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					                         Se Yan
Guanghua School of Management
              Peking University
                    Spring 2010

Guiding Questions
 What is money?

 How is money created?

 What are the functions of the central bank?

 How does the central bank control money supply?

What is Money?
  Money is any commodity or token that is generally
  acceptable as a means of payment.

  Money has three functions:
  Medium of exchange
  Unit of account
  Store of value


 Liquidity is the ease with which an asset can be
 converted into the economy’s medium of exchange.

Types of Money
 Commodity money takes the form of a commodity with
    intrinsic value.
    u   Examples: Gold, silver, cigarettes

 Fiat money is used as money because of government
    u   It does not have intrinsic value.
    u   Examples: Coins, currency, check deposits.

Currency in Prison


Money in the United States Today
 Money in the United States consists of

 Currency: the paper bills and coins in the hands of the

 Deposits at banks and other depository institutions

M1 and M2
  The two main official measures of money in the United
   States are M1 and M2.
  M1 consists of currency outside banks, traveler’s checks,
   and checking deposits owned by individuals and
  M2 consists of M1 plus time deposits, savings deposits,
   and money market mutual funds and other deposits.

M1 and M2
 This figure illustrates
  the composition of these
  two measures in 2003
  and shows the relative
  magnitudes of the
  components of money.

Checks and Credit Cards?
 Checkable deposits are money, but checks are not–
 checks are instructions to banks to transfer money.

 Credit cards are not money. Credit cards enable the
 holder to obtain a loan quickly, but the loan must be
 repaid with money.

Money in China
       Type        Amount       Definition
       M0         19,746.2亿元    Currency in
                  (人均1,969元)    circulation

       M1         84,118.8亿元      M0+
                  (人均8,387元)     活期存款
       M2         219,226.8亿元     M1+
                 (人均21,857元)     定期存款
M2/GDP in China

Depository Institutions
  A depository institution is a firm that accepts deposits
     from households and firms and uses the deposits to
     make loans to other households and firms.
    The deposits of three types of depository institution
     make up the nation’s money:
     Commercial banks
     Thrift institutions
     Money market mutual funds

The Economic Functions of
Depository Institutions
 Depository institutions make a profit from the spread
  between the interest rate they pay on their deposits
  and the interest rate they charge on their loans.
 This spread exists because depository institutions
 Create liquidity
 Minimize the cost of obtaining funds
 Minimize the cost of monitoring borrowers
 Pool risk

Reserves: Actual and Required
  The fraction of a bank’s total deposits held as reserves is
   the reserve ratio.
  The required reserve ratio is the fraction that banks
   are required, by regulation, to keep as reserves. Required
   reserves are the total amount of reserves that banks are
   required to keep.
  Excess reserves equal actual reserves minus required

Creating Deposits by Making Loans

 To see how banks create deposits by making loans, suppose
    the required reserve ratio is 25 percent.
   A new deposit of $100,000 is made.
   The bank keeps $25,000 in reserve and lends $75,000.
   This loan is credited to someone’s bank deposit.
   The person spends the deposit and another bank now has
    $75,000 of extra deposits.
   This bank keeps $18,750 on reserve and lends $56,250.

How Banks Create Money
 The process
  continues and
  keeps repeating
  with smaller and
  smaller loans at
  each “round.”
 This figure
  illustrates the
  money creation

The Money Multiplier

The money multiplier is the reciprocal of
the reserve ratio:
                      M = 1/R
 In China a reserve requirement R = 7%
 The multiplier is 14

