Transcript AP Macro - Sect. 5 PP no bkgdx

Sect. 5 - The Financial Sector
Module 22 - Saving, Investment, and the Financial System
What you will learn:
• The relationship between savings and investment spending
• The purpose of the four principal types of financial assets:
stocks,
bonds, loans and bank deposits
• How financial intermediaries help investors achieve
diversification
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Sect. 5 - The Financial Sector
Module 22 - Saving, Investment, and the Financial System
Savings - Investment Spending Identity Savings and investment spending are always equal for the
economy as a whole
*Total Income = Total Spending
*Total Income = Consumer Spending + Savings
*Total Spending = Consumer Spending + Investment Spending
*Consumer Spending + Savings = Consumer Spending +
Investment Spending
*Savings = Investment Spending
Budget Surplus When tax revenue exceeds government spending
Budget Deficit -
When government spending exceeds tax revenue
National Savings Sum of private savings and the budget balance
- total savings generated in the economy
Capital Inflow Net inflows of funds into a country - includes net exports
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Financial System Where households invest their savings or wealth by
purchasing financial assets
Financial Asset A paper claim that entitles buyer to future income from the
seller - (loans, bonds, stocks, securities)
Physical Asset A claim on a tangible object giving the owner the right to
dispose of as they wish - house, building, equipment
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Three Tasks of a Financial System 1) Reduce Transaction Costs Large sums of money can be borrowed from financial
institutions without incurring large transaction costs
2) Reduce Financial Risk People would not likely take financial risks - financial
system makes it possible to borrow and invest with less risk
Diversification Investing in several different assets to minimize risk
3) Provide Liquidity Because the future is uncertain it may be necessary to
convert assets into cash quickly
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Types of Financial Assets Loans A lending agreement between lender and borrower
- interest is the cost paid for the loan
Bonds An IOU issued by the borrower with a fixed interest
rate and maturity date
- more liquid than loans
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Types of Financial Assets Loans A lending agreement between lender and borrower
- interest is the cost paid for the loan
Bonds An IOU issued by the borrower with a fixed interest
rate and maturity date
- more liquid than loans
Loan-Backed Securities Pooling individual loans together and selling shares in
that pool of loans - mortgages, student loans, credit card
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Stocks A share in ownership of a company - share in the wealth and
profit - used to raise capital and defer risk
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Stocks A share in ownership of a company - share in the wealth and
profit - used to raise capital and defer risk
Financial Intermediaries Institution that transforms the funds gathered from many
individuals into financial assets
Mutual Funds Creates a diversified collection of stocks then resells
shares to individual investors - lower risk
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Pension Funds & Life insurance Companies Pension Fund - retirement version of mutual fund
Life Insurance Co. - sell policies that guarantee
payment to beneficiaries
Banks Allow liquidity for depositors as well as loans from deposits
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Module 23 - The Definition and Measurement of Money
What you will learn:
• The definition and functions of money
• The various roles money plays and the many forms it takes
in the economy
• How the amount of money in the economy is measured
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Module 23 - The Definition and Measurement of Money
Money Any asset that can easily be used to purchase goods and
services - currency or other highly liquid assets like bank deposits
Role of Money Medium of Exchange -
An asset used to trade for goods & services
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Module 23 - The Definition and Measurement of Money
Money Any asset that can easily be used to purchase goods and
services - currency or other highly liquid assets like bank deposits
Role of Money Medium of Exchange -
An asset used to trade for goods & services
Store of Value It holds purchasing power over time
Unit of Account A standard measure to set prices and make economic
calculations
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Types of Money Commodity Money A good that has intrinsic value like gold or silver
Commodity Backed Money Has no intrinsic value but is backed by a valuable good
like gold or silver
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Types of Money Commodity Money A good that has intrinsic value like gold or silver
Commodity Backed Money Has no intrinsic value but is backed by a valuable good
like gold or silver
Fiat Money Money whose value is derived only from its official
status as a means of exchange - US currency
- does not tie up resources and supply is based on need
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Measuring the Money Supply Two monetary aggregates calculated by The Federal Reserve
M1 = Only cash, travelers checks, and checkable bank deposits
- $1,676.4 trillion ( 51% cash, 48% checking, 1% trav. checks)
M2 = M1 + Near Moneys
(liquid - savings accounts, CDs, money market)
- $8,462.9 trillion
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Module 24 - The Time Value of Money
What you will learn:
• Why a dollar today is worth more than a dollar a year from now
• How present value can help you make decisions when costs or
benefits come in the future
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Module 24 - The Time Value of Money
