Transcript O`Sullivan, Sheffrin, Perez: Economics: Principles, Applications, and

Money and the Banking
System
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,
KYLE THIEL & APARNA SUBRAMANIAN
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
chapter
16.1
WHAT IS MONEY?
• money
Any items that are regularly used in economic
transactions or exchanges and accepted by buyers
and sellers.
Three Properties of Money
MONEY SERVES AS A MEDIUM OF EXCHANGE
• medium of exchange
Any item that buyers give to sellers when they
purchase goods and services.
• barter
The exchange of one good or service for another.
• double coincidence of wants
The problem in a system of barter that one person
may not have what the other desires.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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16.1
WHAT IS MONEY?
Three Properties of Money
MONEY SERVES AS A MEDIUM OF EXCHANGE
MONEY SERVES AS A UNIT OF ACCOUNT
• unit of account
A standard unit in which prices can be stated
and the value of goods and services can be
compared.
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16.1
WHAT IS MONEY?
Three Properties of Money
MONEY SERVES AS A STORE OF VALUE
• store of value
The property of money that it preserves value
until it is used in an exchange.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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chapter
16.1
WHAT IS MONEY?
Different Types of Monetary Systems
• commodity money
A monetary system in which the actual
money is a commodity, such as gold or silver.
• gold standard
A monetary system in which gold backs up
paper money.
• fiat money
A monetary system in which money has no
intrinsic value but is backed by the
government.
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16.1
WHAT IS MONEY?
Measuring Money in the U.S. Economy
• M1
The sum of currency in the hands of the public, demand
deposits, other checkable deposits, and travelers’ checks.
 FIGURE 16.1
Components of M1
for the United States
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16.1
WHAT IS MONEY?
Measuring Money in the U.S. Economy
• M2
M1 plus other assets, including deposits in savings and
loans accounts and money market mutual funds.
 FIGURE 16.2
Components of M2
in the United States
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MORE THAN HALF OF U.S. CURRENCY IS HELD OVERSEAS
APPLYING THE CONCEPTS #1: What fraction of the stock of U.S. currency is held abroad?
According to a report from the U.S. Treasury, between 55 and 60 percent of U.S.
currency outstanding is held abroad.
About 25 percent of the currency held abroad is located in Latin America, 20
percent in Africa and the Middle East, and about 15 percent in Asia. The remaining
40 percent is held in Europe and countries of the former Soviet Union and their
trading partners.
Why do foreigners want to hold U.S. dollars?
• They provide a safe store of value.
• They also provide anonymity to the holder of the currency and are accepted
widely throughout the world.
• As long as the U.S. economy remains strong, there will always be a
worldwide demand for dollars.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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16.2
HOW BANKS CREATE MONEY
A Bank’s Balance Sheet: Where the Money Comes From
and Where It Goes
• balance sheet
An account statement for a bank that shows the
sources of its funds (liabilities) as well as the uses
of its funds (assets).
• liabilities
The sources of funds for a bank, including deposits
and owners’ equity.
• assets
The uses of the funds of a bank, including loans
and reserves.
• owners’ equity
The funds provided to a bank by its owners.
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chapter
16.2
HOW BANKS CREATE MONEY
A Bank’s Balance Sheet: Where the Money Comes From
and Where It Goes
 FIGURE 16.3
A Balance Sheet for a Bank
• reserves
The portion of banks’ deposits set aside in either vault cash or as
deposits at the Federal Reserve.
• required reserves
The specific fraction of their deposits that banks are required by law to
hold as reserves.
• excess reserves
Any additional reserves that a bank holds above required reserves.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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16.2
HOW BANKS CREATE MONEY
How Banks Create Money
• reserve ratio
The ratio of reserves to deposits.
 FIGURE 16.4
Process of Deposit Creation:
Changes in Balance Sheets
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16.2
HOW BANKS CREATE MONEY
How the Money Multiplier Works
• money multiplier
The ratio of the increase in
total checking account
deposits to an initial cash
deposit.
How the Money Multiplier Works in Reverse
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16.3
A BANKER’S BANK: THE FEDERAL RESERVE
• central bank
A banker’s bank: an official bank that
controls the supply of money in a country.
