Chapter 13 Money _ Banking by qingyunliuliu


									There is $800 billion in currency [notes & coins].
                                       [2/3 is overseas]

       Money = paper notes + coins + Demand Deposits
                  [52%]      [2%]       [46%]
                “Anything you can buy
                 a candy bar with”
Paper notes printed at:   1st-A-Boston (0)         7th-G-Chicago (1)
1. FW Currency Center     2nd-B-New York (1)       8th-H-St. Louis (3)
2. Washington D.C.
                          3rd-C-Philadelphia (0)   9th-I-Minneapolis (1)
Coins minted at:          4th-D-Cleveland (2)      10th-J-Kansas City (3)
1. Denver
2. Philadelphia           5th-E-Richmond (2)       11th-K-Dallas (3)
3. San Francisco
                          6th-F-Atlanta (5)        12th-L-San Francisco (4)
                    Dollar Decoded
              Bills are crowded with numbers and
              letters that help the U.S. Treasury track
              printing errors & authenticate currency.
              Here’s what many of them mean:

Fed bank
that issued
 the bill
                          Last letter tells how many
                          times serial number has run
                                             Number corresponds to letter in
   First letter corresponds                  circle indicating issuing Fed bank.
   to issuing Fed bank
             Bogus Bills – fined up to $5,000
      [5,000 arrested in 2002] -imprisoned up to 15 years.
                                          Notice that counterfeiting
                                          has really decreased with
                                          the new security features.

                                       $48 M        $46 M $62 M

                                                     2004 2006
The so-called supernote – a counterfeit $100 bill of extremely
high quality began showing up around 1990.

Most of world’s bogus bills come from Columbia & North Korea.
Columbia borders Ecuador, which converted to the U.S. dollar
in 2000.
The $20 bill is the most popular domestic counterfeit bill, while
the $100 bill is most popular among foreign counterfeiters.
Of the fake bills found in the U.S. in 2002, half were produced with
computers, copiers, and printers, up from just 1% in 1996.
Only about 3/100ths of 1% is counterfeited.
         History of U.S. Money
            Beaver skins [1600’s-1800] were
            traded to the Indians for wampum
Tobacco Leaves became legal tender in 1642.

Cut nails were used as change.
100 nails were worth 10 pence.
Pine Tree Shilling [1642-1684] became
the first minted American coin.
            Spanish milled dollar was the
            main coin of the 1770’s. “Two bits, four
                 [“Piece of Eight”]    bits, six bits…”

            An average colonial worker
            earned two bits a week.
                       Colonial Times
  Colonists brought coins with them but sent them back to Europe to pay
for European goods. This led to a shortage of coins, so Indian wampum
[1600-1800] – beads of polished clam shells strung in strands – was used
as money. It lost its value when they started counterfeiting wampum. Also
used as money were staples of the local economies – such as tobacco,
grain, and fish. Nails and bullets frequently were used for small change.

  Until 1857, the Spanish eight-reale coin was
used because it had a higher content of pure
silver and they could be cut to make change.
[“Two bits, four bits”]

The first coin minted in the colonies was the pine
tree shilling [12 pence or pennies] [1652]. They also
minted the willow and oak shilling. Hundreds of
different types of paper notes [such as the five
shilling note] were printed in the colonies
denominated in pounds and shillings and made
reference to the crown of England for credibility.
                        The Continental (1775-1781)
 Between 1775-1781, almost $250 million in continental currency [“The
United Colonies”] was printed. There was so much of it, it created demand-
inflation in the extreme. They were not worth much because people didn’t
think it could be backed by gold or silver [This, even though the Continental
Congress made it “treason” not to accept continentals.        [“not worth a
continental”] From 1775-1779, inflation was 8.5% per month[went from
$6 M in circulation to $263 M]. The MS rose to 10 times its previous level
as price climbed more than 100 times their previous level. It took $146 to
buy what $1 would in 1775.             As George Washington commented:
“A wagon-load of money will scarcely purchase a wagon-load of

         1/3 of a Dollar                      1/6 of a Dollar
         Continental Currency [1775-1781]
            Wildcat Banking 1790-1860
Over 3,000
banks issued
10,000 bills
but 5,000 were

Because some banks were more sound than others, a $5 note at one
rarely had the same purchasing power as a $5 note at another.

