And Financial Institutions Chapter 13 Money And Financial Institutions

What is Money? Money is anything generally accepted as a medium of exchange, a store of value, and a measure of value. Stability Portability Durability Uniformity Divisibility Recognizability

Different kinds of Money The Money Supply Currency, travelers’ checks, demand deposits (checking accounts), other checkable deposits M2 M1 plus, small savings deposits, passbook/money market savings deposits, mutual fund money market accounts M3 M2 plus, institutional money market accounts, large savings deposits, eurodollars, other

What Banks Do History lesson Basic function of banks: Collect funds from those that have no immediate need, pay interest on those funds, funnel them to borrowers Accepting and holding deposits Make loans (coordinate lenders and borrowers) Collecting/transferring funds

Fractional Reserve Banking How it started It’s a wonderful life

Let’s make some money Required reserves Reserve ratio Fixed portion of deposits that cannot be loaned Reserve ratio The percentage of reserves a bank is required to keep Inverse relationship (teeter totter) between reserve ratio and the amount banks can lend

How does this create money? Some of each deposit is kept (reserve ratio) The total left is loaned to others Is the money removed from the vault and given to borrowers? Bank “creates” money by starting or adding to account How much money will be created? Deposit multiplier (100÷reserve ratio)

The FED The federal reserve system Entities of the Fed The nation’s central bank Entities of the Fed Federal Reserve Banks (12 districts) Board of governors (7 members) Nominated by Pres. Confirmed by Senate 14 year term, one chairman (Greenspan) Federal Open Market Committee FOMC Increase/decrease reserves Advisory Committees

What does the Fed do? Issues currency Processes checks/EFT Hold reserves for banks Required reserves (transferred nightly) Banker to federal Government\ Tax payments, treasury department, bonds and securities

Value of money changes Inflation Deflation A period of rising prices. Purchasing power of dollar falls. More money required to purchase same bundle of goods. Deflation A time when prices are falling. Purchasing power of dollar rises. Less money required to purchase same bundle of goods.

How inflation happens Demand-pull inflation Cost-push inflation Demand for goods/services increases faster than industry’s ability to produce more goods Consumers bid up the price Cost-push inflation Prices rise due to increase in cost of production Raw materials, wage-price (wages more than productivity), price-wage

Ouch! Inflation hurts Fixed income Savers Lenders Businesses Cost of living goes up, income doesn’t Savers ROI must be more than inflation Same money buys less Lenders Interest must be more than inflation Same money buys less Businesses Increases production costs Increases uncertainty

Inflation Make it hurt so good Adjustable income If increases are more than inflation rate Borrowers The money they repay is worth less Interest less than inflation rate Government Income tax Sales tax