Money and Banking Managing Financial Resources Exploring Business Chapter 13 Thursday 9/6/11

Economics Study of the economy as a whole Macro Economics - Study of the economy as a whole

Exploring Business © 2009 FlatWorld Knowledge 13-3 Bartering v. Money Bartering Trade Stuff For Stuff Difficult To Determine Value Stuff Cannot Always Be Saved DivisiblePortableDurable Hard to Counterfeit Easy To State Price Stores Value Money

The Functions of Money What Three Basic Functions Does Money Serve?

Functions of Money Medium of Exchange Measure of Value Store of Value

Money Supply What are the Two Primary Measures of the Money Supply?

Money Supply Measures: M- 1 M - 2 How much M – 1 is there? What is M-1 comprised of?

M–1 Measures  M-1 was about $1.6 trillion dollars in 2008 Composition  All currency in circulation  All “checkable deposits”  It’s the Narrowest measure of money supply  Includes the most Liquid forms of money  What does Liquid mean?

M–1 Liquid = cash checking accounts, etc.  When the press refers to the Money Supply growing, it’s referring to M – 1 What’s the percentage breakdown of M-1 between currency and demand deposits?

M – 1 Currency Breakdown 25% of Currency is in Circulation 75% of Money is in Demand Deposits* *Note: ONLY demand deposits are subject To the Multiplier Effect.

What Does M–2 Measure? Money Supply

M – 2 = Everyting in M-1 plus near-cash items invested for the short term like savings accounts, time deposits below $100,000, [non-negotiable bank CDs], and money market mutual funds. M – 2 is a much broader money definition than M-1

Exploring Business © 2009 FlatWorld Knowledge U.S. Money Supply

Exploring Business © 2009 FlatWorld Knowledge “ Plastic Money ” 1)Not Spending Money 2)Buy-Now-Pay-Later = Loan [high interest] 3)Money = Bill Paid

Financial Institutions What are Three Types of Depository Institutions?

Depository Institutions Commercial Banks – Lends funds to commercial Customers and provide a variety of services. Can you name some of the services a commercial bank provides?

Exploring Business © 2009 FlatWorld Knowledge Services Offered By Banks  Checking/Savings Accounts  ATMs  Credit/Debit Cards  Loans  Financial Advice  Sells Financial Products  Insurance  Electronic Banking

Depository Institutions Savings Banks – called “thrifts” and S&Ls. Set up to provide mortgages and encourage savings

Depository Institutions Credit Unions – provide member-only services

Depository Institutions In which Depository Institution is most of our money deposited? Approximately what percent of Total Deposits does that bank represent?

Exploring Business © 2009 FlatWorld Knowledge Where Our Money Is Deposited

80/20 Rule and Its Antithesis [20/80 Rule] 1)Basic Rule is a Truism in Commercial & Industrial Sales: 80% of your sales comes from 20% of your customer base. Mr. “Ks” Career Observation: 2) Antithesis Rule: Truism in the Labor Force: 20% of your employees have the positive attitude, motivation, drive, and example to help a company succeed. The problem is finding the 20%ers

Financial Institutions What are Three Types of Non-Depository Institutions?

Non-Depository Institutions Finance Companies – Non-deposit financial institution that makes loans from funds acquired by selling securities or borrowing from Commercial Banks

Non-Depository Institutions Insurance Companies – non-deposit institution that collects premiums from policyholders for protedction against losses and invests these funds

Non-Depository Institutions Brokerage Firms – financial institutions that buy and sell stocks [equities], bonds [debt instruments], and other investments for their clients.

Exploring Business © 2009 FlatWorld Knowledge Bank Regulation  Federal Depository Insurance Corporation Insures Deposits ($100,000) Insures Deposits ($100,000) Periodic Examinations Periodic Examinations  Office of Thrift Supervision  National Credit Union Administration

Federal Reserve System 1.What kind of bank is it? 2.Where is it headquartered 3.Who is its current Chairman 4.How many regional Federal Reserve banks are there in the US? 5. What are its principal duties?

Federal Reserve System 1.What kind of bank is it? Central bank 2.Where is it headquartered? Washington DC 3.Who is its current Chairman? Ben Bernanke 4.How many regional Federal Reserve banks are there in the US? 12 5.What are its principal duties?  Conduct the nations monetary policy  Supervise & regulate banks  Maintain stability of the financial system  Provide financial services to depository institutions

The Federal Reserve System

What are the Three Fundamental Goals of the Federal Reserve? Federal Reserve

Goals of the Federal Reserve Price Stability Sustainable Economic Growth Full Employment

Federal Reserve 1.Fed seeks to Stabilize Prices by regulating the money supply and interest rates 2. Theoretically, Stable Prices promote Economic Growth and Full Employment How does the FED marry its Goals with its Monetary Policy?

What are the Three Tools the FED uses To Conduct Monetary Policy? Federal Reserve

The FED’s Monetary Policy Set Reserve Requirements For Whom?

The Fed’s Monetary Policy: A Tool to Control Money Supply 1.Assume the RR for the Banks is 10%. The Bank must keep 10% of deposits on reserve and can lend the other 90%. In theory, $1 deposited in a Bank with a 10% RR results in the creation of another $10 in credit through the “multiplier effect” [$1/0.1 = $10]. If the FED wanted to tighten credit, what action might it take?

Reserve Requirements [RR] and the Bank Multiplier Effect The FED would raise the RR. In an exaggerated example, if the FED raised the RR from 10% to 15%, because of the “multiplier effect”, $1 deposited in the bank would now result in the creation of $6.67 in credit [$1/0.15 = $6.67]

Exploring Business © 2009 FlatWorld Knowledge The Effect of the Money Multiplier BanksDepositRRLending Amount 1 $10,000 $1,000$9,000 2 $9,000 $900$8,100 3 $8,100 $810$7,290 Assume 10% RR

The Fed’s Monetary Policy: A Second Tool to Control Money Supply The Discount Rate – the interest rate that the FED charges member banks to borrow reserves.

Fed’s Impact on Interest Rates Fed Funds Rate – rate of interst member banks charge each other for overnight loans. Lowest rate currently fluctuating between 0.00 % and 0.25% Discount Rate – rate at which member banks can borrow from Fed. Generally 1% higher than FFR. Currently at 0.75% Prime Rate – Rate at which banks make unsecured loans to their best commercial customers. It is the most widely used benchmarks in setting home equity lines of credit and credit card rates. Currently 3.25%

Exploring Business © 2009 FlatWorld Knowledge Key Interest Rates

The Fed’s Monetary Policy: A Third Tool to Control Money Supply Open Market Operations – The FED adjusts credit availability through the sale and purchase of US government bonds in the “open market” [primarily commercial banks]. When a member bank uses cash to buy US Government bonds: 1)What happens to their reserve balances? 2)What happens to the economy as a Whole? 3)During what economic cycle might you employ this strategy?

Federal Reserve When a member bank uses cash to buy US Government bonds, the FED takes potential reserve money out of circulation. This means less money to lend and less of a Multiplier Effect. This action tends to slow the economy down and would be used during inflationary cycles

Federal Reserve Mr. “Ks” Observation: Fact: There is nothing backing the US currency other than the “faith” and confidence of the people in the Store of Value. The FED can print money at its discretion [e.g, its Quantitative Easing program – QE1 and QE2], which is, in effect, a hidden inflation. I’m not against central banking – I’m against our currency not backed by some tangible value [gold, platinum, etc.]