State banks issued paper notes in denominations from $1 to $13.
They lost their value the farther away you were, thus the name,
“wildcat banking”, only a wildcat could get back to a distant
bank to verify its authenticity.
                                                        This $450 million
                                                        brought on severe

                       Civil War Money 1860-1865
  Both the Union & the Confederacy paid troops with notes. In 1861,
the nation issued Greenbacks [1st paper money issued by the federal
G]. These $5’s, $10’s, & $20’s[total of $10 M] were redeemable in coins.
In 1862, $450 M in U.S. notes, from $1-$10,000 replaced the
Greenbacks. Because of widespread hoarding of coins, Congress
issued 5, 10, 25, & 50 cent notes. They were called “paper coins” or
“shinplasters.” Northern prices doubled from 1861-1864.
 The South issued Confederate notes. Note-holders were to be repaid
in gold & silver after the Civil War. Northerners printed up counterfeit
confederate notes so these notes increased 20-fold from 1861-1865
and inflation increased 9,200%. $2 billion from .50 to $1,000 printed.
            Yap Island Money

   Yap Island is a tiny, U.S. trust territory in the S. Pacific,
500 miles from Guam. It is one of the 4 Federated States of
Micronesia & has 12,000 Yapese & 6,000 “rai” limestone stones.
                Money and Banking

  Money is the grease that lubricates the economic machinery of
the world. It reduces the friction of the voluntary exchange.
Too little oil can leave some parts creaking; too much oil can
gum up the works. Similarly, too little or too much in circulation
makes exchange more difficult and creates economic problems.

 “Money is the only commodity that is good for nothing but to
be gotten rid of. It will not feed you, cloth you, shelter you, or
amuse you unless you spend it or invest it. People will do
almost anything for money and money will do almost anything
for people.
  Overview of Money, The Fed and
          Monetary Policy
1. The functions and measurement of money
2. The Federal Reserve and its functions
3. Fractional reserve banking & how it works
4. The Money Multiplier [MM=1/RR(.10)=10]
5. Tools of Monetary Policy
  a. Discount Rate - rate the Fed charges banks
  b. Reserve Ratio-% of deposits banks have to
     keep in reserve and can not loan out.
  c. Buying (recession) & selling (inflation) of bonds
 1. Three functions (roles) of money
   a. medium of exchange b. unit of account     c. store of value
 2. What constitutes money in our economy?
   a. Currency (paper dollars-52%)
  b. DD-46%

3. What “backs” the money supply?
  (gold/silver/the faith of the “G”)   .

                                           “Faith” of the “G”
 4. Explanation of the demand for money.
    Dt + Da = DM
 5. The four-part make-up of the Federal Reserve
    a. Board of Governors b. FOMC c. 12 Fed Banks d. Member banks

Money – any good widely accepted for goods
        and services or repayment of debt.
 Money is anything generally acceptable as a medium of exchange.
           Three FUNCTIONS OF MONEY

1. Medium of Exchange
[any asset that sellers will accept as payment for g/s]
Medium means “something in the middle”, so money is a “medium of trade
between buyers and sellers” because it can be exchanged for something else.
Avoids “double coincidence of wants” that bartering requires.
You would have to have a trading partner who “wants to sell
you goods you want to buy” and “wants to buy
goods you want to sell.”
Liquidity – how easily an asset can be converted into cash
without any additional expense. [Cash has 100% liquidity]

2. Unit of Account
[measuring the relative value of goods by
stating prices]
Example: Microsoft Stock is selling for $50 a share.
         The new Jag is selling for $32,000.
A $2 item is twice as valuable as a $1 item.

Money is like a    yardstick.  People use it to
compare the worth of things that they buy and sell.