Borrowing, Lending, and Interest The cost for borrowed money is interest
- a percentage of the money we borrow paid over time
$X x (1+r )
Ex: $500 x (1 + 0.08) = $500 x 1.08 = $540
Present Value -
What is the value of a dollar today as compared to the value of
that dollar in the future
$X / (1+r )
Ex: $540 / (1 + 0.08) = $540 / 1.08 = $500
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Net Present Value The present value of current and future benefits minus
the present value of current and future costs
*Best option is the one with the highest net present value
Module 25 - Banking and Money Creation
What you will learn:
• The role of banks in the economy
• The reasons for and types of banking regulations
• How banks create money
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Module 25 - Banking and Money Creation
The Monetary Role of Banks Banks use liquid assets from deposits to finance the
investments of borrowers
Bank Reserves Banks cannot lend out all deposits - reserves are held at the
bank or with The Federal Reserve - part of M2
T-Accounts A table showing the assets and liabilities of a business or bank
- used to analyze a businesses financial situation
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Module 25 - Banking and Money Creation
The Monetary Role of Banks Banks use liquid assets from deposits to finance the
investments of borrowers
Bank Reserves Banks cannot lend out all deposits - reserves are held at the
bank or with The Federal Reserve - part of M2
T-Accounts A table showing the assets and liabilities of a business or bank
- used to analyze a businesses financial situation
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Required Reserve Ratio % of deposits banks must hold in reserve and cannot loan out
Bank Run -
When many depositors try to withdraw their funds at the same
time - caused by a panic or fear of financial trouble
Bank Run
Bank Regulation Deposit Insurance - 1933
The FDIC (Federal deposit Insurance Corporation)
insures deposits up to $250,000
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Required Reserve Ratio % of deposits banks must hold in reserve and cannot loan out
Bank Run -
When many depositors try to withdraw their funds at the same
time - caused by a panic or fear of financial trouble
Bank Run
Bank Regulation Deposit Insurance - 1933
The FDIC (Federal deposit Insurance Corporation)
insures deposits up to $250,000
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Capital Requirements Banks are required to have capital of at least 7% of total
assets in addition to required reserves
Discount Window Banks can borrow money from The Federal Reserve at
the “discount rate” if necessary
How Banks Create Money Monetary Base Total of currency in circulation plus bank reserves
- is controlled by The Federal Reserve
Capital Requirements Banks are required to have capital of at least 7% of total
assets in addition to required reserves
Discount Window Banks can borrow money from The Federal Reserve at
the “discount rate” if necessary
How Banks Create Money Monetary Base Total of currency in circulation plus bank reserves
- is controlled by The Federal Reserve
Money Multiplier The total number of dollars created in the banking system for
each additional dollar added to the monetary base
Multiplier = 1/ rr
Ex #1: If rr = .10 then
1/ .10 = 10 x $1000 = $10,000 addition to the Money Supply
Ex #2: If rr = .05 then
1/ .05 = 20 x $1000 = $20,000 addition to the Money Supply
Module 26 - The Federal Reserve System: History & Structure
What you will learn:
• The history of The Federal Reserve System
• The structure of The Federal Reserve System
• How The Federal Reserve responds to major financial crises
Module 26 - The Federal Reserve System: History & Structure
The Creation of The Federal Reserve The central bank of the United States that oversees the
banking system and controls the monetary Base (money supply)
- Created in 1913 to help control financial crises - given the sole
power to issue currency
Structure of the Federal Reserve Board of Governors:
- Seven members appointed by the president for 14 year terms
- Chair(man) appointed every 4 years - Janet Yellen
Module 26 - The Federal Reserve System: History & Structure
The Creation of The Federal Reserve The central bank of the United States that oversees the
banking system and controls the monetary Base (money supply)
- Created in 1913 to help control financial crises - given the sole
power to issue currency
Structure of the Federal Reserve Board of Governors:
- Seven members appointed by the president for 14 year terms
- Chair(man) appointed every 4 years - Janet Yellen
- 12 regional Federal Reserve Banks provide banking services and
supervise the banks in their region
- 12 regional Federal Reserve Banks provide banking services and
supervise the banks in their region
The Federal Reserve Bank of New York carries out open-market
operations and holds more gold than anywhere on earth
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- 12 regional Federal Reserve Banks provide banking services and
supervise the banks in their region
The Federal Reserve Bank of New York carries out open-market
operations and holds more gold than anywhere on earth
Federal Reserve
Commercial Banks Accepts deposits, make loans, and is covered by FDIC
(Federal Deposit Insurance Corporation)
Investment Banks Trades in financial assets and is NOT covered by FDIC
Savings & Loans (thrifts) Deposit-taking bank, usually specializing in home loans
Savings & Loan Crisis of the 1980s High inflation of late 70s lowered value of S&L assets and
discouraged public from investing in low-interest paying S&Ls
Congress de-regulated S&Ls allowing them to undertake more
risky and long term investments - by early 1980s many had failed
- FDIC paid over $124 billion - caused recession
Financial Crisis of 2008 Low interest rates caused a housing boom making subprime
mortgage loans seemed safe
- financial institutions sold shares in pools of mortgages.
