Chapter 13: Money, Banks, and the Federal Reserve
How many members are apart of the Fed's Board of Governors? How long are their terms?
there are 7 members and each serves for 14 years
what is the main function of depository institutions?
they accept deposits from the general public and then lend deposits to borrowers
how do brokering services earn profit?
they charge a higher interest rate on the funds they lend than the interest rate they pay to savers
what does it mean for a bank to be fully loaned up?
this means a bank has no excess reserves
what is the purpose of banks having accounts with the Federal Reserve?
to have an account (at a very low interest rate) that they can add to or subtract from when making transactions with other banks
what is the purpose of the Fed's regulation of banks?
to keep the rate of bank failure low
what is the most common cause of bank insolvency?
when households or businesses that borrowed from the bank declare bankruptcy
what are the most basic checking accounts?
demand deposits
why type of checking account pays no interest?
demand deposits
what is the money supply? what does the US money supply consist of?
the total amount of money held by the public US money supply = cash in the hands of the public + checkable deposits + travelers checks
who benefits from efficient brokering services? how?
-both savers and borrowers benefit -savers benefit because they earn a higher interest rate, have a lower risk, and have easier access to funds on short notice (through a brokering service) -borrowers benefit because they pay lower interest rates on loans that are specially designed for a specific purpose
what are the functions of financial intermediaries?
-assemble loanable funds and then channel them -reduce risk to savers/lenders by spreading loans among many borrowers
what are the impacts of the creation of the Federal Deposit Insurance Corporation (FDIC)?
-essentially caused the end of banking panics -major impact on the psychology of the banking public -can make bank failures more likely because this leads to more risky lending by banks -if the FDIC runs out of funds themselves, they have to borrow from the US Treasury, causing a burden on taxpayers
what are the purposes of holding excess reserves, as opposed to loaning them out?
-flexibility to increase amount loaned out -cushion if interest rates rise -cushion during recessions (when borrowers are more likely to declare bankruptcy)
what are the impacts of banking panics?
-hardship suffered by people that lose their accounts -decreases the banking system's reserves -decrease in the money supply
how do commercial banks profit?
-loan interest -profit made on direct services (like check-printing or ATM fees)
what are the main differences in bank and non-banks?
-non-banks are less strictly regulated -non-banks have no government-guaranteed deposits
what are the impacts of a higher capital ratio?
-provides greater incentive for banks to avoid risky loans -reduces risk of bank failure -reduces the amount of interest-earning assets a bank can hold for each $ of capital that the owners invested (reduces rate of return to bank owners, decreasing incentive to invest in or open banks)
what is the relationship between the Federal Reserve and the government?
-the Fed is not a part of the government -the Fed was created by Congress -Congress could eliminate the Fed -both the President and Congress exert influence over the Fed by appointing key officials within the Fed's system
how does the M1 money supply differ from the M2 money supply?
-the M2 money supply is much larger than M1 -the M2 money supply additionally includes savings deposits, money market deposits, and money market funds
what is shareholders' equity?
-the difference between total assets and total liabilities -included on the liabilities side of a balance sheet because it is what a bank would "owe" to its owners if it went out of business
what are other actions, besides open market purchases or sales, that the Fed can do to change the money supply?
1. change the required reserve ratio -if the Fed raises the RRR, banks are required to have more reserves on hand, meaning they need to reduce their outstanding loans, overall decreasing the money supply 2. changes in the discount rate -a lower discount rate (enabling banks to borrow more cheaply) encourages more borrowing, increasing the money supply 3. changes in the interest rate on reserves -if the IOR is lowered, the opportunity cost of keeping reserves at the Fed is higher, increasing incentive to lend out reserves, increasing the money supply
what are the 2 provisos about the behavior of the public and of banks that can reduce the value of the money multiplier?
1. changes in the public's cash holdings -as the money supply increases, people want to hold part of the increase in their accounts, but also want to hold part of it in cash (holding in cash reduces value of multiplier) 2. increased reserve holdings -when banks hold on to some of their excess reserves instead of loaning out all of their excess, the multiplier is smaller
what are the 3 categories of bank liabilities we covered?
1. checking account deposits -assets for households or business, but liabilities for banks because the bank's customers have the right to withdraw funds from their checking accounts whenever they want 2. other deposits -funds that households and firms hold at the bank in some form other than checking accounts 3. bank borrowing -funds borrowed via loans from other banks
what are the 3 functions of money?
1. means of payment (higher efficiency than bartering) 2. it is a store of value (is a form in which wealth can be held for later use) 3. it is a unit of account (is a common unit for measuring how much something is worth, allowing the comparison of costs and to communicate costs when trading)
what are the 4 characteristics that all non-banks in the shadow banking system share?
1. short-term liabilities -different than those of banks because these aren't customer deposits, but instead are funds that are borrowed (from banks, funds, households, etc) 2. long-term assets 3. do not include government-insured deposits 4. not closely regulated by the government
what are the 4 characteristics all banking systems share?
1. short-term liabilities -most of the funds that come into the bank can be demanded back on short-term notice (is what entices depositors to put their funds in a bank in the first place) 2. long-term assets -the assets the bank acquires (when it lends) pay off over long periods of time -primarily how banks earn income because borrowers pay relatively high interest to borrow long-term 3. liabilities include government-insured deposits 4. close regulation by the government
what are the 6 functions of the Fed?