                                                            Greek Coin
                                                          2,500 years old

3. Store of Value             [storing wealth from one point in time to another]
[doesn’t wear out easily and holds up to inflation]
Ability of money to hold value over time [Money that lacked durability
or did not hold up well to inflation would not make good money [would not
store value].
Ice cream cones would suffer monetary meltdown, become a
sticky puddle. If money suffers high inflation, it causes the
value of money to “melt.”

Other desirable qualities for money are:
A. Scarcity B. Portability C. Divisible D. Difficult to counterfeit
      The Two Types of Money
• Commodity Money: something that
  performs the function of money and
  has alternative, non-monetary uses.
  – Examples: Gold, silver, cigarettes, corn

• Fiat Money: something that serves as
 money but has no other important uses.
 – Paper notes
 – Coins
       Money In The American Economy
Currency + DD equal M1 [Spendable Money]
Also included here would be Travelers checks,                            M1 M2         MZM
Checklike deposits [NOW and Super NOW Accts]
  Completely                                                             $1,375
    Liquid                                                            [billions]
                   2%         52%                   46%
M1 + savings deposits, small TDs [like CDs &
bonds] under $100,000, & MMMFs                      for individuals   =M2
M2 + 2 more categories = [money zero maturity] MZM
 [money available at “0” cost to HH & businesses] [ So, subtract small
 TDs; add MMMFs owned by businesses –no penalty to spend MMMFs]

“V” – how many times a dollar changes hands in a year                         $6,758
V = GDP[Y]/M1 = 13 tr./1.3 tr. = 10
They are not “plastic money.” They do serve as a:
1. medium of exchange & the
2. credit card statement serves as a unit of account.
3. but, they do not have a store of value.

If the credit card company goes out of business or decides
not to honor your card, it is worthless. They are not money
because they don’t store value.
 WHAT ABOUT Debit CARDS? Are They Money?
Debit cards are money. They serve as a:
 1. medium of exchange; they also serve as a
 2. store of value (not an extension of credit); and
 3. debit card statements serve as a unit of account.

                    Debit Card
     Our Money Is Growing More Abstract
Money has grown increasingly more abstract
- from a physical commodity,

- to a piece of paper representing a claim
   on a physical commodity,

- to a piece of paper of no intrinsic value,
                [just a Federal Reserve note]

- to an electronic entry representing a claim
   on a piece of paper of no intrinsic value.
      The Value of Money and Price Level

      Value of Money                 Prices
The value of money goes in the opposite direction
of the general price level.
Or, the amount a dollar will buy varies inversely
with the price level.
Old Bond Prices and the Interest Rate
                       $1,000 x .08 = $80

                     $1,333 x .06 = $80

                          $800 x .10 = $80
                 Normal, Flat, & Inverted Yield Curves
                                     [and the Liquidity Trap]
         So, an Inverted Yield Curve would exist in an interest rate environment
        in which short-term bonds have a higher yield than long-term bonds,
        caused by inflation now but expect the economy to slow in the future.
Yield on bonds

                 8%                                Short-term bonds yield less than long-term bonds
                                                       The economy is predicted to grow.
                 6%               Flat yield curve Short-term & long-term bonds yield about the same
                 5%                                  Transition between normal & inverted curves
                                                     Long-term bonds yield less than short-term bonds
                                                            Rare – predictor of recession
                      1 Yr 10Yr            30 Yr
                      Maturity of bonds

