The Nature and Creation of Money

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• The Nature and Creation of Money
• Read Chapter 9 pages 184 200.
• I What is Money?
• Money is anything that serves as a medium of
  exchange.

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• B) Three Functions of Money.
• A medium of exchange is anything that is widely
  accepted as a means of payment.
• Barter occurs when goods are exchanged
  directly for other goods.
• A unit of account is a consistent means of
  measuring the value of things.
• 3) A store of value is an item that holds value
  over time.

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• Types of Money
• Commodity money is money that has value apart
  from its use as money.
• Fiat money is money that some authority has
  ordered to be accepted as a medium of exchange.
• Examples
• a) Currency is paper money and coins.
• b) Checkable deposits are balances in
  checking accounts. A check is a written order to
  a bank to transfer ownership of a checkable
  deposit.

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• Measuring Money
• The total quantity of money in the economy at any
  one time is called the money supply.
• Economists refer to the ease with which an asset
  can be converted into currency as the assets
  liquidity.
• M1 consists of currency in circulation, checkable
  deposits and travelers checks.
• 4) M2 is M1 plus small time deposits.

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• II The Banking System and Money Creation
• Banks and other Financial Intermediaries
• A financial intermediary is an institution that
  amasses funds from one group and makes them
  available to another.
• A bank is a type of financial intermediary which
  accepts deposits, makes loans, and offers
  checking accounts.

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• Bank Finance and a Fractional Reserve System
• A balance sheet is a financial statement showing
  assets, liabilities and net worth.
• 2) Assets are anything of value.
• 3) Liabilities are obligations to other parties.
• 4) Net worth equals assets less liabilities.
• 5) Banks keep only a fraction of their deposits
  as cash in their vaults and in deposits with the
  Fed called reserves.

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• 6) A system in which banks hold reserves whose
  value is less than the sum of claims outstanding
  on those reserves is called a fractional reserve
  banking system.

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• C) Money Creation
• The quantity of reserves banks are required to
  hold is called required reserves.
• 2) The reserve requirement is the ratio of
  reserves to checkable deposits.
• 3) Excess reserves are reserves that a bank holds
  in excess of the required level.
• 4) Excess reserves plus required reserves equal
  total reserves.
• 5) When a banks excess reserves are zero, it is
  loaned up.

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• D) Money Creation Illustration
• Bank (Acme Bank) is initially loaned up.
• Next they receive a deposit of 1,000
• The bank has excess reserves of 900.
• So they make a loan for 900 increasing their
  loans and deposits by 900.
• The person who receives the loan buys a stereo
  and writes a check for 900 to someone with an
  account at Bellville Bank.
• 6) Now the steps repeat.

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• E) The Deposit Multiplier
• The deposit multiplier equals the ratio of the
  maximum possible change in checkable deposits to
  the change in reserves.
• Md
• Change in deposits/Change in reserves.
• Md 1/reserve ratio.
• example reserve ratio of .1 implies
  deposit multiplier of 10.

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• F) The regulation of banks.
• Deposits Insurance provided by the FDIC
• Regulated to maintain a minimum level of net
  worth as a fraction of total assets.

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• III The Federal Reserve system
• A central Bank performs four primary functions
• 1) acts as a banker to the government,
• 2) acts as a banker to banks,
• 3) acts as a regulator of banks,
• 4) sets monetary policy.

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• B) Structure of the Fed
• 1) 12 regional branches.
• 2) 7 members of the Board of Governors
  located in Washington.
• 3) Federal Open Market committee consists of
  the 7 BOG members plus 5 regional bank presidents
  who serve on a rotating basis.
• 4) Fed decides policy independent of
  political demands.

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• C) Powers of the Fed
• Set Reserve Requirements.
• 2) Sets the discount rate which is the interest
  rate that banks can borrow from the Fed at on
  overnight loans.
• 3) Targets the Federal Funds rate which is the
  interest rate that banks can borrow from the
  other banks on overnight loans.

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• D) Implementation of Monetary policy
• Carried out by the New York Fed President who is
  a permanent member of the FOMC.
• Done using open market operations which occur
  when the Fed buys and sells federal government
  bonds on the open market.
• E) Impact on the Money Supply.

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