Chapter 12: Money, Banking, and Monetary Policy

lending money to banks and thrifts

(Fed) From time to time the Fed lends money to banks and thrifts and charges them an interest rate called the discount rate. In times of finacial emergencies, the Fed serves as a lender of last resort to the US banking industry.

Acting as fiscal agent

(Fed) The Fed acts as the fsical agent (provider of financial services) for the Federal government. The gov't collects huge sums through taxation, spends equally large amounts, and sells and redeems bonds. To carry out these activities, the fov't uses the Fed's facilities.

issuing currency

(Fed) The Fed issues Federal Reserve Notes, the paper money currency used in the US monetary system.

Providing for check collection

(Fed) The Fed provides the banking system with a means for collecting checks.

Supervising banks

(Fed) The Fed supervises the operations of banks. It makes periodic examinations to assess bank profitability, to ascertain that banks perform in accordance with the many regulations to which they are subject, and to uncover questionable practices or fraud.

Controlling the money supply

(Fed) the Fed ahs ultimate responsibility for regulating the supply of money, and this in turn enables it to influence interest rates. The major task of the Fed is to manage the money supply (and thus interest rates) according to the needs of the economy. This requires the Fed to make basic, but unique policy decisions.

savings deposits, including money market deposit accounts

(M2) A depositor can easily withdraw funds from a savings account at a bank or thrift or simply request that the funds be transferred from a savings account to a checkable account. A person can also withdraw funds from a money market deposit account (MMDA), which is an interest-bearing account containing a cariety of interest-bearing short-term securites. MMDAs have a minimum balance requirement and a limit of how often a person can withdraw funds.

money market mutual funds held by individuals

(M2) By making a telephone call, using Internet, or writing a check for > $500, a depositer can redeem shares in a money market mutual fund (MMMF) offered by a mutual fund company. Such companies use the combined funds of individual shareholders to buy interest-bearing short-term credit instruments such as certificates of deposit and US government securities. Then they can offer interest on the MMMF accounts of the shareholders (depositors) who joint;y own those finanical assets. In M2 they only include held by the individual, not businesses and other institutions.

small (>$100,000) time deposits

(M2) Funds from time deposits become available at their maturity. (TIME DEPOSITS: "certificate of deposit" or "CD") In return for this withdrawl limitation, the financial institution pas a higher interest rate on such deposits than it does on its MMDAs. Also, a person can "cash in" a CD at any time but must pay a severe penalty.

What are the Fed functions?

-issuing currency -setting reserve requirements and holding reserves -lending money to banks and thrifts -providing for check collection -acting as fiscal agent -supervising banks -controlling the money supply

token money

All coins in circulation in the US are token money. This means that the instrinsic value, or the value of the metal contained in the coin itself, is less than the face value of the coin. This is to prevent people from melting down the coins for sale as a "commodity" in this case, the metal.

near-monies

Certain highly liquid finanical assets that do not function firectly or fully as a medium of exchange but can be readily converted into currency or checkable deposits.

Currency: Coins + Paper Money

Coins are the "small change" of our money supply. Most of the nation's currency is paper money.

commercial banks

Commercial banks are the primary depository institutions. They accept the deposits of HH and businesses, keep the money safe until it is demanded via checks, and in the meantime use it to make available a wide variety of loans.

What is the historical background of the Fed?

Early in the 20th century, Congress decided that centralization and public control were essential for an efficient banking system. Decentralized, unregulated banking led to the inconvenience and confusion of numerous private bank notes being used as currency and monetary mismanagement where the money supply was inappropriate to the needs of the economy. An unusually acute banking crisis in 1907 motivated Congress to appoint the NAtional Monetary Commission to study the montary and banking problems of the economy an to outline a course of action for Congress. The result was the Federal Reserve Act of 1913.

What is money?

In a general sense, anything that performs the functions of money is money. The functions include: -medium of exchange -unit of account -store of value

Money Definition M2

Includes M1 plus several near-monies. There are three categories of near-monies included in the M2 definition of money. Money, M2 = M1 + savings deposits, including MMDAs + small (less than $100,000) time deposits + MMMFs held by the individual.

store of value

Money also serves as a store of value that enables people to transfer purcahsing power from the present to the future. People normally do not spend all their incomes on the day they recieve them. In order to buy things later, they store some of their wealth as money. Money is often the preferred store fo value for short periods because it is the most liquid (spendable) of all assets. People can obtain their money nearly instantly and can immedietely use it to buy goods or take advantafe of financial investment opportunities.