An economy's bond rates are more apt to have an inverted yield curve when:
  (A) the economy's real output is increasing.
  (B) the economy is experiencing inflation.
  (C) the economy is exporting more.
  (D) the economy's price level is constant.
  (E) the economy is importing more.
                        Money NS 1-13
1. The most important function of money is as a:
   (unit of account/store of value/medium of exchange).
2. If you are estimating that it will take $5,000 to escort Suzie Rah
   Rah to the prom so that you can demonstrate your
   talent with the “Econ Rap,” you are using money as a:
   (unit of account/store of value/medium of exchange).
3. If you place some of your Kroger’s earnings in a safety deposit
   box so that you can get your boyfriend, Roger Rocket, a pair of
   roller blades for Christmas, you are using money as a:
   (unit of account/store of value/medium of exchange).
4. Estimating expenses for A&M at $13,001 illustrates money
   serving as a (unit of account/store of value/medium of exchange).
5. If Suzie Nomics writes a check for a new Honda, she is using
   money as a (unit of account/store of value/medium of exchange).
6. M1 [also called transactions money or medium of exchange money or “spendable money”] is
   comprised of coins, paper money and (gold certificates/checkable deposits).
7. The major component of M1 is (currency/checkable deposits).
8. The volume of M1 is closer to ($1/$3/$4) trillion.
9. (M1/M2) includes non-checkable savings accounts, MMA’s & TDs under $100,000.
10. (Fiat/Commodity) money is money because the G says that it is [G fiat].
11. The value of money varies (directly/inversely) with the price level.
12. If the price index increases from 100 to 120, the value of the dollar will
    fall by (one third/one fifth/one fourth).
13. The money supply is backed by (silver/gold/the government).
                3 Tools               of Monetary Policy
            1. Discount Rate – banks borrow from the Fed (symbolic)
Recession   2. Required Reserve - % of DD which cannot be loaned.      Inflation
Lower       3. Buy/Sell Bonds – government debt                        Raise
Lower                                                                  Raise
                     - 3 mo., 6 mo., & 1 year; purchase price: $10,000 Sell
           AS                                                                     AD AS
   LRAS              - 2 yr., 3 yr., 5 yr.,($5,000), & 10 yr., ($10,000)     AD
                     - 30 years with purchase of $1,000
                     Prime Rate-loan rate to the best (prime) customers.          Y*YI
   YR Y*
            Federal Funds Target Rate – overnight lending rate between
                    banks to correct a temporary imbalance in reserves.

                               Real GDP 2.3%
                                                                      17 increases
                                                  “Easy Money” During Recessions
“Students, should the Fed                                     MS1 MS2                         DI
buy or sell bonds to

                          Nominal Interest Rate
jumpstart this economy?”
                    10                                                               10               Demand

                                                  8                                   8


If there is                                                                           0
                                                              Money Market                       QID1   QID2
RECESSION                                             AD1      AD2 LRAS
MS will be                                             [C+Ig+G+Xn]         AS “Easy Money” – (Buy/Sell) bonds,
increased.                                                                    which (increase/decrease) MS, which
                Price level

Jobs are                                                                      (increase/decrease) interest rates,
tough to get.                                                                 which (appreciate/depreciate)
                                                                              the dollar, which (increase/decrease)
                                                                           E2 C, Ig, & Xn, which (increase/decrease)
                                  P1                          E1              AD & therefore, PL, GDP, & emp.

                                                                 YR Y*       Real GDP
                                           “Tight Money” during Inflation
“Now, should I                                    Dm    MS2 MS1                    DI

                   Nominal Interest Rate
buy or sell?”
                                           10                             10                 Demand
                                            8                              8

If there is                                 0
                                                Money Market               0
INFLATION,                                               LRAS   AS                        QID2 QID1
MS will be
decreased.                                           AD2                “Tight Money” – (Buy/Sell)
                                                                        bonds, which (incr/decr) the MS,
“I’ll get rid of                           P1                      E1
                                                                        which (incr/decr) in. rates, which
some money.”
                                                                        (apprec/deprec) the dollar,
                                                                        which (incr/decr) C, Ig, & Xn,
                                                                        which (incr/decr) AD, PL, & GDP.

