Money, Banks, and the the Central Bank Lecture notes 5 Instructor: MELTEM INCE

What is Money? Money is any commodity or token that is generally acceptable as a means of payment. A means of payment is a method of settling a debt. Money has three other functions: Medium of exchange Unit of account Store of value

What is Money? Medium of Exchange A medium of exchange is an object that is generally accepted in exchange for goods and services. In the absence of money, people would need to exchange goods and services directly, which is called barter. Unit of Account A unit of account is an agreed measure for stating the prices of goods and services. Store of Value money can be held for a time and later exchanged for goods and services.

What is Money?

Depository Institutions A depository institution is a firm that accepts deposits from households and firms and uses the deposits to make loans to other households and firms. The deposits of three types of depository institution make up the nations money: Commercial banks Thrift institutions Money market mutual funds

Depository Institutions Commercial Banks A commercial bank is a private firm that is licensed to receive deposits and make loans. A commercial banks balance sheet summarizes its business and lists the banks assets, liabilities, and net worth. Reserves are the cash in a banks vault and deposits at Federal Reserve Banks.

Depository Institutions The thrift institutions are A savings and loan association (S&L) is a depository institution that accepts checking and savings deposits and that make personal, commercial, and home-purchase loans. A savings bank is a depository institution owned by its depositors that accepts savings deposits and makes mainly mortgage loans. A credit union is a depository institution owned by its depositors that accepts savings deposits and makes consumer loans. A money market fund is a fund operated by a financial institution that sells shares in the fund

How Banks Create Money Reserves: Actual and Required The fraction of a banks total deposits held as reserves is the reserve ratio. The required reserve ratio is the fraction that banks are required, by regulation, to keep as reserves. Required reserves are the total amount of reserves that banks are required to keep. Excess reserves equal actual reserves minus required reserves.

The Deposit Multiplier The deposit multiplier is the amount by which an increase in bank reserves is multiplied to calculate the increase in bank deposits.

The Quantity Theory of Money The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level. MV = PY The equation of exchange states that the quantity of money (M) multiplied by the velocity of circulation (V) equals GDP