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Macroeconomics - ECO 2013

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					Macroeconomics - ECO 2013
Fall 205 – 1 Term
August 24 – December 16, 2005
Chapter 13: Money & Banking
  When working properly, the monetary system
  provides lifeblood of the circular flows of
  income & expenditure.
  Well-operating monetary system helps
  economy achieve full employment & efficient
  use of resources.
  Malfunctioning monetary system creates
  severe fluctuations in the economy’s levels of
  output, employment & prices, distorting the
  allocation of resources
The Functions of Money
1. Mediums of Exchange for buying & selling
   goods & services
2. Unit of Account, yardstick for measuring
   the relative worth of a variety of goods,
   services & resources.
     Price of each item stated only in terms of the
      monetary unit
     Money aids rational decision making by enabling
      buyers & sellers to easily compare the prices of
      various goods, services, and resources.
3. Store of value enables transfer of
   purchasing power from present to future
     Store some of wealth as money
The Supply of Money
  Money Definition M1
  Money Definition M2
  Money Definition M3
Money Definition M1
  Narrowest definition
  Consists of:
     Currency (coins & paper money) in hands of public
        Coins are token money: Intrinsic value (of the metal
        contained in the coin) < face value
     All checkable deposits (in commercial banks &
      “thrifts” or savings on which checks can be drawn)


  Money, M1 = Currency + Checkable Deposits
Money Definition M2
  Broader definition
     Near-monies are certain highly liquid financial
      assets that do not function directly or fully as a
      medium of exchange but can be readily converted
      into currency or checkable deposits
  Savings deposits, including money market
  deposit accounts (MMDA)
  Small time deposits (<$100,000)
  Money market mutual funds (MMMF)
  Money, M2 = M1 + Savings Deposits
  including MMDAs + Small time Deposits
  (<$100,000) + MMMFs)
Money Definition M3
  Includes large time deposits
  (>$100,000)
     Certificates of deposit
  Money, M3 = M2 + large time deposits
  (>$100,000)
Credit Cards
  Not really money
  Means of obtaining a short-term loan
  from commercial bank or other financial
  institution that issued the card
  Means of deferring or postponing
  payment for a short period
What “backs” the money
supply?
  Government’s ability to keep its value stable
  provides the backing
  Money is debt; paper money is a debt of
  Federal Reserve Banks & checkable deposits
  are liabilities of banks & thrifts b/c depositors
  own them
  Value of money arises not from intrinsic
  value, but its value in exchange for goods &
  services
Value of Money
  Acceptable as a medium of exchange
  Currency is legal tender or fiat money; must
  be accepted by law
  Relative scarcity of money compared to
  goods & services will allow money to retain
  its purchasing power
  Money’s purchasing power determines its
  value. Higher prices mean less purchasing
  power.
Inflation & Acceptability
  Excessive inflation may make money
  worthless & unacceptable
  Worthless money leads to use of other
  currencies that are more stable
  Worthless money may lead to barter
  exchange system.
Stabilization of Money’s Value
  The government tries to keep supply
  stable w/ appropriate fiscal policy
  Monetary policy tries to keep money
  relatively scarce to maintain its
  purchasing power, while expanding
  enough to allow the economy to grow
The Demand for Money:
Two Components
 Transactions demand, Dt is money kept for
 purchases, will vary directly w/ GDP
 Asset demand, Da is money kept as store of
 value for later use, varies inversely w/
 interest rate, since that is price of holding idle
 money
 Total demand, Dm will equal quantities of
 money demanded for assets & transactions
The Money Market
 Sm represents money supply
     Vertical line b/c monetary authorities &
      financial institutions have provided the
      economy w/ particular stock of money
 Intersection of demand & supply
 determines equilibrium price
The Federal Reserve Bank &
The Banking System
  Board of Governors of the Federal Reserve
  System (“the Fed”)
  Board directs 12 Federal Reserve Banks which
  control lending activity of nation’s banks &
  thrift institutions
  Federal Open Market Committee (FOMC)
     Sets Fed’s monetary policy & directs purchase &
      sale of government securities in the open market,
      “open-market operations”
Fed Functions &
The Money Supply
  Issuing currency
  Setting reserve requirements & holding
  reserves
  Lending money to banks
  Providing for check collection
  Acting as fiscal agent
  Supervising banks
  Controlling money supply
Federal Reserve
Independence
  Protects Fed from political pressures to
  effectively control money supply & maintain
  price stability
  Political pressures on Congress & Executive
  Branch result in inflationary fiscal policy,
  including tax cuts & special-interest spending,
  but Fed can take actions to increase interest
  rates when higher rates are needed to stem
  inflation
  Countries w/ independent central banks have
  lower rates of inflation, on average, than
  countries w/ little or no independence
Recently Developments in
Money & Banking
  Relative decline of banks & thrifts
  Consolidation among banks & thrifts
  Convergence of services provided by
  financial institutions
  Globalization of financial markets
  Electronic transactions
Last Word: The Global
Greenback
  Two-thirds of all U.S. currency is circulating
  abroad
  U.S. profits when dollars stay overseas
  Black markets & illegal activity overseas are
  usually conducted in dollars b/c are such a
  stable form of currency
  The dollar is a reliable medium of exchange,
  measure, & store of value that facilitates
  transactions everywhere
  All dollars will not return to the U.S.
Chapter 13 Study Questions
  1: Functions of Money
  5: Backing Money
Next Class
  Chapter 14: How Banks and Thrifts
  Create Money
  Chapter 15: Monetary Policy
Quiz on Ch. 9 – 12, 16