16. Money and Banking
Economics 102 with Stevenson at University of Michigan - Ann Arbor
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Monetary Policy
Manipulation of the money supply to achieve macroeconomic stability
Money Supply (M)
- total value of financial assets in the economy that are considered money
- made up by currency in circulation and checkable bank deposits
Federal Reserve ("The Fed")
- Central bank of the USA
- Regulates the banking system and controls the amount of currency available
Money
- any asset that can be easily used to purchase goods/services
- the most liquid of all assets
Liquidity
Ability of an asset to be turned into cash without any (or much) loss in value
Currency in Circulation
Cash held by the public
Checkable Bank Deposits
Bank accounts on which people can write checks
Characteristic of Money
It must serve as a:
- Medium of Exchange
- Store of Value
- Unit of Account
Medium of Exchange
People can use money to trade for goods/services
Store of Value
- Can use it to move purchasing power through time
- You can save it and spend it later without losing value (inflation is not too much)
Unit of Account
Measure prices using money
Barter
- trading good for good
- requires double coincidence of wants: not efficient
Commodity Money
- Good that is used as medium of exchange which can be used for other things (intrinsic value)
- cocoa beans, gold, furs, and wampum
Commodity-Backed Money
- No intrinsic value
- Value guaranteed by the promise that it can be converted into a valuable good
Fiat Money
value not associated with any tangible good
Seignorage
printing money to raise revenue
Federal Open Market Committee
Arm of the Fed that engages in Monetary Policy
Banks
- Assemble money of people/firms
- Use the money to create large loans for a project
- Make profit by paying you to hold money while selling it as a loan
- Banks create money by loaning
Bank Reserves
- Currency that banks hold in their vaults plus their deposits at the Fed
- Not part of Money Supply
- Reserve Ratio = (Bank Reserves) / (Total Bank Deposits)
T-Account
- Summary of a bank's (firm's) financial position
- T-shaped table with two columns: assets and liabilities
- loans are assets: promise to be paid back
- deposits are liabilities: promise to pay
What Banks Do
- Put money into reserves (take money out of money supply)
- Create Checkable Accounts (Add to the money supply)
Reserve Requirement (RR)
Fraction of Checkable deposits hat bank must legally hold in its vaults
Excess Reserves
Bank cash reserves in excess of those needed to meet reserve requirement
Potential Money Multiplier (1/RR)
Money Created = (potential money multiplier) * deposit - initial deposit
Actual Money Multiplier
ratio of money supply to monetary base
Monetary Base
- All currency in economy
- Sum of currency in circulation and currency held as bank reserves
Fractional Reserve Banking
- For example: A reserve ratio of 20% implies that a bank has promised to hold and return $1000, but only has $200 at any time
- Allows banks to create money
Bank Run
People trying to quickly withdraw their money from bank before it falls
Protection for Depositore
- Deposit Insurance: FDIC guarantees $250,000
- Capital Requirements: Banks hold more assets than the value of reserves (capital must be above 7% of assets)
- Reserve Requirements: Bank reserves much stay above a certain level
- Discount Window: Troubled banks can borrow cheaply from the Fed
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