Transcript Money

392
Money
393
What is Money?
• Money is any commodity or token that is
generally acceptable as the means of
payment.
• A means of payment is a method of settling
a debt.
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What is Money?
• Other functions of Money
1) Medium of exchange
2) Unit of account
3) Store of value
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What is Money?
• Medium of Exchange
• A medium of exchange is an object that is
generally accepted in exchange for goods and
services.
• Without money, people would have to exchange
goods for goods, or barter.
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What is Money?
• Unit of Account
• A unit of account is an agreed measure for
stating the prices of goods and services.
• This simplifies value comparisons and purchase
decision making if all prices are expressed using a
uniform measure.
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The Unit of Account Functions of
Money Simplifies Price Comparisons
Good
Price in
money units
Price in units
of another good
Movie
$6.00 each
2 six-packs of soda
Soda
$3.00 per six-pack
2 ice-cream cones
Ice cream
$1.50 per cone
3 packs of jelly beans
Jelly beans
$0.50 per pack
2 cups of coffee
Coffee
$0.25 per cup
1 local phone call
398
What is Money?
• Store of Value
• A store of value is any commodity or token that
can be held and exchanged later for goods and
services.
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What is Money?
• Money in the United States Today
• Money in the U.S. consists of:
• Currency
• Deposits at banks and other financial institutions
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What is Money?
• Money in the United States Today
• Currency is the bills and coins that we use.
• Deposits are also money because they can be
converted into currency and are used to settle
debts.
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What is Money?
• Official Measures of Money
1) M1 consists of currency and traveler’s
checks plus checking deposits.
• Includes accounts held by individuals and
businesses, but does not include currency held by
banks, or currency and checking deposits owned by
the U.S. government
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What is Money?
• Official Measures of Money
2) M2 consists of M1 plus saving deposits
and time deposits
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What is Money?
• Official Measures of Money
3) M3 consists of M2 plus large-scale time
deposits and term deposits
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Two Measures of Money
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What is Money?
• Are M1 and M2 Really Money?
• The test of whether an asset is money is
whether it serves as a means of payment.
• Currency does so
• Checking deposits are money because they can be
transferred by writing a check.
• M1 is money
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What is Money?
• Are M1 and M2 Really Money
• Some savings deposits are readily accessible
and can be used as a means of payment.
• Other deposits are less liquid.
• Liquidity is the property of being instantly
convertible into a means of payment with little loss
in value.
• M2 is money
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What is Money?
• Other Points Regarding Money
1) Deposits are money but checks are not.
2) Credit cards are not money.
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Financial Intermediaries
• Financial intermediaries are firms that take
deposits from households and firms and
makes loans to other households and firms.
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Financial Intermediaries
• Four Types of Financial Intermediaries
1) Commercial banks
2) Savings and loan associations
3) Savings banks and credit unions
4) Money market mutual funds
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Financial Intermediaries
• Commercial Banks
• A commercial bank is a firm, licensed by the
Comptroller of the Currency or by a state
agency to receive deposits and make loans.
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Financial Intermediaries
• Commercial Banks
• Their balance sheet lists their assets, liabilities,
and net worth.
• The assets are what the bank owns
• The liabilities are what the bank owes
• These include deposits
• Net worth is the difference between assets and
liabilities.
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Financial Intermediaries
• Commercial Banks
• Their balance sheet is described by the
following formula:
Liabilities + Net Worth = Assets
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Financial Intermediaries
• Profit and Prudence: A Balancing Act
• Banks attempt to maximize the net worth of
their stockholders
• They earn profit by lending at a higher interest rate
than they borrows
• Lending is risky
• Banks must be prudent in how they uses their
deposits
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Financial Intermediaries
• Reserves and Loans
• Banks divide their funds into two parts:
• Reserves are cash in a bank’s vault plus its deposits
at Federal Reserve banks
• Loans
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Financial Intermediaries
• Three Types of Assets Held by Banks
1) Liquid assets are U.S. government Treasury
bills and commercial bills
2) Investment securities are longer-term
U.S. government bonds and other bonds
3) Loans are commitments of fixed amounts of
money for agreed- upon periods of time
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Financial Intermediaries
• Savings and Loan Associations
• A savings and loan association is a financial
intermediary that receives checking deposits
and savings deposits and that makes personal,
commercial, and home-purchase loans.
