PRINCIPLES OF ECONOMICS Chapter 27 Money and Banking PowerPoint Image Slideshow

MONEY Money is anything that is generally accepted as a medium of payment. Money is not income, and money is not wealth. Income and wealth are measured in money. Money has the following functions: Medium of paymentMedium of payment Store of valueStore of value Unit of accountUnit of account

MONEY: MEDIUM OF PAYMENT Barter system: direct exchange of goods and services for other goods and service Barter system requires a double coincidence of wants for trade to take place. Money eliminates the barter problem and facilitates market transactions.

MONEY: STORE OF VALUE The value of money is the purchasing power embodied in it. Why do we prefer a $100 bill to a $1 bill? Money is as an asset that can be used to transport purchasing power from one time period to another. Money is easily portable across time and space.

MONEY: UNIT OF ACCOUNT Money serves as a unit of account for quoting prices keeping books calculating debts

TYPES OF MONEY Commodity Money: an item used as money that also has intrinsic value in some other use (e.g., gold & silver). Fiat or Token Money: money that is intrinsically worthless (e.g., coins & bills). Legal Tender: money that a government requires to be accepted in settlement of debts (e.g., dollar bills).

TOKEN MONEY For centuries, the extremely durable cowrie shell was used as a medium of exchange in various parts of the world.

FIAT MONEY Until 1958, silver certificates were commodity-backed money—backed by silver, as indicated by the words “Silver Certificate” printed on the bill. Today, U.S. bills are backed by the faith of people on the US economic system.

SUPPLY OF MONEY M1 or Transactions Money is money that can be directly used in transactions. M1 = currency held outside banks + checking accounts + plus traveler’s checks + other checkable deposits Checking accounts are called “demand” deposits

SUPPLY OF MONEY M2 or Broad Money includes near monies that are close substitutes for transactions money. M2 = M1 + savings accounts + money market accounts + other near monies Saving accounts are called “time” deposits

M1 AND M2 M1 = coins and currency in circulation + checkable (demand) deposit + traveler’s checks. M2 = M1 + savings deposits + money market funds + certificates of deposit + other time deposits.

COMMERCIAL BANKING: BANK RESERVES Total Reserves = Total deposits at a bank Required Reserves: A fraction of Total Reserves a bank must hold at its account in the FED Excess Reserves: The rest of Total Reserves that a bank can use for loans

COMMERCIAL BANKING: MONEY CREATION Banks use their Excess Reserves to make loans.

COMMERCIAL BANKING: MONEY CREATION Banks act as financial intermediaries because they stand between savers and borrowers. Savers place deposits with banks, and then receive interest payments and withdraw money. Borrowers receive loans from banks and repay the loans with interest. In turn, banks return money to savers in the form of withdrawals, which also include interest payments from banks to savers.

COMMERCIAL BANKING: MONEY CREATION