- when housing prices fell many defaulted on their mortgages and
investors took heavy losses - investment companies failed
Module 27 - The Federal Reserve System: Monetary Policy
What you will learn:
• The function of The Federal Reserve System
• The tools the Federal Reserve uses to serve its functions
Module 27 - The Federal Reserve System: Monetary Policy
Functions of the Fed. Provide Financial Services -
Holds bank reserves, clears checks, provides cash, is the
bank for the U.S. Government
Regulate Banking Institutions Regulates and supervises the banks within each region
Maintain Stability of the Financial System Maintains the integrity and stability of the financial system
Conduct Monetary Policy Control extreme fluctuations in the economy
The Reserve Requirement Minimum percent of deposits that banks must hold on reserve
with the Fed. - face penalties if not maintained
Federal Funds Market Allows banks to borrow reserves from banks with excess
reserves at a set interest rate
Federal Funds Rate Interest rate set by the Fed for banks to borrow in the
Federal Funds Market
The Discount Rate -
The interest rate the Fed charges banks on loans through the
discount window
Open-market Operations The Fed’s assets consists of short term Govt. bonds known as
U.S. Treasury Bills
The Fed buys or sells Treasury Bills (from commercial banks)
- These transactions start the money multiplier in motion which
increases or decreases the money supply
Open-market Operations The Fed’s assets consists of short term Govt. bonds known as
U.S. Treasury Bills
The Fed buys or sells Treasury Bills (from commercial banks)
- These transactions start the money multiplier in motion which
increases or decreases the money supply
Module 28 - The Money Market
What you will learn:
• What the the money demand curve is
• Why the Liquidity Preference Model determines the interest rate
in the short run
Module 28 - The Money Market
The Demand for Money Firms and individuals want to hold a certain amount of money
at any given time - what determines how much?
Module 28 - The Money Market
The Demand for Money Firms and individuals want to hold a certain amount of money
at any given time - what determines how much?
Short-term Interest Rates Interest rates on financial assets that mature in a year or less
Long-term Interest Rates Interest rates on financial assets that mature a number of years
in the future
Money Demand Curve Relationship between the interest rate and the quantity of
money demanded by the the public
Module 28 - The Money Market
The Demand for Money Firms and individuals want to hold a certain amount of money
at any given time - what determines how much?
Short-term Interest Rates Interest rates on financial assets that mature in a year or less
Long-term Interest Rates Interest rates on financial assets that mature a number of years
in the future
Money Demand Curve Relationship between the interest rate and the quantity of
money demanded by the the public
Shifts of Money Demand Curve Money demand curve shifts just like ordinary demand curve
- more or less money demanded at all interest rates
Shifts of Money Demand Curve Money demand curve shifts just like ordinary demand curve
- more or less money demanded at all interest rates
Changes in Aggregate Price Level Demand for money is proportional to the change in price
level - prices increase 10%, demand for money increases 10%
Changes in Real GDP The greater the quantity of goods and services produced and
sold - the greater the money demand
Changes in Technology -
ATMs, on-line transactions, debit cards, etc. make it less
necessary to hold cash - shifts curve ???