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Financial Intermediaries
• Savings Banks and Credit Unions
• A savings bank (mutual savings bank) is a
financial intermediary owned by its depositors
that accepts deposits and makes mostly homepurchase loans.
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Financial Intermediaries
• Savings Banks and Credit Unions
• A credit union is a financial intermediary
owned by its depositors that accepts savings
deposits and makes mostly consumer loans.
• The key difference between savings banks and
credit unions is that credit unions are owned by a
social or economic group such as a firm’s
employees.
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Financial Intermediaries
• Money Market Mutual Funds
• A money market mutual fund is a financial
institution that obtains funds by selling shares
and uses these funds to buy highly liquid assets
such as U.S. Treasury bills
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Financial Intermediaries
• The Economic Functions of Financial
Intermediaries
1) Creating Liquidity
2) Minimizing the cost of borrowing
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Financial Intermediaries
• The Economic Functions of Financial
Intermediaries
3) Minimizing the cost of monitoring
borrowers
4) Pooling Risk
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Financial Regulation,
Deregulation, and Innovation
• Financial Innovation
• Financial innovation is the development of new
ways of borrowing and lending.
• Primary aim is to increase the profit from financial
intermediation
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Financial Regulation,
Deregulation, and Innovation
• The three main influences on financial
innovation are:
1) Economic environment
2) Technology
3) Regulation
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Financial Regulation,
Deregulation, and Innovation
• Financial Innovations
•
•
•
•
Variable interest rate mortgages
Widespread credit card usage
Rise in the importance of the Eurodollar
Paying interest on checkable deposits
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How Banks Create Money
• Reserves: Actual and Required
• The reserve ratio is the fraction of a bank’s total
deposits that are held in reserves.
• The required reserve ratio is the ratio of
reserves to deposits that banks are required, by
regulation, to hold.
• Excess reserves are actual reserves minus
required reserves.
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How Banks Create Money
• Creating Deposits by Making loans in a
One-Bank Economy
Let’s see an example of how
banks create money.
Creating Money at the
One-and-Only Bank
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Balance sheet on January 1
Assets
(millions of dollars)
Liabilities
(millions of dollars)
Reserves
$100
Loans
$300
Total
$400
Deposits
$400
Total
$400
Creating Money at the
One-and-Only Bank
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Balance sheet on January 2
Assets
(millions of dollars)
Liabilities
(millions of dollars)
Reserves
$101
Loans
$300
Total
$401
Deposits
$401
Total
$401
Creating Money at the
One-and-Only Bank
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Balance sheet on January 3
Assets
(millions of dollars)
Liabilities
(millions of dollars)
Reserves
$101
Loans
$303
Total
$404
Deposits
$404
Total
$404
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How Banks Create Money
• The Deposit Multiplier
Change in deposits
Deposit multiplier 
Change in reserves
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How Banks Create Money
• Creating Deposits by Making Loans with
Many Banks
Let’s see how the
banking system creates money
The Multiple Creation
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of Bank Deposits
The sequence
The running tally
Reserves
Loans
Deposits
$75,000
$25,000
Deposit
$100,000
Reserve
$25,000
Loan
$75,000
$25,000
$75,000
$100,000
$43,750
$131,250
$175,000
Deposit
$75,000
Reserve
$18,750
Loan
$56,250
The Multiple Creation
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of Bank Deposits
The sequence
The running tally
Reserves
Deposit
$56,250
Reserve
$14,063
Loan
$42,187
Deposit
$42,187
$43,750
$57,813
Loans
$131,250
$173,437
Deposits
$175,000
$231,250
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The Multiple Creation
of Bank Deposits
The sequence
The running tally
Reserves
Reserve
$10,547
Loan
$31,640
Loans
Deposits
$68,360
$205,077
$273,437
$100,000
$300,000
$400,000
and
so on...
