Chapter 13 Money Banks and the Federal Reserve Money Money is an asset that is widely accepted as a means of payment in the economy It is a means of payment we an use it to buy goods and services or other assets o Coins and paper currency traveler s checks and funds held in checking accounts are all examples of assets that are money o Debit and credit cards are not money The Money Supply Cash in the hands of the public largest category of money total dollar value of all the coins and currency in circulation Checkable deposits accounts held by households and business firms at commercial banks Basic checking accounts demand deposits when you write a check to someone on one of these accounts the person can go into your bank and be paid in cash o Pay no interest o Automatic transfers from savings accounts interest paying savings accounts that automatically transfer funds into demand deposit accounts as you write checks Traveler s checks specially printed checks that you can buy from banks or other private companies Money supply Cash in the hands of the public checking account deposits traveler s checks M1 versus M2 M1 includes cash checkable deposits and traveler s checks M2 includes all of M1 plus savings deposits money market deposits money market funds certificates of deposit Functions of Money Money serves three functions in the economy o Means of payment paying with money increases the efficiency of trading compared to bartering o Store of value a way to hold wealth o Unit of account a common unit for measuring how much something is worth Permits us to compare the costs of different goods and services and to communicate these costs when we trade A Brief History of the Dollar During the Civil War the govt issued the first federal paper currency the greenback Federal Reserve System created to be the national monetary authority in the US o Charged with creating and regulating the nation s supply of money Why Paper Currency is Accepted as a Means of Payment Commodity money have important uses other than as a means of payment Fiat money money that only serves as a means of payment by government declaration o Long standing acceptability by others The Banking System Financial Intermediaries in General Financial intermediaries business firms that specialize in assembling loanable funds from households and firms whose revenues exceed their expenditures and channeling those funds to households and firms whose expenditures exceed revenues Combines a large number of small savers funds and then lending them to larger borrowers Can reduce the risk to savers by spreading its loans among a number of different borrowers Charge a higher interest rate on the funds they lend than the rate they pay to savers Commercial Banks the public A Bank s Balance Sheet A private corporation owned by its stockholders that provides services to Most important service to provide checking accounts Balance sheet a two column list that provides information about the financial condition of a bank at a particular point in time o Assets everything of value that it owns o Liabilities the amounts that the bank owes A Bank s Assets Buildings and land underneath them Bond a promise to pay funds to the holder of the bond issued by a corporation or a government agency when it borrows money Loans promises to pay back funds Cash in vault and ATMs the coin and currency that the bank has stored in its vault and in its ATMs o Does not pay any interest Accounts with the Federal Reserve banks maintain their own accounts with the Fed and they add to and subtract from these accounts when they make transactions with other banks Banks are required to hold reserves the sum of cash in the vault and ATMs and in accounts with the Federal Reserve Required reserves the amount of reserves a bank must hold Required reserve ratio tells banks the fraction of their checking accounts that they must hold as required reserves Sometimes banks want to hold excess reserves reserves beyond the minimum requirement o May want some flexibility to increase loans in the future in case interest rates the reward for lending rise A Bank s Liabilities Checking account deposits Other deposits funds that households and firms hold at the bank in some form other than checking accounts such as savings accounts or CDs Bank borrowing banks themselves sometimes borrow funds by taking out loans from other banks or by issuing their own bonds Shareholder s equity when a bank sells all of its assets for their value on the balance sheet the money left over goes to its stockholders o Shareholders equity Total assets Total liabilities o What the bank would owe to its owners if it went out of business The Federal Reserve System Every large nation controls its money supply with a central bank the nation s principal monetary authority and the institution responsible for controlling its money supply US is divided into 12 Federal Reserve districts The Structure of the Fed Top Board of Governors consisting of seven members who are appointed by the president and confirmed by the Senate for a 14 year term Chairman of the Board of Governors most powerful person one of the seven governors 4 year term The Federal Open Market Committee Federal Open Market Committee FOMC consists of all seven governors of the Fed along with 5 of the 12 district bank presidents o Meets to discuss current trends in inflation employment GDP interest rates and more o The committee exerts control over the nation s money supply and interest rates by buying and selling government bonds in the public bond market The Functions of the Fed Supervising and Regulating Banks o Sets the required reserve ratio for all banks not just member banks o Determines what sorts of loans and investments banks and other financial institutions are allowed to make and it closely monitors their activities Acting as a Bank for Banks o Banks can borrow from the Fed o The Fed charges a discount rate a special interest rate on loans that it makes to member banks Issuing Paper Currency o Once money is printed it is shipped to the Fed o The Fed in turn puts this currency into circulation Check Clearing o Transfers funds from one bank s reserve account to another s Guiding the Macro economy o Uses tools to attempt to keep the economy as close to potential output as possible o Tries to avoid painful recessions booms that lead to high inflation Dealing with Financial Crises o Stands ready to act as the lender of last resort to make sure that
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