Money, Banking, and Central Banking. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 15-2 Introduction Why is the Federal Reserve System.

Money, Banking, and Central Banking

Copyright © 2008 Pearson Addison Wesley. All rights reserved. 15-2

Introduction

Why is the Federal Reserve System clearing fewer checks, and what is its role in our nations financial system?

In this chapter you will learn the answers, but first you will learn more generally about money and banking.


Learning Objectives

• Define the fundamental functions of money

• Identify key properties that any goods that function as money must possess

• Explain official definitions of the quantity of money in circulation


Learning Objectives (cont'd)

• Understand why financial intermediaries such as banks exist

• Describe the basic structure of the Federal Reserve System

• Discuss the major functions of the Federal Reserve


Chapter Outline

• The Functions of Money

• Liquidity

• Monetary Standards, or What Backs Money

• Defining Money

• Financial Intermediation and Banks

• Banking Structures Throughout the World

• The Federal Reserve System


Did You Know That...

• Money includes not only coins and dollar bills, but also the balance in your checking account?

• Anything widely accepted in exchange for items of value is considered to be money?


Money

• Money

Any medium that is universally accepted in an economy both by sellers of goods and services and by creditors as payment for debts


Table 15-1 Types of Money


The Functions of Money

• The functions of money

Medium of exchange

Unit of accounting

Store of value (purchasing power)

Standard of deferred payment


The Functions of Money (cont'd)

• Medium of Exchange Any item that sellers will accept

as payment

• Barter The direct exchange of goods and services

for other goods and services without the use of money



• Medium of exchange Money facilitates exchange by reducing

transaction costs associated with means-of-payment uncertainty.Permits specialization, facilitates efficiencies

• Barter Simply a direct exchange

Double coincidence of wants



• Unit of Accounting

A measure by which prices are expressed

The common denominator of the price system

A central property of money



• Store of Value

The ability to hold value over time

A necessary property of money

Money allows you to transfer value (wealth) into the future.



• Standard of Deferred Payment

A property of an item that makes it desirable for use as a means of settling debts maturing in the future

An essential property of money


Liquidity

• Liquidity

The degree to which an asset can be acquired or disposed of without much danger of any intervening loss in nominal value and with small transaction costs

Money is the most liquid asset.


Figure 15-1 Degrees of Liquidity


Liquidity (cont'd)

• Question What is the cost of holding money (its

opportunity cost)?

• Answer It is the alternative interest yield obtainable

by holding some other asset.


Monetary Standards,or What Backs Money

• Questions What backs money?

Is it gold, silver, or the federal government?

• Answer Your confidence


Defining Money

• Money is important Changes in the rate at which the money supply

increases or decreases affect important economic variables (at least in the short run) such as inflation, interest rates, employment, and the level of real GDP.

• Money Supply The amount of money in circulation


Defining Money (cont'd)

• Economists use two basic approaches to define and measure money.

The transactions approach

The liquidity approach


Defining Money (cont'd)

• Transactions Approach A method of measuring the money

supply by looking at money as a medium of exchange

• Liquidity Approach A method of measuring the money supply

by looking at money as a temporary store of value


Financial Intermediation and Banks

• Most nations have a banking system that encompasses two types of institutions.

1. One type consists of private banking institutions.

2. The other type of institution is a central bank.


Financial Intermediation and Banks (cont'd)

• Central Bank

A banker’s bank, usually an official institution that also serves as a country’s treasury’s bank

Central banks normally regulate commercial banks.



• Direct finance Individuals purchase bonds from

a business

• Indirect finance Individuals hold money in a bank

The bank lends the money to a business



• Financial Intermediation

The process by which financial institutions accept savings from businesses, households, and governments and lend the savings to other businesses, households, and governments


Banking Structures Throughout the World

• The ways that banks around the world differ Size

United States has banks of various sizes Europe and Japan have a few large banks

Legal Universal banking Limits on financial services such as insurance and bank

stock ownership

Importance in financial system Major importance Part of a varied financial system (United States)


Banking Structures Throughout the World (cont'd)

• Central banks and their roles

1. Perform banking functions for their nations’ governments

2. Provide financial services for private banks

3. Conduct their nations’ monetary policies


The Federal Reserve System

• The Fed

The Federal Reserve System; the central bank of the United States

The most important regulatory agency in the U.S. monetary system

Established in 1913 by the Federal Reserve Act


The Federal Reserve System (cont'd)

• Organization of the Fed

Board of Governors7 members, 14-year terms

Federal Reserve Banks (12 Districts)25 branches

Federal Open Market Committee (FOMC)BOG plus 5 presidents of district banks


Figure 15-7 The Federal Reserve System



• Depository institutions 7,500 commercial banks

1,300 savings and loans

11,000 credit unions

• All may purchase Fed services



• Functions of the Fed

1. Supplies the economy with fiduciary currency

2. Provides a payment-clearing system

3. Holds depository institutions’ reserves

4. Acts as the government’s fiscal agent

5. Supervises depository institutions

6. Acts as a “lender of last resort”

7. Regulates the money supply


Summary Discussion of Learning Objectives

• The key functions of money

1. Medium of exchange

2. Unit of accounting

3. Store of value

4. Standard of deferred payment

• Important properties of goods that serve as money Acceptability, confidence, and predictable value


Summary Discussion of Learning Objectives (cont'd)

• Major functions of the Federal Reserve

Supply the economy with currency

Provide systems for transmitting and clearing payments

Holding depository institutions’ reserves

Acting as the government’s fiscal agent

Supervising banks

Acting as a “lender of last resort”

Regulating the money supply

Intervening in foreign exchange markets

Money, Banking, and Central Banking. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 15-2 Introduction Why is the Federal Reserve System.

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