                                                           Y* YI
      Demand For Money [Demand for “cash in hand”]
       For Daily, Weekly, & Monthly Transactions
        Transactions                                                Utilities
     M1 Demand, D t                                                 Food
Independent of                                 M1                   Emergency money
interest rate                            10                         Tuition for kids
                 Nominal Interest Rate

                                         7.5                        Christmas gifts
Direct with                                                         Valentine candy for wife
Nominal Y                                 5
                                                                    Gift for the girlfriend
Medium of                                        Dt
Exchange                                  0
                                         0 50 100 150 200 250 300
                                          Money demanded(bil.)
We keep this transaction money(M1)
in our wallet, under our mattress, or
in our checking accounts.
                                  THE DEMAND FOR MONEY
                               Demand, Dt                                             +               Asset
                                                                                                    Demand, Da              =
“Walking around”                                                                                                 Da [M2]
                                                                                                  Money that we don’t need for daily, weekly,
                              M1                Rate of interest, i (percent)
                                                                                                  or monthly transactions. We will invest more
                        10                                                      10
Nominal Interest Rate

                                     Dt                                                           of it the higher the interest rate. We will hold
                        7.5                                                     7.5
                                independent                                                       less because the opportunity cost increases.
                                    of the                                                                                10% Da
                         5                                                       5                          Interest Rate
                                     rate                                             CDs or                                    8%
                        2.5                                                     2.5                         Oppor. Cost
                                Dt                                                                Da
                         0                      0                                                           Da[hold less]   6%
                        0 50 100 150 200 250 300 0 50 100 150 200 250
                           Amount of money                                             Amount of money
                          demanded (billions)                                         demanded (billions)   Interest Rate   4%
                                                                                                            Oppor. Cost
                                       Da varies inversely                                                                      2%
                                       with the interest rate.                                                                  1%
                                                                                                            Da[hold more]
                                                                                                                                     0 50 100 150 200
                            Demand, Dt
                                                 +                                       Asset
                                                                                      Demand, Da
                                                                                                         =                                          Total demand
                                                                                                                                                    for money, Dm


                                                     Rate of interest, i (percent)

                                                                                                                    Rate of interest, i (percent)
                          10                                                         10                                                             10
  Nominal Interest Rate

                          7.5                                                        7.5                                                            7.5

                           5                                                          5
                          2.5                                                        2.5
                                                                                                                2.5%                                                       Dm
                                       Dt                                                              Da                                            0

                           0                                                          0                                        0
                                50 100 150 200 250 300                                     50 100 150 200 250 300                                     0 50 100 150 200 250 300
                                Amount of money                                             Amount of money                                                Amount of money
                                demanded (billions                                         demanded (billions                                             demanded (billions
                                   of dollars)                                                of dollars)                                                    of dollars)
                                            Demand, Dt       +                                      Asset
                                                                                                  Demand, Da          =                                       Total demand
                                                                                                                                                              for money, Dm

                                             MS                                                                                                                     MS2 MS1

                                                                                                                             Rate of interest, i (percent)
                                                                 Rate of interest, i (percent)
                                       10                                                        10                                                          10
               Nominal Interest Rate

                                       7.5                                                       7.5                                                         7.5

                                       5                                                          5                                                          55            E

                                       2.5                                                       2.5                                                         2.5
                                                 Dt                                                                Da                                                             Dm
                                       0 50 100 150 200 250 300                                    0 50 100 150 200 250 300 0 50 100 150 200 250 300
                                            Amount of money                                             Amount of money                                            Money market
                                           demanded [billions]                                         demanded [billions]
1. At equilibrium 5% I.R., the amount of money demanded for transactions is
    (0/50/100) and the amount demanded as an asset is (0/50/100).
2. If the interest rate were 10%, the amount of money demanded for Dt would
   be (0/50/100) & the amount demanded as an asset would be (0/50/100).
3. Da slopes down because lower in. rates (incr/decr) the cost of holding money.
[at “E”, money supplied ($200) = money demanded ($200)]
    The Dm curve represents the quantity of money
    people are willing to hold at various interest rates.

