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 Termsmoneymedium of exchangeunit of accountstore of valueliquiditycommodity moneyfiat moneycurrencydemand depositscentral bankmoney supplymonetary policy
reservesfractional-reserve bankingreserve ratiomoney multiplierbank capitalleverageleverage ratiocapital requirementopen-market operationsdiscount ratereserve 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
Money makes trade easier
Both must want what the other has at the
same time
Double coincidence of wants
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 MoneyNo intrinsic value
Declared money by government decree
Fiat MoneyWhy 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
SAMAsama.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 BoardGovernor
Saudi Arabia Monetary AgencySAMA
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 Deposit Reserve10%
LoanRemainder
1000 100 900
900 90 810
810 81 729
• • • •
• • • •
• • • •
Total 10,000
How does 1000 become 10,000?
Reserve Ratio
Fraction Reciprocal MoneyMultiplier
100% 1 1÷1 1
50% 0.50 1 ÷ 0.50 2
25% 0.25 1 ÷ 0.25 4
10% 0.10 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
AssetsBank Capital
Bank Balance Sheet
AssetsAssetsLiabilities and Owner EquityLiabilities 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?
AssetsAssets Liabilities and Owner EquityLiabilities 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
Banksnow have
more cash to loan
Central Bank
Public Banks
Increase Money Supply?Buy bonds for cash
Banksnow 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 from5.5% October 2008
to 2.0% by January 20093 month period of
global financial crisisRate increased
as economyheated 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
ReserveRatio
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