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ch10TheMoneySupplyandtheFederalReserveSystem.ppt

1、Prepared by: Fernando Quijano & Shelly Tefft,CASE FAIR OSTER,P R I N C I P L E S O F MACROECONOMICS T E N T H E D I T I O N,CHAPTER OUTLINE,10,The Money Supply and the Federal Reserve System,An Overview of Money What Is Money?Commodity and Fiat MoniesMeasuring the Supply of Money in the United State

2、s The Private Banking SystemHow Banks Create MoneyA Historical Perspective: GoldsmithsThe Modern Banking SystemThe Creation of MoneyThe Money MultiplierThe Federal Reserve SystemFunctions of the Federal ReserveExpanded Fed Activities Beginning in 2008The Federal Reserve Balance SheetHow the Federal

3、Reserve Controls the Money SupplyThe Required Reserve RatioThe Discount RateOpen Market OperationsExcess Reserves and the Supply Curve for MoneyLooking Ahead,Money is a means of payment, a store of value, and a unit of account.,barter The direct exchange of goods and services for other goods and ser

4、vices.,medium of exchange, or means of payment What sellers generally accept and buyers generally use to pay for goods and services.,An Overview of Money,What Is Money?,A Means of Payment, or Medium of Exchange,store of value An asset that can be used to transport purchasing power from one time peri

5、od to another.,liquidity property of money The property of money that makes it a good medium of exchange as well as a store of value: It is portable and readily accepted and thus easily exchanged for goods.,unit of account A standard unit that provides a consistent way of quoting prices.,An Overview

6、 of Money,What Is Money?,A Store of Value,A Unit of Account,commodity monies Items used as money that also have intrinsic value in some other use.,fiat, or token, money Items designated as money that are intrinsically worthless.,legal tender Money that a government has required to be accepted in set

7、tlement of debts.,currency debasement The decrease in the value of money that occurs when its supply is increased rapidly.,An Overview of Money,Commodity and Fiat Monies,In most countries commodity monies are not used anymore, but the world is a big place and there are exceptions. In the Solomon Isl

8、ands, dolphin teeth are being used as a means of payment and a store of value. Note that even with a currency like dolphin teeth there is a concern about counterfeit currency, namely fruit-bat teeth, but also tooth decay.,Dolphin Teeth as Currency,E C O N O M I C S I N P R A C T I C E,Shrinking Doll

9、ar Meets Its Match in Dolphin Teeth Wall Street Journal,M1, or transactions money Money that can be directly used for transactions.,M1 currency held outside banks + demand deposits + travelers checks + other checkable deposits,An Overview of Money,Measuring the Supply of Money in the United States,M

10、1: Transactions Money,near monies Close substitutes for transactions money, such as savings accounts and money market accounts.,M2, or broad money M1 plus savings accounts, money market accounts, and other near monies.,M2 M1 + savings accounts + money market accounts + other near monies,An Overview

11、of Money,Measuring the Supply of Money in the United States,M2: Broad Money,There are no rules for deciding what is and is not money.This poses problems for economists and those in charge of economic policy.,An Overview of Money,Measuring the Supply of Money in the United States,Beyond M2,financial

12、intermediaries Banks and other institutions that act as a link between those who have money to lend and those who want to borrow money.,An Overview of Money,The Private Banking System,The main types of financial intermediaries are commercial banks, followed by savings and loan associations, life ins

13、urance companies, and pension funds.,run on a bank Occurs when many of those who have claims on a bank (deposits) present them at the same time.,How Banks Create Money,A Historical Perspective: Goldsmiths,Todays bankers differ from goldsmithstodays banks are subject to a “required reserve ratio.”Gol

14、dsmiths had no legal reserve requirements, although the amount they loaned out was subject to the restriction imposed on them by their fear of running out of gold.,Assets Liabilities Net Worth or Assets Liabilities + Net Worth,Federal Reserve Bank (the Fed) The central bank of the United States.,How

15、 Banks Create Money,The Modern Banking System,A Brief Review of Accounting,reserves The deposits that a bank has at the Federal Reserve bank plus its cash on hand.,required reserve ratio The percentage of its total deposits that a bank must keep as reserves at the Federal Reserve.,The balance sheet

16、of a bank must always balance, so that the sum of assets (reserves and loans) equals the sum of liabilities (deposits and net worth)., FIGURE 10.1 T-Account for a Typical Bank (millions of dollars),How Banks Create Money,The Modern Banking System,A Brief Review of Accounting,excess reserves The diff

17、erence between a banks actual reserves and its required reserves.,excess reserves actual reserves required reserves,In panel 2, there is an initial deposit of $100. In panel 3, the bank has made loans of $400., FIGURE 10.2 Balance Sheets of a Bank in a Single-Bank Economy,How Banks Create Money,The

18、Creation of Money,In panel 1, there is an initial deposit of $100 in bank 1. In panel 2, bank 1 makes a loan of $80 by creating a deposit of $80. A check for $80 by the borrower is then written on bank 1 (panel 3) and deposited in bank 2 (panel 1). The process continues with bank 2 making loans and

19、so on. In the end, loans of $400 have been made and the total level of deposits is $500., FIGURE 10.3 The Creation of Money When There Are Many Banks,How Banks Create Money,The Creation of Money,An increase in bank reserves leads to a greater than one-for-one increase in the money supply. Economists