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How Banks Create Money
• The deposit multiplier in the United States
differs from our model economy’s for three
main reasons:
1) The actual required reserve ratio is
smaller than the 25 percent used here.
2) Banks sometimes choose to hold excess
reserves.
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How Banks Create Money
• The deposit multiplier in the United States
differs from our model economy’s for three
main reasons:
3) Not all loans made by banks return to
them in the form of reserves.
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Money, Real GDP, and
the Price Level
• We are going to study the effect the money
supply has on real GDP, the price level, and
the inflation rate.
438
Money, Real GDP, and
the Price Level
• The Short-Run Effects of a Change in the
Quantity of Money
• Let’s study how a change in the quantity of
money effects these factors by examining the
aggregate supply-aggregate demand model.
Price level
(GDP deflator, 1992 = 100)
Short-Run
Effects
of
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Change in Quantity of Money
LAS
140
130
SAS
120
110
107
100
AD0 AD1
6.6 6.8 7.0 7.2 7.4 7.6
Real GDP (trillions of 1992 dollars)
Price level
(GDP deflator, 1992 = 100)
Long-Run
Effects
of
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Change in Quantity of Money
LAS
140
130
SAS2
SAS1
121
113
110
100
AD2
AD1
6.6 6.8 7.0 7.2 7.4 7.6
Real GDP (trillions of 1992 dollars)
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Money, Real GDP, and
the Price Level
• The Quantity Theory of Money
• The quantity theory of money is the proposition
that in the long run, an increase in the quantity
of money brings an equal percentage increase
in the price level.
• This theory is based upon the velocity of
circulation and the equation of exchange.
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Money, Real GDP, and
the Price Level
• The Quantity Theory of Money
• The velocity of circulation is the average
number of times a dollar of money is used
annually to buy goods and services that make
up GDP.
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Money, Real GDP, and
the Price Level
• The equation of exchange states that the
quantity of money (M) multiplied by the
velocity of circulation (V) equals GDP, or
MV=PY
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Money, Real GDP, and
the Price Level
• We can convert the equation of exchange
into the quantity theory of money by
making two assumptions:
1) The velocity of circulation is not
influenced by the quantity of money.
2) Potential GDP is not influenced by the
quantity of money.
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Money, Real GDP, and
the Price Level
• Assuming this is true, the equation of
exchange tells us that a change in the
quantity of money causes an equal
proportional change in the price level.
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Money, Real GDP, and
the Price Level
• This equation shows that the proportionate
change in the price level equals the
proportionate change in the quantity of
money.
• This gives us the quantity theory of money:
• In the long run, the percentage increase in the
price level equals the percentage increase in the
quantity of money.
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Money, Real GDP, and
the Price Level
• The AS-AD model predicts the same
outcome as the quantity theory of money.
• It also predicts a less precise relationship
between the quantity of money and the price
level in the short run than in the long run.
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Money, Real GDP, and
the Price Level
• Historical Evidence on the Quantity Theory
of Money
• The data are broadly consistent with the
quantity theory of money, but the relationship is
not precise.
• The relationship is stronger in the long run than
in the short run.
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Money, Real GDP, and
the Price Level
• Correlation, Causation, and Other
Influences
• The evidence shows that money growth and
inflation are correlated.
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Money, Real GDP, and
the Price Level
• Correlation, Causation, and Other
Influences
• This does not represent causation.
• Does money growth cause inflation, or does
inflation cause money growth?
• Does some other factor cause inflation (deficit
spending)?
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Monetary Policy