1. supervising and regulating banks -establishes the required reserve ratio -determines what loans and investments are allowed -closely monitors all activites of all banks 2. acting as a "bank for banks" -banks hold most of their reserves in reserve accounts with the Fed, which the Fed pays interest on -banks can borrow from the Fed at the discount rate 3. issuing paper currency -puts currency into circulation (controls the money supply) but doesn't acutally print money 4. check clearing -transferring funds from one bank's reserve system to another bank's (used when payments are being made between individuals who use different banks) 5. guiding the macroeconomy -aim of the Fed is to keep the economy as close to potential output as possible 6. dealing with financial crises -goes into overdrive in times of crisis -is the "lender of last resort" to make sure banks have enough reserves to meet their obligations to depositors
what is the M1 money supply?
M1 money supply = cash in the hands of the public + checkable deposits + travelers checks
what is the M2 money supply?
M2 money supply = M1 money supply + other deposit types that can be turned into cash or checking deposits with ease
How does the FOMC exert control over the monetary supply?
They change the money supply and influence the interest rates by buying and selling government bonds in the public ("open") bond market
what is the central rule about assets and liabilities on a bank's balance sheet?
a balance sheet always balances- total assets always equal total liabilities
what are the consequences of a fractional reserve system?
a bank wouldn't be able to meet claims of all it's depositors at once under this system -responsible for the problems of banks & other financial institutions throughout most of history
what is a capital ratio?
a bank's capital (shareholders' equity) as a percentage of its total assets
what is a financial intermediary?
a business firm that specializes in brokering between savers and borrowers
What is the Federal Open Market Committee (FOMC)?
a committee of Federal Reserve officials that establishes US monetary policy
what is a balance sheet?
a financial statement showing assets, liabilities, and shareholders' equity at a point in time
what is a central bank?
a nation's principal monetary authority responsible for controlling the money supply
what is a commercial bank?
a private corporation, owned by its stockholders, that services the public
what is a bond?
a promise to pay back borrowed funds, issued by a corporation or government agency
what is a loan?
a promise to pay back borrowed funds, signed by a household or non-corporate business
what is a banking panic?
a situation where fearful depositors attempt to withdraw funds from many banks simultaneously
what is a means of payment?
anything that's acceptable as payment for goods and services
about how many of the commerical banks in the United States are members of the Federal Reserve System?
about 1/3
what are checkable deposits?
accounts held by households and firms at commercial banks
how many national banks and state banks are members of the Federal Reserve System?
all national banks and about 1000 state banks are a part of the Fed's system
what is money?
an asset that's widely accepted as a means of payment in the economy
what is a run on the bank?
an attempt by many of a bank's depositors to withdraw their funds
what is the term for when the Fed buys government bonds?
an open market purchase
what is the term for when the Fed sells government bonds?
an open market sale
what is bank capital?
another name for shareholders' equity
what are assets? what are the 5 categories included in a bank's assets?
assets are everything of value owned 1. property and buildings 2. government and corporate bonds 3. loans 4. cash in vault and ATMs 5. cash in accounts with the Federal Reserve
what is the equation for the change in money supply when the Fed buys or sells government bonds?
change in money supply = 1/RRR * change in reserves
what is the largest group of depository institutions?
commerical banks
what does the term insolvent mean?
condition of a firm (a bank) when their total liabilities are greater than total assets -shareholders' equity is negative in this situation
what is cash in the hands of the public?
currency and coins held by the non-bank public
what are non-bank financial intermediaries?
financial institutions that aren't banks but that channel funds from savers to borrowers
in what situation would the injection of reserves not increase the money supply?
if banks didn't loan out their excess reserves
what are automatic transfers from savings accounts?
interest-paying savings accounts that automatically transfer funds into demand deposit accounts as you write checks
how many districts is the Federal Reserve divided into?
there are 12 Federal Reserve districts, each one served by its own Federal Reserve Bank
what is commodity money?
means of payment with other important uses than this menas (has intrinsic value)
what is an open market operation?
purchases or sales of government bonds by the Federal Reserve System
how does a non-bank deal with the disparity between its long-term assets and short-term liabilities?
reliance on the ability to roll over their short-term debts- non-banks pay back what is due each day with new short-term borrowing
what are reserves?
reserves = cash in vaults and ATMs + cash in accounts with the Fed
what are excess reserves?
reserves in excess of required reserves
what is an asset?
something of value that's owned by someone
what is fiat money?
something that serves as means of payment by government declaration
what are traveler's checks?
specially printed checks that can be bought from banks or other private companies
what is the fractional reserve system?
system in which banks hold only afraction of their deposit liabilities as reserves
what are the impacts of the Fed making an open market purchase?
the Fed buying bonds in the secondary market causes: -*injection of money in reserves* into the banking system -increase in the money supply because in addition to paying for the bond (added to reserves), this is added to the bank's liabilities side as an addition in checking accounts (owed to the Fed)
what is the central bank of the United States?
the Federal Reserve System
what are liabilities?
the amounts of everything owed
who is the most powerful member of the Board of Governors?
the chairman of the Board
what is a shadow banking system?
the entire collection of non-bank financial intermediaries
what is the discount rate?
the interest rate the Fed charges on loans to banks
what are required reserves?
the minimum amount of reserves a bank must hold, depending on the amount of its deposit liabilities
what is the required reserve ratio?
the minimum fraction of checking account balances that banks must hold as reserves -the RRR is set by the Fed
what is the Federal Reserve System?
the monetary authority of the United States, charged with creating and regulating the nation's supply of money -is not a part of the government
what is the money multiplier?
the multiple by which the money supply changes after a change in reserves -depends on the value of the RRR
what is the most important service of commercial banks?
the provision of checking accounts