Changes in Institutions Demand shifts as banking regulations change allowing banks
to offer more options and interest bearing assets
Liquidity Preference Model of the Interest Rate The interest rate is determined by the supply and demand for
money - equilibrium interest rate
Money Supply Curve The quantity of money supplied by the Fed. - Supply Curve is
vertical because the amount is chosen by the Fed.
Changes in Institutions Demand shifts as banking regulations change allowing banks
to offer more options and interest bearing assets
Liquidity Preference Model of the Interest Rate The interest rate is determined by the supply and demand for
money - equilibrium interest rate
Money Supply Curve The quantity of money supplied by the Fed. - Supply Curve is
vertical because the amount is chosen by the Fed.
Module 29 - The Market for Loanable Funds
What you will learn:
• How the loanable funds market matches savers and investors
• The determinates of supply and demand in the loanable funds
market
• How the two models of interest rates can be reconciled
Module 29 - The Market for Loanable Funds
Loanable Funds Market A simplified hypothetical market that brings together those who
want to lend money and those who want to borrow money
- determines the interest rate (r)
Rate of Return Profit earned on a project expressed as a percentage of its cost
Revenue from Project - Cost of project
Rate of Return =
X 100
Cost of project
500,000 - 465,000
Ex:
= .075 x 100 = 7.5%
465,000
Businesses will want to borrow when rate of return is greater than
or equal to the interest rate
Module 29 - The Market for Loanable Funds
Loanable Funds Market A simplified hypothetical market that brings together those who
want to lend money and those who want to borrow money
- determines the interest rate (r)
Rate of Return Profit earned on a project expressed as a percentage of its cost
Revenue from Project - Cost of project
Rate of Return =
X 100
Cost of project
500,000 - 465,000
Ex:
= .075 x 100 = 7.5%
465,000
Businesses will want to borrow when rate of return is greater than
or equal to the interest rate
Shifts of Demand for Loanable Funds The equilibrium interest rate changes when there is a shift in
the demand curve for loanable funds
Changes in Business Opportunities A change in expectations about the rate of return on
investment spending will shift the demand curve
Changes in Govt. Borrowing When Govt. deficit increases or decreases it increases or
decreases borrowing which shifts the demand curve
Shifts of Demand for Loanable Funds The equilibrium interest rate changes when there is a shift in
the demand curve for loanable funds
Changes in Business Opportunities A change in expectations about the rate of return on
investment spending will shift the demand curve
Changes in Govt. Borrowing When Govt. deficit increases or decreases it increases or
decreases borrowing which shifts the demand curve
Crowding out -
Govt. deficit increases the interest rate which causes
businesses to decrease investment spending
Shifts of the Supply of Loanable Funds Changes in Private Savings As savings increase, the available funds to loan increases
- as savings decrease, available funds to loan decreases
Changes in Capital Inflows As foreign investment in U.S. markets changes
- this changes available funds to loan
Shifts of the Supply of Loanable Funds Changes in Private Savings As savings increase, the available funds to loan increases
- as savings decrease, available funds to loan decreases
Changes in Capital Inflows As foreign investment in U.S. markets changes
- this changes available funds to loan
Inflation and Interest Rates The true cost of borrowing is the real interest rate, not the
nominal interest rate
Real interest rate = Nominal interest rate - Inflation rate
- Expectations about future inflation shifts demand and supply
Fisher Effect An increase in expected future inflation drives up the nominal
interest rate
Fisher Effect An increase in expected future inflation drives up the nominal
interest rate
Interest Rate in the Short-run Increase in the money supply leads to a fall in the interest rate
- Decrease in money supply leads to an increase in interest rate
Fisher Effect An increase in expected future inflation drives up the nominal
interest rate
Interest Rate in the Short-run Increase in the money supply leads to a fall in the interest rate
- Decrease in money supply leads to an increase in interest rate
Interest Rate in the Long-run A change in the money supply does not effect the interest rate
in the long run
- long-run interest rate is determined by the supply and demand
for
loanable funds
Fisher Effect An increase in expected future inflation drives up the nominal
interest rate
Interest Rate in the Short-run Increase in the money supply leads to a fall in the interest rate
- Decrease in money supply leads to an increase in interest rate
Interest Rate in the Long-run A change in the money supply does not effect the interest rate
in the long run
- long-run interest rate is determined by the supply and demand
for
loanable funds
The End
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