Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,*,The Monetary System,CHAPTER 29,In this chapter,look for the answers to these questions:,What assets are considered“money?What are the functions of money?The types of money?,What is the Federal Reserve?,What role do banks play in the monetary system?How do banks“create money?,How does the Federal Reserve control the money supply?,2,THE MONETARY SYSTEM,3,What Money Is and Why Its Important,Without money,trade would require,barter,the exchange of one good or service for another.,Every transaction would require a,double coincidence of wants,the unlikely occurrence that two people each have a good the other wants.,Most people would have to spend time searching for others to trade with a huge waste of resources.,This searching is unnecessary with,money,the set of assets that people regularly use to buy g&s from other people.,0,THE MONETARY SYSTEM,4,The 3 Functions of Money,Medium of exchange,:an item buyers give to sellers when they want to purchase g&s,Unit of account,:the yardstick people use to post prices and record debts,Store of value,:an item people can use to transfer purchasing power from the present to the future,0,THE MONETARY SYSTEM,5,The 2 Kinds of Money,Commodity money,:takes the form of a commodity with intrinsic value,Examples:gold coins,cigarettes in POW camps,Fiat money,:money without intrinsic value,used as money because of govt decree,Example:the U.S.dollar,0,THE MONETARY SYSTEM,6,The Money Supply,The,money supply,(or,money stock,):the quantity of money available in the economy,What assets should be considered part of the money supply?Two candidates:,Currency,:the paper bills and coins in the hands of the(non-bank)public,Demand deposits,:balances in bank accounts that depositors can access on demand by writing a check,0,THE MONETARY SYSTEM,7,Measures of the U.S.Money Supply,M1:currency,demand deposits,travelers checks,and other checkable deposits.,M1=$1.4 trillion(June 2021),M2:everything in M1 plus savings deposits,small time deposits,money market mutual funds,and a few minor categories.,M2=$7.7 trillion(June 2021),The distinction between M1 and M2 will usually not matter when we talk about“the money supply in this course.,0,THE MONETARY SYSTEM,8,Central Banks&Monetary Policy,Central bank,:an institution that oversees the banking system and regulates the money supply,Monetary policy,:the setting of the money supply by policymakers in the central bank,Federal Reserve(Fed),:the central bank of the U.S.,0,THE MONETARY SYSTEM,9,Bank Reserves,In a,fractional reserve banking system,banks keep a fraction of deposits as,reserves,and use the rest to make loans.,The Fed establishes,reserve requirements,regulations on the minimum amount of reserves that banks must hold against deposits.,Banks may hold more than this minimum amount if they choose.,The,reserve ratio,R,=fraction of deposits that banks hold as reserves,=total reserves as a percentage of total deposits,0,THE MONETARY SYSTEM,10,Bank T-account,T-account,:a simplified accounting statement that shows a banks assets&liabilities.,Example:,FIRST NATIONAL BANK,Assets,Liabilities,Reserves$10,Loans$90,Deposits$100,Banks liabilities include deposits,assets include loans&reserves.,In this example,notice that,R,=$10/$100=10%.,0,THE MONETARY SYSTEM,11,Banks and the Money Supply:An Example,Suppose$100 of currency is in circulation.,To determine banks impact on money supply,we calculate the money supply in 3 different cases:,1,.,No banking system,2,.,100%reserve banking system:banks hold 100%of deposits as reserves,make no loans,3,.,Fractional reserve banking system,0,THE MONETARY SYSTEM,12,Banks and the Money Supply:An Example,CASE 1,:No banking system,Public holds the$100 as currency.,Money supply=$100.,0,THE MONETARY SYSTEM,13,Banks and the Money Supply:An Example,CASE 2,:100%reserve banking system,Public deposits the$100 at First National Bank(FNB).,FIRST NATIONAL BANK,Assets,Liabilities,Reserves$100,Loans$0,Deposits$100,FNB holds 100%of deposit as reserves:,Money supply =currency+deposits=$0+$100=,$100,In a 100%reserve banking system,banks do not affect size of money supply.,0,THE MONETARY SYSTEM,14,Banks and the Money Supply:An Example,CASE 3,:Fractional reserve banking system,Money supply=$190(!)Depositors have$100 in deposits,Borrowers have$90 in currency.,FIRST NATIONAL BANK,Assets,Liabilities,Reserves$100,Loans$0,Deposits$100,Suppose,R,=10%.FNB loans all but 10%of the deposit:,10,90,0,THE MONETARY SYSTEM,15,Banks and the Money Supply:An Example,How did the money supply suddenly grow?,When banks make loans,they create money.,The borrower gets,$90 in currency(an asset counted in the money supply),$90 in new debt(a liability),CASE 3,:Fractional reserve banking system,A fractional reserve banking system creates money,but not wealth.,0,THE MONETARY SYSTEM,16,Banks and the Money Supply:An Example,CASE 3,:Fractional reserve banking syst