Econ 102 1st Edition Lecture 17Outline of Last Lecture I. Review for Midterm III. More Review (overhead projector)Outline of Current LectureI. Final Exam InfoII. Chapter 13 Money and BankingIII.How Banks Create MoneyCurrent LectureI. Final Exam Infoa. Worth the same weight as a midtermb. Nothing on Keynesian vs ClassicalII. Chapter 13 Money and Bankinga. Checking account data will show someones plans to spendi. house, car, etcb. Money is measuring Liquidity, NOT CASHi. Cash AND your other plans to spendii. Economists have in mind a very liquid assetiii. Liquidity of various assets is changing over time as bank-ing technologies changeiv. Because liquid assets can get away with offering lower rates of return, people generally only hold liquid assets if they plan to spend themThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.v. Measurement of the money supply helps us predict spend-ing (AD in the Keynesian model) and prices (in both the Keynesian and Classical models)c. Money: Any items that are regularly used in economic transac-tions that are a medium of exchange, a unit of account, and have a store of valuei. medium of exchange: you can buy something with itii. barter : is the alternative, the exchange of one good or ser-vice for another.1. Would only want to provide basic services for that could be traded for things everyone needsa. not going to see innovatorsb. They dont know if it will be able to be traded for medical care c. Inefficient because it makes a double coinci-dence of wantsi. you must be producing what I want for me to give you what you want.iii. Money increases economic efficiency1. you can specialize in the things you are good at2. Increase GDP, competitioniv. Money serves as a unit of account1. Unit of account: A standard unit in which prices can be stated and the value of goods and services can be compared. a. Can you pay your taxes with it? b. NY Ithaca hours is not moneyv. Money serves as a store of value1. earn money today and can use it later2. The property of money that holds that money pre-serves value until it is used in an exchange. 3. Losing control of money supplya. very riskyb. why people pay attention to inflation ratesi. if it gets to high people will stop using US dollar?4. commodity money: A monetary system in which the actual money is a commodity, such as gold or silver. a. EX: wheat, ancient Egypt had “wheat banks”i. If at any point government fell apart, youcould eat it!b. EX2: WWII used cigarettesi. Stop sending cigarettes its causing infla-tion!5. gold standard : A monetary system in which gold backs up paper money.a. used until 1970b. found all these gold industrial usesc. $35 US dollars to $800+ i. then Nixon removed the gold standard changing it to fiat money6. fiat money : A monetary system in which money has no intrinsic value but is backed by the government.a. by declaration, backed by our confidence in thesystem7. Application 1a. local currencies- not a unit of account, do not predict aggregate demand very well.8. M1 : The sum of currency in the hands of the public, demand deposits, other checkable deposits, and trav-eler’s checks.a. by using a method this liquid you are forgoing the stock market rates of returnb. move here right before you were going to buy something9. M2: M1 plus other assets, including deposits in sav-ings and loans accounts and money market mutual funds.a. Savings accounts used to over 14% interest, to-day 2%b. Used today to predict prices. c. M1 or M2?i. Both measures are currently in use in the U.S.ii. M2 rose in prominence as technological advances increased the liquidity of sav-ings deposits, mutual funds, and time de-posits, thus increasing the predictive power of M2iii. The technological advances in the bank-ing industry began with banking deregu-lation in the 1980’s and are frequently-cited gains from financial deregulation.iv. Banks clearly create liquidity, and so we can say they “create” money (which mea-sures plans to spend by measuring liq-uidity)III. How Banks Create Moneya. A Bank’s Balance Sheet: Where the Money Comes from and Where It Goesi. Balance sheet An account statement for a bank that shows the sources ofits funds (liabilities) as well as the uses of its funds (as-sets). 1. balance assets and liabilitiesii. liabilities : The sources of funds for a bank, including de-posits and owners’ equity.iii. assets : The uses of the funds of a bank, including loans and reserves.iv. Owners ’ equity : The funds provided to a bank by its own-ers.v. Reserves : The portion of banks’ deposits set aside in eithervault cash or as deposits at the Federal Reserve.1. Want to lend out as much as possible (because that how the bank makes money) but must keep enough on hand to meet the customers liquidity needs.vi. Required reserves: The specific fraction of their deposits that banks are required by law to hold as reserves.1. minimum fraction of every deposit banks must keep in reserve2. where banks usually stayvii. Excess reserves : Any additional reserves that a bank holdsabove required reserves.1. Why is the bank holding so much?2. Must think new loans are risky3. Afraid to make loans- bad sign!viii. Reserve ratio : The ratio of reserves to deposits.b. Figure 13.4i. “First Bank of Hollywood” 1. Start on Liabilities sidea. You find $1,000 and deposit into bankb. 10% required reserve ratio2. Bank lends 90%($900) and saves 10%($100)ii. “Second Bank”1. 90% of $9002. save 10% ($90) lend 90% ($810)iii. Banks lend out the fraction “1-reserve ratio” out of every dollar in new deposits. Call that fraction “b” iv. 1+ b+ b^2 + b^3 + b^4 = 1/ (1-b)v. Increase in checking account balances = initial deposit X 1/ reserve ratiovi. Where the denominator 1-b = 1-(1-reserve ratio) = reserveratioc. Application 2i. the Great Recessionii. Banks are not creating loans, not lending for cars and houses as much as they couldiii. causes capital deepening1. effects aggregate demandiv. Excess reserve ratio has fallen dramatically in the last 6 months- GOOD SIGNv. Summary 1. Banks are financial intermediariesa. They affect long-run GDP and real wages by in-creasing the efficiency with which households lend to firms (Keynesians and Classical econo-mists agree)2. Banks affect
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