              Nominal Interest Rate
                                                     Dm MS

                                       5                     E


                                       0    50   100 150   200   250 300
                     Money Market
       Due to a recession, suppose the money supply
       is increased from $200 billion to $250 billion.
                 [at “E”, money supplied ($200) = money demanded ($200)]
                                                                                  A temporary surplus of

                                Nominal Interest Rate
                                                                                  $50 billion beyond which
                    S2 S 1                                                 MS1MS2 the people wish to hold,
Price of Bonds

                                                                                    so money becomes a
                                                                         Dm         “hot potato”.
                                                                                     They react by buying
                                                         5                     E     bonds [pushing bond
                   # of Bonds
                                                                                     prices up] to meet the
                                                                                     desired level of liquidity.

                                                          0   50   100   150 200 250 300
                                                               Money Market
                                                                         MS1 MS2

                              Nominal Interest Rate
                  LRAS SRAS

     AD AD                                                     Dm

      YD              GDP


                                                      0   Money Market   500

     Liquidity Trap – in a stagnant economy with interest rates near or at zero, an
     increase in MS fails to stimulate AD, so recession or depression gets worse.
     With low returns expected on financial investments, people hoard their money.
     Banks are unwilling to lend in a slack economy. Fiscal policy is needed here.
[at “E”, money supplied ($200) = money demanded ($200)]
    Due to inflation, suppose the money supply is
    decreased from $200 billion to $150 billion.

                                                           Dm MS
             Nominal Interest Rate

                                      5                          E


                                           0    50   100   150 200   250 300
                                               Money Market
   A temporary shortage of money will require the sale of some
   assets [bonds-which will make their price fall] to meet the
   money shortage need.

                                 Nominal Interest Rate
        S1 S 2               Dm 2 MS1                    10
Price of Bonds


                                                          5                         E
                  # of T-bills

                                                              0   50    100   150 200   250 300
                                                                       Money Market
                Thrifts Earn More, Pay Less
[Commercial Banks v. Thrifts (S&Ls, Credit Unions, & Mutual Savings Banks]

Thrifty deal because with no taxes or stockholders to pay, thrifts
can pay higher returns on deposits & charge lower rates on loans.

Interest Paid On Deposits               Credit Unions          Banks
Checking accounts                        0.39%                 0.14%
Money Market Accounts                    1.02%                 0.32%
1-Year CD                                2.15%                 1.48%
5-Year CD                                4.23%                 3.38%

Interest Charged on Loans               Credit Unions Banks
New-car loans                             5.26%        7.23%
Home equity loan                          4.38%        4.73%
Variable rate credit card                10.21%       12.60%
Personal loan                           12.39%        14.43%
                   Financial Reform Act - 1980
  This act eliminated many historical distinctions between financial
institutions. These once staid financial institutions moved into the
fast lane. They could now “wheel and deal” with other peoples
money but with the benefit of deposit insurance.
                Commercial Banks                       7,600
                Thrifts                               11,400
                Credit Unions                          9,490
                Savings and Loans                      1,404
                Mutual Savings Banks                     387
Prior to 1980
 Commercial banks issued checking accounts [others could not] and gave
business loans [no interest was allowed to be given on these checking accts].
Non Commercial Banks – accepted savings deposits [3%] and made
mortgage loans [6%]. They started issuing NOW Accounts which paid
about 5% if you kept $1,000 in. People were not writing checks, they
were writing Negotiable Orders of Withdrawal. They may not have
been called checking accts but they looked like checking accounts,
sounded like checking accounts, smelled like checking accounts, and
were even represented to customers as checking accounts.
           Deregulation Act of 1980
1. All were now allowed to issue interest-bearing checking deposits.
   [Commercial banks had been forbidden to pay interest on checking
   accounts, while thrifts claimed to be paying interest on savings accts]
2. S&Ls could give auto and real estate loans.
3. There was no limitation on interest rates paid.
4. All depository institutions were now subject to the Fed’s legal RR.
5. All now enjoyed the advantages that only Fed member banks
     formerly enjoyed-including check clearing & borrowing from the Fed

