$31,640

Reserve$10,547

andso on...

$100,000 $300,000 $400,000

Page 44: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

44How Banks Create Money

• The deposit multiplier in the United States differs from our model economy’s for three main reasons:

1) The actual required reserve ratio is smaller than the 25 percent used here.

2) Banks sometimes choose to hold excess reserves.

Page 45: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

45How Banks Create Money

• The deposit multiplier in the United States differs from our model economy’s for three main reasons:

3) Not all loans made by banks return to them in the form of reserves.

Page 46: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

46 Money, Real GDP, andthe Price Level

• We are going to study the effect the money supply has on real GDP, the price level, and the inflation rate.

Page 47: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

47 Money, Real GDP, andthe Price Level

• The Short-Run Effects of a Change in the Quantity of Money

• Let’s study how a change in the quantity of money effects these factors by examining the aggregate supply-aggregate demand model.

Page 48: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

48Short-Run Effects of

Change in Quantity of Money

Real GDP (trillions of 1992 dollars)

Pri

ce le

vel

(GD

P d

efla

tor,

199

2 =

100

)

100

110

130

140

AD0

6.6 7.0 7.2 7.6

120

107

6.8 7.4

LAS

SAS

AD1

Page 49: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

49Long-Run Effects of

Change in Quantity of Money

Real GDP (trillions of 1992 dollars)

Pri

ce le

vel

(GD

P d

efla

tor,

199

2 =

100

)

100

110

130

140

6.6 7.0 7.2 7.6

121

6.8 7.4

LAS

113

AD1

SAS1

AD2

SAS2

Page 50: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

50 Money, Real GDP, andthe Price Level

• The Quantity Theory of Money

• The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level.

• This theory is based upon the velocity of circulation and the equation of exchange.

Page 51: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

51 Money, Real GDP, andthe Price Level

• The Quantity Theory of Money

• The velocity of circulation is the average number of times a dollar of money is used annually to buy goods and services that make up GDP.

Page 52: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

52 Money, Real GDP, andthe Price Level

• The equation of exchange states that the quantity of money (M) multiplied by the velocity of circulation (V) equals GDP, or

MV=PY

Page 53: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

53 Money, Real GDP, andthe Price Level

• We can convert the equation of exchange into the quantity theory of money by making two assumptions:

1) The velocity of circulation is not influenced by the quantity of money.

2) Potential GDP is not influenced by the quantity of money.

Page 54: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

54 Money, Real GDP, andthe Price Level

• Assuming this is true, the equation of exchange tells us that a change in the quantity of money causes an equal proportional change in the price level.

Page 55: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

55 Money, Real GDP, andthe Price Level

• This equation shows that the proportionate change in the price level equals the proportionate change in the quantity of money.

• This gives us the quantity theory of money:

• In the long run, the percentage increase in the price level equals the percentage increase in the quantity of money.

Page 56: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

56 Money, Real GDP, andthe Price Level

• The AS-AD model predicts the same outcome as the quantity theory of money.

• It also predicts a less precise relationship between the quantity of money and the price level in the short run than in the long run.

Page 57: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

57 Money, Real GDP, andthe Price Level

• Historical Evidence on the Quantity Theory of Money

• The data are broadly consistent with the quantity theory of money, but the relationship is not precise.

• The relationship is stronger in the long run than in the short run.

Page 58: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

58 Money, Real GDP, andthe Price Level

• Correlation, Causation, and Other Influences

• The evidence shows that money growth and inflation are correlated.

Page 59: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

59 Money, Real GDP, andthe Price Level

• Correlation, Causation, and Other Influences

• This does not represent causation.• Does money growth cause inflation, or does

inflation cause money growth?

• Does some other factor cause inflation (deficit spending)?

Page 60: 392 Money. 393 What is Money? Money is any commodity or token that is generally acceptable as the means of payment. A means of payment is a method of.

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Monetary Policy

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