Lecture 21 Money and BankingThree functions of Money1. Medium of ExchangeExamples: gold, silver, tobacco, wampum, stonesThe alternative is barterDouble coincidence of wants: someone want to sell, and want your stuf2. Unit of account3. Store of value4. One way we store our wealthThree types of Money1. Commodity money2. Commodity-backed money3. Fiat Money: no inherent valueNew problem: DiscretionThe government has discretion to change the quantity of money: if gov owes money, they justprint money and pay billsdiscretion is worse than inherent price riskUS Money SupplyM1: Money supply checking account: currency+checking account+Traveler’s checksM2: Broader measure of money supply: M1+Saving deposits (essentially)15 trillion: GDPKey:M=Currency+DepositsCommercial banks (banks)banks is just like a firm: inputs firm output Deposits LoansTwo macroeconomic Roles1. Middlemen in loan market2. Channel of monetary policyBalance SheetAssets (uses of funds) Liabilities+Owner’s Equity (sources of funds)ReservesLoansUS Treasury secutitiesOther AssetsDeposits (key source)BorrowingsOwner’s equityReserves: the part that bank does not loan outBank Reserves: Fractional Reserve banking systemwhy don’t bank keep everything reserve? because bank wont make money. there is anopportunity cost of making reservesloans make higher interest rate than reserveswhy don’t the banks loan out everything?1. reduces their risk (everybody show up and want their money back)2. it’s the law. they have to. a reserve requirementBank ReservesRequired reserve ratio (rr)=10%bankrupt: great depression: people want their money in the bank backsolution (new deposit): the federal deposit insurance (FDIC)New problem: moral hazard (no moral consequences to your action)banks are playing with other people’s money. and people don’t carenobody care about the stability of the
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