Bank Panic
 Bank Panic in Argentina in 2001

The Central Bank
  Partial reserve in depository institutions

  Bank panic: many people withdraw in the same time

  Need an organization to help commercial banks during
  bank panic

Central Bank in China

      The People’s Bank of China, PBOC

      China Bank Regulation Commission

 Balance Sheet of PBC 2009
                                163731.   179720.                                129653.   133406.
国外资产 Foreign Assets                                 储备货币 Reserve Money
                                    49        25                                     44        64
                                150784.   166460.       货币发行 Currency            47672.6   40504.7
    外汇 Foreign Exchange
                                    95        89    Issue                              6         8
                                                                                 81980.7   92901.8
    货币黄金 Monetary Gold           337.24    669.84   款 Deposits of Financial
                                                                                       8         6
    其他国外资产 Other Foreign        12609.3   12589.5                                81837.8   92797.9
                                                    司 Other Depository
Assets                                1         1                                      9         5
                                16195.9   15676.7
对政府债权 Claims on Government                          司 Other Financial              142.9     103.9
                                      9         4
    其中:中央政府 Of which:           16195.9   15676.7   存款Deposits of financial
                                                                                  580.49    635.72
Central Government                    9         4   corporations excluded from
                                                    Reserve Money
对其他存款性公司债权 Claims on                                                             43521.2   39915.6
                                8378.06   7591.72   发行债券 Bond Issue
Other Depository Corporations                                                          1         1
对其他金融性公司债权 Claims on            11852.7             国外负债 Foreign
                                           11701                                  771.49    746.92
Other Financial Corporations          5             Liabilities
对非金融性公司债权 Claims on                                 政府存款 Deposits of             17618.1   27247.7
                                  44.12     43.96
Non-financial Corporations                          Government                         1         1
其他资产 Other Assets                8052.7   7817.24   自有资金 Own Capital              219.75    219.75
                                208255.   222550.   其他负债 Other                   15890.6   20378.5
总资产 Total Assets
                                    12        91    Liabilities                        2         4
                                                                                 208255.   222550.
                                                    总负债 Total Liabilities
                                                                                     12        91
The Federal Reserve System
  The Federal Reserve System, or the Fed, is the central
  bank of the United States.

  A central bank is the public authority that regulates a
  nation’s depository institutions and controls the
  quantity of money.

The Federal Reserve System

        The Fed was created in 1914 after a series of bank
         failures convinced Congress that the U.S. needed
         a central bank to ensure the health of the nation’s
         banking system.

Do you agree Currency War?

 Can the central bank owned privately?

 Can there be more than one central bank?

 How was paper bill invented in history?

 Why didn’t merchants in Shanxi evolve out to be modern
  commercial banks?

The Structure of the Fed

1) The Board of Governors

2) The Regional Federal Reserve Banks

3) The Federal Open Market Committee

The Fed’s Organization

 The Fed is run by a Board of Governors, which has
     seven members appointed by the President and
     confirmed by the Senate.

 Among the seven members, the most important is the
     chairman. The chairman directs the Fed staff, presides
     over board meetings, and testifies about Fed policy in
     front of Congressional Committees.

 The Federal Open Market Committee

     u   Serves as the main policy-making organ of the
         Federal Reserve System.

     u   Meets approximately every six weeks to review the

     u   Monetary policy is conducted by the Federal Open
         Market Committee.

Three Primary Functions of the Fed
    Regulates banks to ensure they follow federal laws
     intended to promote safe and sound banking practices.

    Acts as a banker’s bank, making loans to banks and as a
     lender of last resort.

    Conducts monetary policy by controlling the money

Open-Market Operations
        The money supply is the quantity of money
         available in the economy.
        The primary way in which the Fed changes the
         money supply is through open-market operations.
        The Fed purchases and sells U.S. government bonds.
            To increase the money supply, the Fed buys
             government bonds from the public.
            To decrease the money supply, the Fed sells
             government bonds to the public.

Other Tools the Central Bank Can Use
        Discount rate
            is the interest rate the Fed charges banks for loans.
            Increasing the discount rate decreases the money
            Decreasing the discount rate increases the money
        Required reserve ratio
         u   Increasing the reserve requirement decreases the
             money supply.
         u   Decreasing the reserve requirement increases the
             money supply.

Problems in Controlling the Money Supply

    The Fed’s control of the money supply is not precise.
    The Fed must wrestle with two problems
     u   The Fed does not control the amount of money that
         households choose to hold as deposits in banks.
     u   The Fed does not control the amount of money that
         bankers choose to lend.
      In  the open economy, it is difficult for the Fed to
         control the money supply

Did We Answer the Guiding Questions?

 What is money?

 How is money created?

 What are the functions of the central bank?

 How does the central bank control money supply?


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