CHAPTER 30 Money, Banking, and the Federal Reserve System PowerPoint® Slides by Can Erbil © 2005 Worth Publishers, all rights reserved

2 What you will learn in this chapter: The various roles money plays and the many forms it takes in the economy. How the actions of private banks and the Federal Reserve determine the money supply. How the Federal Reserve uses open-market operations to change the monetary base.

3 Roles of Money  A medium of exchange  A store of value  A unit of account

4 Types of Money  Commodity money  A commodity-backed money  Fiat money

5 Monetary Aggregates The Federal Reserve uses three definitions of the money supply: M 1, M 2, and M 3. M 1 = $1,368.4 (billions of dollars), June 2005 M 1 is equally split between currency in circulation and checkable bank deposits.

6 Monetary Aggregates The Federal Reserve uses three definitions of the money supply: M 1, M 2, and M 3. M 2 = $6,510.0 (billions of dollars), June 2005 M 2 includes M 1, plus a range of other deposits and deposit-like assets, making it about three times as large.

7 The Monetary Role of Banks A bank is a financial intermediary. Bank reserves are the currency banks hold in their vaults plus their deposits at the Federal Reserve. The reserve ratio is the fraction of bank deposits that a bank holds as reserves.

8 Bank Regulations  Deposit insurance  Capital requirements  Reserve requirements

9 Determining the Money Supply Effect on the Money Supply of a Deposit at First Street Bank

10 How Banks Create Money

11 Reserves, Bank Deposits, and the Money Multiplier Increase in bank deposits from $1,000 in excess reserves = $1,000 + $1,000 × (1 – rr) + $1,000 – (1 – rr)2 + $1,000 – (1 – rr) this can be simplified to: Increase in bank deposits from $1,000 in excess reserves = $1,000/rr

12 The Money Multiplier in Reality The monetary base is the sum of currency in circulation and bank reserves. The money multiplier is the ratio of the money supply to the monetary base.

13 The Federal Reserve System

14 What the Fed Does: Reserve Requirements and the Discount Rate  The federal funds market  The federal funds rate  The discount rate

15 Open-Market Operations The Federal Reserve’s Assets and Liabilities:

16 Open-Market Operations by the Federal Reserve An Open-Market Purchase of $100 Million

17 Open-Market Operations by the Federal Reserve An Open-Market Sale of $100 Million

18 The End of Chapter 30 coming attraction: Chapter 31: Monetary Policy