20、 call the relationship between the final change in deposits and the change in reserves that caused this change the money multiplier.,money multiplier The multiple by which deposits can increase for every dollar increase in reserves; equal to 1 divided by the required reserve ratio.,How Banks Create

21、Money,The Money Multiplier, FIGURE 10.4 The Structure of the Federal Reserve System,The Federal Reserve System,Federal Open Market Committee (FOMC) A group composed of the seven members of the Feds Board of Governors, the president of the New York Federal Reserve Bank, and four of the other 11 distr

22、ict bank presidents on a rotating basis; it sets goals concerning the money supply and interest rates and directs the operation of the Open Market Desk in New York.,Open Market Desk The office in the New York Federal Reserve Bank from which government securities are bought and sold by the Fed.,The F

23、ederal Reserve System,From a macroeconomic point of view, the Feds crucial role is to control the money supply.The Fed also performs several important functions for banks, such as clearing interbank payments, regulating the banking system, and assisting banks in a difficult financial position. The F

24、ed is also responsible for managing exchange rates and the nations foreign exchange reserves.It is often involved in intercountry negotiations on international economic issues.,lender of last resort One of the functions of the Fed: It provides funds to troubled banks that cannot find any other sourc

25、es of funds.,The Federal Reserve System,Functions of the Federal Reserve,The Federal Reserve System,Expanded Fed Activities Beginning in 2008,When housing prices began to fall in late 2005, the stage was set for a worldwide financial crisis, which essentially began in 2008.There has been much politi

26、cal discussion of whether the Fed should have regulated more in 20032005 and whether it should be intervening in the private sector as much as it has been doing.It is certainly the case that the Fed has taken a much more active role in financial markets since 2008.,The Federal Reserve System,The Fed

27、eral Reserve Balance Sheet,If the Fed wants to increase the supply of money, it creates more reserves, thereby freeing banks to create additional deposits by making more loans. If it wants to decrease the money supply, it reduces reserves.Three tools are available to the Fed for changing the money s

28、upply: Changing the required reserve ratio. Changing the discount rate. Engaging in open market operations.,How the Federal Reserve Controls the Money Supply,How the Federal Reserve Controls the Money Supply,The Required Reserve Ratio,Decreases in the required reserve ratio allow banks to have more

29、deposits with the existing volume of reserves. As banks create more deposits by making loans, the supply of money (currency + deposits) increases. The reverse is also true: If the Fed wants to restrict the supply of money, it can raise the required reserve ratio, in which case banks will find that t

30、hey have insufficient reserves and must therefore reduce their deposits by “calling in” some of their loans. The result is a decrease in the money supply.,How the Federal Reserve Controls the Money Supply,The Required Reserve Ratio,discount rate The interest rate that banks pay to the Fed to borrow

31、from it.,How the Federal Reserve Controls the Money Supply,The Discount Rate,moral suasion The pressure that in the past the Fed exerted on member banks to discourage them from borrowing heavily from the Fed.,How the Federal Reserve Controls the Money Supply,The Discount Rate,open market operations

32、The purchase and sale by the Fed of government securities in the open market; a tool used to expand or contract the amount of reserves in the system and thus the money supply.,How the Federal Reserve Controls the Money Supply,Open Market Operations,The Treasury Department is responsible for collecti

33、ng taxes and paying the federal governments bills.The Fed is not the Treasury. It is a quasi-independent agency authorized by Congress to buy and sell outstanding (preexisting) U.S. government securities on the open market.,Two Branches of Government Deal in Government Securities,How the Federal Res

34、erve Controls the Money Supply,Open Market Operations,The Mechanics of Open Market Operations, An open market purchase of securities by the Fed results in an increase in reserves and an increase in the supply of money by an amount equal to the money multiplier times the change in reserves. An open m

35、arket sale of securities by the Fed results in a decrease in reserves and a decrease in the supply of money by an amount equal to the money multiplier times the change in reserves.,We can sum up the effect of these open market operations this way:,How the Federal Reserve Controls the Money Supply,Op

36、en Market Operations,The Mechanics of Open Market Operations,If the Feds money supply behavior is not influenced by the interest rate, the money supply curve is a vertical line. Through its three tools, the Fed is assumed to have the money supply be whatever value it wants., FIGURE 10.5 The Supply o

37、f Money,How the Federal Reserve Controls the Money Supply,Excess Reserves and the Supply Curve for Money,Looking Ahead,This chapter has discussed only the supply side of the money market. In the next chapter, we turn to the demand side of the money market.We will examine the demand for money and see

38、 how the supply of and demand for money determine the equilibrium interest rate.,barter commodity monies currency debasement discount rate excess reserves Federal Open Market Committee (FOMC) Federal Reserve Bank (the Fed) fiat, or token, money financial intermediaries legal tender lender of last re

39、sort liquidity property of money M1, or transactions money M2, or broad money medium of exchange, or means of payment money multiplier,moral suasion near monies Open Market Desk open market operations required reserve ratio reserves run on a bank store of value unit of account 1. M1 currency held ou

40、tside banks + demand deposits + travelers checks + other checkable deposits 2. M2 M1 + savings accounts + money market accounts + other near monies 3. Assets Liabilities + Net Worth 4. Excess reserves actual reserves required reserves 5. Money multiplier ,R E V I E W T E R M S A N D C O N C E P T S,

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