• lender of last resort
A central bank is the lender of last
resort, the last place, all others having
failed, from which banks in emergency
situations can obtain loans.
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16.3
A BANKER’S BANK: THE FEDERAL RESERVE
THE FED SUPPLIES CURRENCY TO THE ECONOMY
THE FED PROVIDES A SYSTEM OF CHECK COLLECTION
AND CLEARING
THE FED HOLDS RESERVES FROM BANKS AND OTHER
DEPOSITORY INSTITUTIONS AND REGULATES BANKS
THE FED CONDUCTS MONETARY POLICY
• monetary policy
The range of actions taken by the
Federal Reserve to influence the level
of GDP or inflation.
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16.3
A BANKER’S BANK: THE FEDERAL RESERVE
The Structure of the Federal Reserve
• Federal Reserve Bank
One of 12 regional banks that are an
official part of the Federal Reserve
System.
 FIGURE 16.5
Locations of the 12 Federal Reserve Banks
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16.3
A BANKER’S BANK: THE FEDERAL RESERVE
The Structure of the Federal Reserve
• Board of Governors of the Federal Reserve
The seven-person governing body of the Federal Reserve System in Washington, D.C.
• Federal Open Market Committee (FOMC)
The group that decides on monetary policy: It consists of the seven members of the Board
of Governors plus five of 12 regional bank presidents on a rotating basis.
 FIGURE 16.6
The Structure of the
Federal Reserve System
The Independence of the Federal Reserve
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TWO RECENT MAJOR LEADERS OF THE FEDERAL RESERVE BOARD
APPLYING THE CONCEPTS #2: Who were the two men who served as chairman of the Federal
Reserve between 1979 to 2006 and what were their principal accomplishments?
The two chairmen before the current chairman,
Benjamin Bernanke, were Paul Volcker, who served
from 1979 to 1987, and Alan Greenspan, who
served from 1987 to 2006. In their day, each was the
country’s major figure in monetary policy.
• Paul Volcker was appointed by President Jimmy Carter, who sought an
established banker to help combat inflation.
• In 1987, President Ronald Reagan appointed Alan Greenspan. Greenspan
was first tested by the 1987 stock market crash and steered the economy
away from a recession. Over the following years, he successfully guided
monetary policy.
• In 1999 and 2000, the Federal Reserve may have tightened
monetary policy prematurely. Nonetheless, Greenspan’s
performance has earned near universal praise, and one author
deemed him the “maestro.’’
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16.4
WHAT THE FEDERAL RESERVE DOES DURING A
FINANCIAL CRISIS
COPING WITH A STOCK MARKET CRASH: BLACK MONDAY, 1987
APPLYING THE CONCEPTS #3: How did the Fed successfully respond to the major stock market
crash in 1987?
On October 19, 1987, known as “Black Monday,” the Dow Jones index of
the stock market fell a dramatic 22.6 percent in one day. Similar declines
were felt in other indexes and stock markets around the world.
• These declines shocked both businesses and investors.
• A sharp drop in available credit could plunge the economy into a
deep recession.
Alan Greenspan had just become chairman of the Federal Reserve that
year.
• He quickly issued a public statement in which he said that the
Federal Reserve stood ready to provide liquidity to the economy
and the financial system.
• The Fed provided liquidity to such an extent that interest rates
even fell.
• Result: “Black Monday” did not cause a recession in the United
States.
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THE FINANCIAL SYSTEM UNDER STRESS: SEPTEMBER 11, 2001
APPLYING THE CONCEPTS #4: How did the Fed manage to keep the financial system in
operation immediately following the attacks on September 11, 2001?
The Fed was tested again on September 11, 2001, following the terrorist attacks
against the United States.
• The first tool that the Federal Reserve used was to allow banks to borrow
more.
• The difference between the credits and the debits extended by the Federal
Reserve is called the “Federal Reserve float.” Immediately following
September 11, the Federal Reserve allowed this float to increase sharply
from $2.9 billion to $22.9 billion.
• The Federal Reserve also purchased government securities in the
marketplace.
Result: Taken together, all these actions increased the credit extended by the
Federal Reserve by over $90 billion. This massive response by the Federal
Reserve prevented a financial panic that could have had devastating effects on the
world economy.
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