31 Money, Banking, and Financial Institutions McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 13.

31

Money, Banking, and Financial Institutions

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

13

Functions of Money

• Medium of exchange

• Used to buy/sell goods

• Unit of account

• Goods are valued in dollars

• Store of value

• A place to store wealth.

LO1 31-2

Money Definition M1

• M1

• Currency

• Checkable deposits (demand deposits)

• Institutions offering checkable deposits

• Commercial banks

• Savings and loan associations

• Mutual savings banks

• Credit unions

LO1 31-3

Money Definition M2

• M2

•M1 plus near-monies

• Savings deposits including money market deposit accounts (MMDA)

• Small-denominated time deposits

• Money market mutual funds (MMMF)

• What makes these different from M1?

LO1 31-4

Money Definitions

January 2010

Source: Federal Reserve System

LO1 31-5

What “Backs” the Money Supply?

• Guaranteed by government’s ability to keep value stable

• Money as debt

• Why is money valuable?

• Acceptability

• Legal tender – “fiat money:” money because the govt. says its money..

• Relative scarcity

LO2 31-6

The Demand for Money

• Transactions Demand – Dt

• Amount of money needed for purchases, etc.

• Main determinant is nominal GDP.

• Why?

• Asset Demand – Da

• Amount of wealth people want to hold as money (instead of bonds, stocks, whatever).

• It’s main determinant is the interest rate.

LO3 31-8

The Demand for Money

• Total Demand for Money - Dm

• Is the sum of Dt and Da

• Change in nominal GDP will shift the total money demand curve.

• Change in interest rate will cause a movement along the curve.

LO3 31-9

Demand for MoneyR

ate

of

inte

rest

, i p

erce

nt

10

7.5

5

2.5

050 100 150 200 50 100 150 200 50 100 150 200 250 300

Amount of moneydemanded(billions of dollars)

Amount of moneydemanded(billions of dollars)

Amount of moneydemanded and supplied(billions of dollars)

=+

(a)Transactionsdemand formoney, Dt

(b)Assetdemand formoney, Da

(c)Totaldemand formoney, Dm

and supply

Dt Da Dm

Sm

5

LO1 33-10

Interest Rates

• Equilibrium interest rate

• Changes with shifts in money supply and money demand

• Interest rates and bond prices

• Inversely related

• Bond pays fixed annual interest payment

• Lower bond price will raise the interest rate

LO1 33-11

Federal Reserve - Banking System

• Board of Governors

• 12 Federal Reserve Banks

• Serve as the central bank

• Quasi-public banks

• Banker’s bank

LO3 31-12

Federal Reserve – Banking System

LO3

The 12 Federal Reserve Banks

31-13

Federal Reserve Functions

• Issue currency

• Set reserve requirements

• Lend money to banks

• Collect checks

• Act as a fiscal agent for U.S. government

• Supervise banks

• Control the money supply

LO4 31-15

Federal Reserve Independence

• Established by Congress as an independent agency

• Protects the Fed from political pressures

• Enables the Fed to take actions to increase interest rates in order to stem inflation as needed

LO4 31-16