Spring 2012 J Neri Lesson 1 Introduction to Money Chapter 1 Five parts of a bank system 1 Money pay for purchase store wealth 2 Financial instruments transfer wealth or risk 3 Financial markets transfer funds from people with excess to those with shortage a Results in greater economic efficiency 4 Financial institutions access to financial market 5 Central banks monitor and stabilize economy financial institutions Security financial instrument claim on the issuer s future income or assets debt security makes payments periodically for certain period of time ownership of a piece of a public company property or financial claim subject to ownership Bond Stock Interest rate Financial intermediaries saved and in turn make loans to others most common is a bank also includes insurance companies mutual funds finance companies and investment banks Banks loan associations mutual savings banks and credit unions cost of borrowing or price paid for rental of funds institutions that borrow funds from people who have accept deposits and make loans includes commercial banks savings and Aggregate output total production of goods and services o Most common measure of this is Gross Domestic Product GDP value of all final goods and services produced in a country during the course of the year o Nominal GDP indicates measurement in current prices Changes based on price not quantity therefore can be misleading measure of economic well being o Real GDP indicates measurement with a base year Only changes if actual quantities have changes Aggregate income total income of factors of production land labor and capital from producing gods and services in the economy during the course of the year o Same thing aggregate output because the payments for final goods and services must eventually flow back to the owners of the factors of production as income o Income payments must equal payments for final goods and services Aggregate price level o GDP Deflator Price level for base year is 100 measure of average prices in the economy nominal GDP divided by real GDP Indicates how much prices have risen on average o Consumer price index CPI measured by pricing a basket list of goods and services bought by a typical urban household over a given period and compares it with other time periods to see how the price of this basket of goods changes Calculate by dividing the nominal magnitude by the price index Price level for base year is 100 upward and downward movement of aggregate output produced Business cycles in a economy o Recession Monetary theory when agg output declining theory that relates changes in the quantity of money to changes in aggregate economic activity and the price level Aggregate price level Inflation a continual increase in the price level average price of goods and services in an economy o Data shows that a continuing increase in the money supply might be an important factor in causing the increase in the price level aka inflation o Positive association between inflation and growth rate of money supply countries with highest money growth rates are also the ones with the highest money growth rates such as Brazil Argentina and Peru Inflation rate rate of change of price level Money plays important role in interest rate fluctuation as money growth rate in 60s and 70s rose long term bon rate rose with it but relationship has been less clear cut recently Monetary policy Central Bank Federal Reserve System Budget deficit the management of money and interest rates responsible for conduct of a nation s monetary policy US central bank excess gov t expenditures over tax revenues Chapter 3 repayment of debts o Currency Money anything generally accepted in payment form goods or services or in the Wealth is only one type of money the total collection of pieces of property that serve to store value o Includes money and other assets such as bonds common stock and property flow of earnings per unit of time Income Functions of money o Medium of exchange used to pay for goods and services Promotes economic efficiency by eliminating time spent in exchanging goods and services called a transaction cost To function effectively a commodity must be easily standardized widely accepted divisible easy to carry and not deteriorate quickly o Unit of account o Store of value used to measure value in the economy repository of purchasing power over time Allows us to save without value of past income deteriorating Other assets also have store of value Liquidity converted into an a medium of exchange relative ease and speed with which an asset can be Highly desirable Money is most liquid asset of all because it IS the medium of exchange and does not have to be converted to make purchases Transaction costs for other assets ie selling your house need to pay brokerage commission and if you need cash immediately might need to settle for lower price Store of value money depends on the price level because its value is fixed in terms of the price level If value of money drops people more likely to hold wealth in other forms Hyperinflation month extreme inflation rate exceeds 50 per o Occurred in Germany after WWI Measuring money o Monetary aggregates supply in an economy broad categories measuring total value of money Hard for policymakers and economists to decide which is true measure of money M1 M2 currency checking account deposits and travelers checks physical cash and coin M1 plus all other assets that have check writing features money market deposit accounts and money market mutual fund shares and other assets small denomination time deposits savings deposits overnight repurchase agreements and overnight Eurodollars Very liquid turned into cash quickly and at little cost o Hard to measure money because the data is not always accurate and revisions in data occur so not reliable in short run movements in money supply Lesson 2 Overview of the Financial System Chapter 2 Financial markets channel funds from people with surplus to people with shortage set people up together which promotes economic efficiency Includes o Lender savers Households business firms gov t foreigners o Borrower spenders business firms gov t households foreigners Direct finance Borrowers borrow directly from lenders by selling them securities o Securities are assets for the buyer but liabilities for the issuer Indirect finance financial intermediary that helps transfer funds between lender and borrower Structure of financial markets o Maturity time to debt