What do the following have in common? Bronze knives Farm Tools Cacao Beans Salt Chunks Stone Disks Fish Hooks Beaver Pelts Musket balls Nails Cigarettes.

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Presentation transcript:

What do the following have in common? Bronze knives Farm Tools Cacao Beans Salt Chunks Stone Disks Fish Hooks Beaver Pelts Musket balls Nails Cigarettes All of these items have been used as money

What is Money? Anything accepted as payment for goods and services by most people in an area at a given time. Money is NOT the same as wealth! Wealth can be either non-monetary assets (like stocks, bonds, houses or gold etc.) or monetary assets (like cash)

2 types of money Commodity money –Commodities used for money have an “intrinsic” value other than their use as money –Examples are… Gold, silver, animal skins, cigarettes Fiat money -Money with NO intrinsic value It’s value comes from government decree. What is an example of Fiat money?

Fiat Money The value of this 5 dollar bill is backed by nothing other than faith in the American Government

Money has 3 functions 1.Medium of Exchange 1.We use it to buy things. 2.It’s uniform, easily countable. Much easier than bartering! 2.Unit of Account 1.Money is used so we can assess fairly and consistently measure the value of what we own and what people owe us (debts). 3.Store of value 1.Money can be saved for use at a later date. Money can be stored in different ways. What are some ways money can be “stored”? What factors should one consider when storing money to be used at a later date?

3. Money as a “Store of Value” How people choose to store their money requires decision making. “Liquidity”- how quickly can I get at that money if I need it? “Safety” – What are the chances that I can get all of my money back? “Inflation”- will that money have the same buying power later as it does today? People need to decide how “liquid” their assets need to be. Liquidity = The ability of assets to be easily converted into money. Evaluate the liquidity of cash stored in a piggy bank. High liquidity or Low? Very high Safety? What’s the likelihood this money will be there when you need it?

What has been America’s biggest economic problem in recent history?

Would having more money in the economy help the economy grow??…. YES!! –Firms need easy access to money to make investments in their businesses. –People need easy access to money to help them buy things like houses Question: If somebody made it super easy to borrow $ (20 years, 0% interest) could you find something to buy?

Growth in M to 2013 What happened here?? Answer: The people who control our economy wanted more money in the system.

There is a person in charge of keeping our economy stable and growing. Who is it? Hint: She’s a girl! Janet Yellen, chairwoman, U.S. Federal Reserve Bank Most powerful person in the world?

The Federal Reserve keeps track of how much money is in the system and they can add or subtract $ when they want? 1.M1 = Cash in circulation + Checking accounts and Traveler’s checks (the most liquid money available for purchases) 1.M2 = M1 + Savings Deposits and Money Market Mutual Funds The Money Supply

Figure 1 Money in the U.S. Economy Copyright©2003 Southwestern/Thomson Learning Billions of Dollars Currency Demand deposits Traveler’s checks Other checkable deposits Everything in M1 ($1,371 billion) Savings deposits Small time deposits Money market mutual funds A few minor categories ($4,276 billion) 0 M1 $1,371 M2 $6,475

CASE STUDY: Where Is All The Currency? In 2001 there was about $580 billion of U.S. currency outstanding. –That is $2,734 in currency per adult. Who is holding all this currency? –Currency held abroad –Currency held by illegal entities

Changing the Money Supply There are times when the government wants to increase or decrease the amount of money in circulation (money supply) When might the government want to increase the money supply?? In times of economic stagnation… to stimulate spending (increase GDP)

Using the banking system to increase or decrease the Money Supply It’s magic!

BANKS AND THE MONEY SUPPLY Banks take in deposits from customers. Reserves are deposits that banks have received but have not loaned out. In a fractional-reserve banking system, banks hold only a “fraction” of the money deposited as REQUIRED RESERVES and lend out the rest (Excess Reserves) Why do banks need to hold a fraction of their deposits as reserves?? So they have some money to return to customers when they need money.

BANKS AND THE MONEY SUPPLY Reserve Requirement –The reserve requirement is the fraction of deposits that banks must hold so they can return $ to their depositors. –Currently the U.S. national RESERVE REQUIREMENT is 10% of all deposits. –That means the government REQUIRES banks to hold only 10% or their deposits as reserves. They then can loan out the rest!! How do banks make money?? Banks are in business to make loans!

It’s a Wonderful Life Bank Run

Money Creation with Fractional-Reserve Banking –When a bank makes a loan from its reserves, the money supply increases. –The money supply is affected by the amount deposited in banks and the amount that banks loan.

A T-Chart Showing a $100 Deposit with 100% Reserve Banking Structure (A bank takes in a $100 deposit, but to be safe, the bank must hold the entire deposit as required reserves.) AssetsLiabilities Reserves $100Deposits$100 In this case no money is added to the system!! Let’s see how it would work if banks had to keep all their deposits in reserve and not loan any out

Money Creation with Fractional-Reserve Banking (that’s the system we have here!) This T-Account shows a bank that… –accepts deposits, –keeps a portion as reserves, –and lends out the rest. –It assumes a reserve ratio of 10%. AssetsLiabilities First National Bank Reserves $10.00 Loans $90.00 Deposits $ Total Assets $ Total Liabilities $100.00

Money Creation with Fractional-Reserve Banking When one bank loans money, that money is generally deposited into another bank. This creates more deposits and more reserves to be lent out. When a bank makes a loan from its reserves, the money supply increases.

The Money Multiplier AssetsLiabilities First National Bank Reserves $10.00 Loans $90.00 Deposits $ Total Assets $ Total Liabilities $ AssetsLiabilities Second National Bank Reserves $9.00 Loans $81.00 Deposits $90.00 Total Assets $90.00 Total Liabilities $90.00 Money Supply = $190.00!

The Money Multiplier How much money is eventually created in this economy? That depends on the reserve requirement.

The Money Multiplier The money multiplier is the amount of money the banking system generates with each dollar of deposits. The money multiplier is the reciprocal of the reserve requirement: M = 1/R So, if the reserve requirement is 10%, what is the money multiplier? M= 1/R or 1/.10 = 10

What is the total increase in money supply if ALL excess reserves are loaned out??? With a reserve req. of 10%, how much does a new deposit of $100 add to the money supply? Total Increase in the Money Supply = Money Multiplier x Initial Deposit = 10 x 100 = $1000 So, one way the government can increase the money supply would be to change the…. (fill in the blank)? Reserve Requirement

What about buying power? INFLATION  Is cash in a piggy bank a good store of value? Not over the long-term, because inflation will eat into the value. Is buying a house a good store of money? Liquidity? Safety? Inflation? Buying a house might be fairly safe and might keep up with inflation but what about liquidity? Houses are not very “liquid” investments