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MONEY, BANKING, AND MONETARY POLICY PowerPoint Presentation

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Money, Banking, AND Budgetary POLICY

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MONEY, BANKING, AND MONETARY POLICY

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  1. Coin, Cyberbanking, AND Monetary POLICY The focus of this first week is on the bones concepts of the United states' fiscal organization. Students will first learn what money is, how banks and the banking systems can influence and control the supply and disposition of money, and the function of the Federal Reserve. Lastly, the relationship between coin and various economic variables volition be discussed. OBJECTIVES 1. Identify the functions of money and the money supply. 2. Illustrate the cosmos of money using the money multiplier effect. iii. Delineate the office of the Federal Reserve Organisation in designing and implementing U.S. Monetary policies. 4. Describe how changes in the money supply impact inflation. 5. Analyze the consequence of changes in the reserve requirement, discount rate, and open up market policies. TOPICS Delight read all the lectures by clicking on the following topics. FUNCTIONS OF MONEY MEASURES OF Coin BANKS AND Coin CREATION FEDERAL RESERVE SYSTEM Monetary POLICY THE MONEY Market EQUATION OF Exchange

  2. Functions of Money Money is whatsoever good that is widely accepted in exchange of appurtenances and services, as well as payment of debts. About people volition misfile the definition of coin with other things, similar income, wealth, and credit. Three functions of money are: ane. Medium of substitution: Money can exist used for buying and selling goods and services. If there were no coin, goods would accept to exist exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the footing of mutual need). For example: If I heighten chickens and want to buy cows, I would have to notice a person who is willing to sell his cows for my chickens. Such arrangements are oftentimes difficult. But Money eliminates the demand of the double coincidence of wants. 2. Unit of account: Coin is the common standard for measuring relative worth of goods and service. 3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets tin be spent to buy goods and services). Money's value can be retained over time. Information technology is a convenient way to store wealth.

  3. Measures of Money In the existent globe, coin supply has different definitions: M1 and M2. Coin is categorized according to its liquidity. The most liquid items are in M1. M1: includes currency (coins minted by the U.S. Treasury and paper currency issued by the Federal Reserve), checkable deposits and traveler's checks (issued by the commercial banks and thrift institutions). Currency and checkable deposits belonging to the federal regime, Federal Reserve, or other financial institutions are not included in M1. M1 = Currency + Checkable deposits + Traveler's checks M2: includes all of the components of M1 plus near-moneys which includes items like: a) Pocket-size Time deposits: interest-earning deposits with a value of less than $100,000, and having a specified maturity. b) Savings deposits: interest-earning deposits with no specific maturity of maximum value. c) Money market accounts: savings that invest in short-term financial instruments, pay higher than savings account interest. d) Overnight repurchase agreements: agreements by a financial institutions to sell short –term securities to its customers, accompanied by an agreement to repurchase the securities within 24 hours. e) Overnight Eurodollar deposits: 24-60 minutes dollar-denominated deposits held in fiscal institutions outside the Us. M2 = M1 + all nearly moneys  (Such as Small-scale time deposits, Savings deposits, Coin market accounts, overnight repurchase agreements, overnight Eurodollar deposits).

  4. Banks and Money Creation History: The mod banking system was developed from fractional reserve banking of the early on days. Goldsmiths had safes for gold and precious metals, which they ofttimes kept for consumers and merchants for a fee. They issued receipts for these deposits. After on, the receipts came to be used every bit money in place of gold for their convenience, and goldsmiths became enlightened that much of the stored gold was never redeemed. Goldsmiths realized they could loan gold by issuing receipts to borrowers, who agreed to pay back gilt plus interest. The actual gold in the vaults became only a fraction of the receipts held by borrowers and owners of gold. Fractional reserve banking is significant because banks tin create coin past lending more the original reserves on manus. Creation of money: Individual banks are not allowed to print their ain money. But, banks may create money past creating checkable deposits, which are a function of the money supply. Suppose the Fed prints $100 and decided to deposit it in Bank X. Bank X sets aside a portion of that $100 that is required reserves (a specific amount that banks must concur equally reserves on all deposits), say 10%. The remaining 90%, $xc becomes backlog reserves. Banking company 10 can lend that $90 to Client A, who deposits into his account in Bank Y. At this step, the original $100 remains in the system, and nosotros can now add Customer A's $xc. Bank Y sets aside 10%, and lends out the rest. This procedure continues until no new excess reserves tin can be created. Federal deposit Insurance Corporation (FDIC) Deposits at banks are insured past the FDIC. Such insurance guarantees deposits in amounts of upwardly to $100,000 per depositor before the 2008 recession. Since then, the amount is increased to $250,000. This guarantee gives financial institutions the incentive to make risky loans, and gives depositors conviction for their funds.

  5. Banks and Money Cosmos The money multiplier is the number by which a change in the monetary base is multiplied to find the resulting change in the quantity of money. Change in quantity of coin = Money multiplier X Modify in budgetary base. The money multiplier is adamant past the required reserve ratio (r) and by the currency drain (c). c: an increment in currency held outside the banks,  tells us the portion of currency which people volition hold every bit cash for their expanses after they borrowed from the banks.  r is the required reserve ratio which determined by the Federal Reserve. Banks are required to agree r portion of their total deposit every bit their required reserve. RR: Required Reserve = Total deposit x r ER: Excess Reserve = Actual reserve - Required Reserve Maximum new loan corporeality of the banks is equal to the excess reserve held by the banks. Money multiplier = 1/ {1- (ane-r)(1-c)} Maximum modify in checkable deposits = Money multiplier X Change in reserves from the initial injection For instance, A deposits $grand in Bank 10. The current required reserve ratio (r) is 10%, c is 25% Coin multiplier = ane / {1- (one-10%)(one-25%)} = 3 Maximum change in checkable deposits = 3 X $grand = $3000 When c=0, Money multiplier = 1/r, this is the uncomplicated money multiplier.