    The worst S&L scandal was Lincoln S&L in California
    under Charles Keating ($3 billion horror story). Five
    senators [including John McCain] received $1.5 million
    in campaign contributions to influence regulators.
    Keating got 12 years in prison & had to pay $122 million
    although the government could never find any of his assets.
    This will cost around $300 billion – the worst financial
    mistake since the Great Depression.                         Charles Keating
Commercial Bank/Thrift Failures
Cost of Bank/Thrift Failures
The Federal Reserve - 1913

                      A. Boston
                      B. New York
                      C. Philly
                      D. Cleveland
                      E. Richland
                      F. Atlanta
                      G. Chicago
                      H. St. Louis
                      I. Minneapolis
                      J. Kansas City
                      K. Dallas
                      L. San Francisco
Twelve Fed Banks and 25 Branches

  1st-A-Boston (0)        7th-G-Chicago (1)
  2nd-B-New York (1) 8th-H-St. Louis (3)
  3 rd-C-Philadelphia (0) 9th-I-Minneapolis (1)

  4th-D-Cleveland (2) 10th-J-Kansas City (3)
  5th-E-Richmond (2) 11th-K-Dallas (3)
  6 th-F-Atlanta (5)      12th-L-San Francisco (4)
    The Fed’s 25 Branches                Fed

Quasi-Public Banks    . [in combo]
Blend of [private ownership (corporations) but public
(government) control]
The 12 banks are instruments of the government but not
owned by the government. The over 5,000 banks in the
12 districts buy stock ($1 per share) in their district bank
(& get 6% dividends [no capital gains]) so the banks are
privately owned. Serving the public, it is owned by citizens.
The 12 banks are a corporation owned by the banks
in their districts, but a public (G) agency directly
responsible to Congress.
They might make $30 billion - 90% to Treasury.
First Dallas Fed [1921] at Akard and Wood
Current Dallas Fed at 2200 N. Pearl

                     Richard Fisher - President of
                     Dallas Fed. Majored in economics
                     at Harvard
     Four Part Structure of the Fed
1. Seven Board of Governors
 - most important body of the Fed
 - appointed by the President and
   confirmed by the Senate
 - 14-year terms are staggered
   (one replaced each two years)
   [they are paid $162,100]
 - isolation from political pressure
   (only one 14 year term)
 - the Chairman serves only four years but can be
   reappointed [4-year renewable term] 4 times
   His pay is $180,100.
  Every president gets to appoint at least two. Clinton
   appointed eight and Bush appointed 4 in 1st 2 years.
  2. Federal Open Market Committee [FOMC]
-Fed’s main policy-making arm

-includes 7 Board of Governors,
 NY Fed President, and 4 other
 bank presidents (rotate among
 the other 11 every 3 years)

-other 7 bank presidents are
 non-voting members

-they meet every six weeks

-they make about $30 bil. a year
 (90% goes to the Treasury)
   The FOMC Meeting Room in Washington DC
The FOMC meets around a 27-foot oval mahogany table in a room
with a 23-foot ceiling with a 1,000-pound chandelier.
3. Twelve Fed Banks and 25 Branches
4. Several Thousand Member Banks
          Functions of the Fed

                                     Destroy/Issue paper notes

                                   Refund Check

         The Fed clears 40%;
Banks clear rest electronically.
                     Margin Calls
               [went from 65% to 50% in 1974]

 Let’s say you buy 100 shares of Playboy stock at $100 a
 share which would cost $10,000. You only buy 50 shares
 with cash ($5,000) and buy 50 shares on margin at 10%
 (so, you owe $5,500). Your 50 shares worth $5,000 is your

 If Playboy stock drops to $50 per share – the 50 shares
 you own are worth only $2,500 (your collateral now will
 not cover what you owe [$5,500]. So the broker may make
 a margin call for $3,000 and if you can’t pay it he might
 sell your stock for $2,500 and tell you that you still owe
 $3,000 more. If you could have paid the $3,000, he may
 have let you keep your 50 shares.