medium of exchange

Money is a medium of exchange that is uable for buying and selling goods and services. Money is readily acceptable as payment. As a medium of exchange, money allows society to escape the complications of barter. And because it provides a convenient way of exchanging goods, money enables society to fain the advantages of geographic and human specialization.

unit of account

Money is also a unit of account. Society uses monetary units ($) as a yardstick for measuring the relative worth of a wide variety of goods, services, and resources. With money as an acceptable unit of account, the [roce of each item need be stated only in terms of the monetary unit. We need not state the price of cows in terms of corn, crayons, and cranberries. Money aids rational decision making by enabling buyers and sellers to easily compare the prices of various goods, services, and resources. It also permits us to define debt obligations, determine taxes owed, and calculte the nation's GDP.

Money Definition MZM

Money zero maturity. Focuses exclusively on monetary balances that are immedietely available, at zero cost, for households and businesses transactions. 2 adjusments to M2 to make MZM. -subtract small time deposits because the maturity on deposits is a length beyond instant maturity. Withdrawl prior to maturity requires the payment of a substancial financial penalty. -add money market mutal fund (MMMF) balances owned by businesses. Like those held by the individual MMMFs held by businesses are immedietely available for purchases. Money MZM = M2 - small time deposits + MMMFs held by businesses

Central bank

Most nations have a single central bank, but the US' central bank consists of 12 banks whose policies are coordinated by the Fed's Board of Governors.

Federal Reserve Notes

Paper money-- This "folding currency" consists of Federal Reserve Notes, issued by the Federal REserve System with the authorization of Congress. Every bill carries the phrase "Federal Resere Note" on its face.

How is money's purchasing power stabilized?

Rapidly rising price levels and the conqequent erosion of the purchasing power typically result from imprudent economic policies. Stabilization of the purchasing power requires stabilzation of the price level. Such price-level stability mainly necessitates intelligent management of regulation of the nation's money supply and interest rates (monetary policy). Also requires appropriate fiscal policy. The critical role of the US monetary authorities (the Federal Reserve) in maintaining the purchasing power of the dollar is the subject of Chapter 14.

Recent Developments in Money and Banking

Read the section of Recent Developments in Money and Banking!!!

thrift institutions

Savings and loan associations (S&Ls), mutual savings banks, and credit unions supplemnet the commercial banks and are known collectively as savings or thrift institutions (thrifts). -S&Ls and mutual savings banks: accept deposits of HH and businesses and then use the funds to finance housing mortgages and to provide other loans. -credit unions: accpets deposits from and lend to "members" who usually are a group of ppl who work for the same company.

How does purchasing power affect inflation and acceptability?

Situations have occured where a nation's currency became worthless and unacceptable in exchange. The gov't issued so many pieces of paper currency that the purchasing power of each of those units was almost totally undermined. Runaway inflation may depreciate the value of money between the time it is recieved and the time it is spent. Rapid declines in the value of a currency may cause it to cease being used as a medium of exchange. Businesses and HH may refuse to accept paper money in exchange bc they do not want to bear the loss in its value that will occur while it is in their possession. This can cause as economy to revert back to barter. Alternatively, they could go to more stable currencies like the dollar or euro. At the extreme, a country may adopt a foreign currency as its own official currency as a way to counter hyperinflation. Also has large effect when the value of the dollar declines rapidly, sellers will not know what to charge, and buyers will not known what to pay, for goods and services.

Federal Reserve System

The "monetary authorities" we have been referring to are the member of the Board of Governers of the Federal Reserve Sytem (the Fed).

Quasi-Public banks

The 12 Fed. Res. Banks are quasi-public banks, which blend private ownership and public control. Each Fed. Res. Bank is owned by the private commercial banks in its district. (Federally chartered banks are required to purchase shares of stocks on the Federal Reserve Bank in their district.) But the Board of Governors, a gov't body, sets the basic policies that the Fed. Res. Banks pursue.

The 12 Federal Reserve Banks

The 12 Fed. Res. Banks, which blend private and public control, collectively serve as the nation's "central bank." These banks also serve as bankers' banks.

Bankers' bank

The Fed. Res. Banks are "bankers' bank." They perform essentially the same functions for banks and thrifts as those institutions perform for the public. Just as banks and thrifts accept the deposits of and make loans to the public, so the central banks accept the deposits of an make loans to banks and thrifts. In emergency circumstances, the Fed become the "lender of last resort" to the banking system and can lend out as much needed to ensure that banks and thrifts can meet their cash obligations.