  6. Federal Reserve System The Federal Reserve System, established by Congress in 1913, regulates the money supply and banking organisation in the U.Due south. Its principal components are the following: 1. Board of Governors: controls and coordinates the activities of the Federal Reserve System. The vii governors are appointed by the president and confirmed by the Senate to staggered 14-year non-renewable terms. The president designates one member of the board as the chair for a four year, renewable term. 2. Federal Open up Market Committee (FOMC): is made upwardly of the seven governors plus five presidents of Federal Reserve District Banks (the president of the New York commune has a permanent seat; the other 4 places rotate among the remaining xi district banks). FOMC has the say-so to bear open up marketplace operations, which is the buying and selling of government securities for the purposes of manipulating the money supply. 3. Federal Reserve District Banks: assist the Lath of Governors in overseeing the banking system and controlling the coin supply, the system was divided into 12 geographic districts and each district is overseen past a Federal Reserve District Bank. Functions of the Federal Reserve Systems are: 1. Control the coin supply two. Supply the economic system with paper coin 3. Provide bank check-clearing services 4. Agree depository institution'due south Reserves 5. Supervise member banks 6. Serve as the Authorities's broker 7. Serve every bit a lender of last resort 8. Serve as a Fiscal Agent for the Treasury.

  7. Monetary Policy Monetary Policy tools: The Fed tin employ the following tools to influence the coin supply. ane. Open up Market place Operation: The Fed tin can affect the money supply by buying or selling U.S. government securities, using open up market place operations. When the Fed purchases a government security from the public, information technology does so with money that did not exist in the system. Thus, bank reserves volition ascension, increasing the coin supply. 2. The Required-Reserve Ratio (r): The Fed can influence money supply by changing this ratio. This ratio specified the amount banks must concur equally reserves on all deposits and limits the amount that banks may lend out. If the Fed increases the reserve ratio, the deposit and money multiplier will be smaller, thereby further limiting the amount past which banks may expand the coin supply. 3. Discount Rate: Banks volition borrow funds when needed. When the banks borrow from the Fed, they pay an interest charge per unit called the Discount rate. When the disbelieve rate is raised, banks will have less incentive to borrow, thus lowering the money supply in the organization. When the economy is in inflationary gap, the Fed will adopt contractionary monetary policy to decrease the money supply in the market by selling securities, raising the reserve rate, and/or increasing the discount rate. These actions will lower the AD and close the GDP gap. When the economic system is in recessionary gap, the Fed will adopt expansionary monetary policy to increase money supply in the market by ownership securities, lowering the required reserve rate, and/or decreasing the disbelieve/federal funds rate. These actions volition increase the Advertizement and shut the GDP gap. However, these policy tools may not be effective due to issues like fourth dimension lags, liquidity trap, or interest-insensitive investments.

  8. Money Market The demand for coin has two components: transactional demand and asset demand. Transactional demand (Dt) is money kept for purchases and will vary straight with GDP. Asset demand (Da) is coin kept equally a store of value for later utilise. . Asset demand varies inversely with the interest rate, since that is the price of property idle coin. Full demand for money will equal quantities of money demanded for avails plus that for transactions. The demand bend for money illustrates the inverse relationship between the quantity demanded of money and the interest charge per unit. The supply of money is a vertical line, suggesting the quantity of coin is fixed at a level largely determined past the Fed. Equilibrium in the coin market place exists when the quantity demanded of money equals the quantity supplied. In the above graph, it shows an equilibrium of the money market at interest rate of 6%, and quantity of money at 600 billions. The vertical curve indicates the money supply decided by the Federal Reserve. At any involvement rate higher up the equilibrium rate, in that location is an excess supply of money. At whatever interest charge per unit below the equilibrium rate, there is an excess demand of money. Fed can influence the market interest rate by adjusting the coin supply. If the money supply increases (moving the vertical curve in the in a higher place graph towards the right), the interception betoken will demonstrate a lower interest rate in the marketplace. If the coin supply decreases  (moving the vertical bend in the above graph towards the left), the interception betoken will  demonstrate a college interest rate. Therefore, market's interest rate is closely related to the monetary policy of the Fed.

  9. Equation of Substitution The Equation of Exchange addresses the relationship between money and price level, and betwixt money and nominal Gdp. The equation just states:   Yard x V = P x Y Where M = the money supply, ordinarily the M1             V = the velocity of coin             P = the price level             Y = real output, or real Gdp. Velocity is the number of times the average dollar is spent to buy terminal goods and services in a given year.  Velocity tin be calculated by using Five = (P x Y ) / M The equation tells us that total spending (M x V) is equal to total sales revenue (P x Y). Since (P x Y) is equal to the nominal Gdp, then M 10 V = nominal Gross domestic product. Velocity (5) and Real Gross domestic product (Y) are effectively constant in the short run, therefore any changes in money supply (One thousand), will cause a proportional change in the price level (P). Re-writing the equation, we get: P = ( M x V ) / Y This equation demonstrated a straight relationship between price and money supply. If V and Y are constant, a certain percentage change in money supply will cause a same corporeality of alter in the price level.

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