 So market slides can lead to sell-offs.
             The Check Clearing Process
             Roger Econ and Suzie Nomics
       Roger writes a $1,000 check on his Dallas Bank
       and sends it to Suzie in L.A.

             Suzie and Her Los Angeles Bank
 Suzie endorses the check and deposits it in her local bank in
 Los Angeles. The balance in her account rises by $1,000.

    The Los Angeles Bank & the San Francisco Fed
  Suzie’s local bank in L.A. sends the check to the Fed Bank of San
Francisco, which increases the reserve account of the L.A. bank by
$1,000 & decreases the reserve account of the L.A. Bank by $1,000
and decreases the reserve of the Dallas bank by $1,000.

        The San Francisco Fed and Dallas Bank
 The San Francisco Fed sends the check to Roger’s bank in
Dallas which reduces his account by $1,000. Fed
First Board of Governors, 1914
     Ben Bernanke,                    Donald Kohn                  Kevin Warsh
Chairman   to 1/31/10 [1590 on SAT] Vice Chairman to 1/31/16   Unexpired term to 1/31/18

Randall Kroszner Frederic Mishkin                       Vacant              Vacant
Unexpired to 1/31/08     Unexpired to 1/31/14
   Ben Bernanke B elieves In “Core” Inflation Targeting
             [Here is How It would Work]          2%
The Fed would choose and publish a target
goal for core inflation of–say, 2% a year..
The Fed publicly estimates how high it expects inflation to be in
the coming year. It steers monetary policy to try to hit the target
inflation rate. The Fed, in effect, is an “inflation hawk”.
If inflation is getting above the target, the bank raises interest
rates to cool the economy. If inflation is too low, the Fed
would lower interest rates to juice up growth.
The “Target Rate” is used in Britain, Canada, Australia, Sweden,
New Zealand, Brazil, and South Korea, working well in all seven.

In a crisis like 9/11, the Fed could still do
what was necessary to stabilize the economy,
that is, lower interest rates further.
                           NS 14-21
14. The transaction demand [making daily, weekly, & monthly
   transactions] for money is most closely related to money
   functioning as a (medium of exchange/store of value).
15. The asset demand for money is most closely related to money
   functioning as a (medium of exchange/store of value).
16. If nominal (money) GDP is $900 billion, and on the average, each
   dollar is spent three times per year, then the amount of money
   demanded for transaction purposes will be ($200/$300/$400).
17. The Dt will shift to the right as a result of a(n)
    (increase/decrease) in nominal GDP. The Dt will
    shift to the left as a result of a[n] (increase/decrease)
    in nominal GDP.
18. The asset demand for money varies
    (directly/inversely) with the interest rate.
19. The basic policy-making body in the American banking system is
   the (Council of Economists/Board of Governors).
20. The Fed was created in (1900/1913/1929/2004)
21. Commercial Banks and thrifts, since 1980, have become
   increasingly (similar/dissimilar).
                              NS 22-26

   5%                    5%                    5%

           200                                         200    400

22. The transaction demand for money (“walking around” money) is
   shown by (D1/D2/D3).
23. The asset demand for money (“betting” money) is shown by (D1/D2/3).
24. The total demand for money is shown by (D1/D2/D3).
25. If each dollar held for transaction purposes is spent 4 times per year,
    nominal [money] GDP is ($200/$400/$600/$800).
26. If the Fed increased the MS, the MS curve would shift (right/left) and
   the interest rate would (rise/fall).
                       NS 27-28
27. The (Fed/Council of Economic Advisors) hold the
  deposits of commercial banks, provide for the collection
  of checks, act as fiscal agent for the federal government,
  and exercise supervisory power over member banks.
28. In the U.S. economy, it is the (President/Congress/Fed)
  who controls the money supply.
29. The 12 Fed banks are (privately/publicly) owned and
  (privately/publicly) controlled central banks whose basic
  goal is to control the money supply and interest rates in
  stabilizing the economy.
30. The term “thrift” includes S&L’s, credit unions, and
   (mutual savings banks/ commercial banks).
The End

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