FOMC

The Federal Open Market Committee (FOMC) aids the Board of Governors in conducting monetary policy. Made up of 12 individuals: -the seven members of the Board of Governors -the president of the NY Federal Reserve Bank -four of the remaining presidents of Federal Reserve Banks on a 1-year rotating basis. The FOMC meets reguarly to direct the purchase and sale of government securites (bills, notes, bonds) in the open market in which such securities are bought and sold on a daily basis.

Board of Governors

The central authority of the US money and banking system is the Board of Governors of the Federal Reserve System. The US president, with confirmation by Senate, appoints sdeven Board members. Terms are 14 yrs and staggered so that one member is replaced every 2 yrs. In addition, new members are appointed when resignation occurs. The president selects the chairperson and vice-chairperson of the Board from among the members. Those officers serve 4-yr terms and can be reappointed to new 4-ys terms by the president. The long term appointments prived the Board with continuity, experienced membership, and independece from political pressures that could result in inflation.

What is money as debt?

The majr componenets of the money supply (paper money and checkable deposits) are debts, promises to pay. (paper money - debt of the Fed. Checkable deposits - debts of commercial banks and thrift institutions). Paper cuurency and checkable deposits have no instrinsic value. In effect, the gov't has chosen to "manage" the nation's money supply. Its monetary authorities attempt to provide the amount of money needed for the particular volume of business activity that will promote POE. In short, ppl cannot convert paper money into a fixed amount of gold or any other precious commondity. Money is exchangable only for paper money.

What "backs" the money supply?

The money supply in the US essentially is "backed" (guarenteed) by government's ability to keep the value of money relatively stable.

money definition M1

The narrowest definition of the US money supply is called M1. It consists of: -currency (coins and paper money) in the hands of the public -all checkable deposits (all deposits in commercial banks and "thrift" or savinfs institutions on which checks of any size can be drawn) Government and government agencies supply coins and paper money. Commercial banks (banks) and savings institutions (thrifts) provide chackable deposits. Money, M1 = currency + checkable deposits

What is the purchasing power of the dollar?

The purchasing power of money is the amount of goods and services a unit of money will buy. When money rapidly loses its purchasing power, it loses its role as money. The amount a dollar will buy varies inversely with the price level. When the consumer price index or "cost-of-living" index goes up, the value of the dollar goes down and vise versa. Higher prices lower the value of the dollar, bc more dollars are needed to but a particular amount of something. Conversely, lower prices increase the purchasing power of the dollar because fewer dollars are needed to obtain a specific quantity of goods and services. $V = 1 / P (V=value of the dollar)

checkable deposits

The safety and convenience of checks has made checkable deposits a large component of M1 money supply. The person cashing a check must endorse it (sign on reverse side); the writer of the check subsequently reciees a record of the cashed check as a reciept attesting to the fulfillment of the obligation. Similarly, because the writing of a check requires endorsement, the theft or loss of your checkbook is not nearly as calamitous as losing an identical amount of currency. Finally, it is more convenient to write a check than to transport and count out a large sum of currency. For these reasons, checkable deposits (checkbook money) are a large component of the stock of money is the US.

What is the value of money?

What gives money its value? (3 parts) -acceptability: Currency and checkable deposits are money bc ppl accept them as money. They perform the basic function of money: they are acceptable as a medium of exchange. We accept paper money bc we are confidrnt it will be exchangable for real goods, services, and resources. -legal tender: Gov't has designated currency as legal tender. That means paper money is a valid and legal means of paymeny and debt. -relative scarcity: The value of money depends on its supply and demand. Money derives its value from its scarcity relative to its utility (its want-satisfying power). the utility of money lies in its capacity to be exchanged for goods and services, now or in the future. The economy's demand for money thus depends on the toal dollar volume of transactions in any period plus the amount of money individuals and businesses want to hold for future transactions. With a reasonably constant demand for money, the supply of money will determine the domestic value or "purchasing power" of the monetary unit.

What Institutions offer checkable deposits?

commercial banks -checkable deposits of banks and thrifts are known as demand deposits, NOW (negotiable order of withdrawl) accounts, ATS (automatic transfer service) accounts, and share draft accounts.

setting reserve requirements and holding reserves

(Fed) the Fed sets reserve requirements, which are the fraction of the checking account balances that banks must maintain as currency reserves. Teh central banks accept as deposits from the banks and thifts any portion of their mandated reserves not held as vault cash.

Is the Fed independent?

Congress purposely established teh Fed an independent agency of the gov't. This was to protect the Fed from political pressures and effectivly control the money supply and maintain price stability.