13 Money and Banking $$$$

FUNCTIONS OF MONEY 1.Unit of Account Measurement of value of goods and services Standard unit for stating prices Basis for comparing market prices of goods, services, and resources

2. Store of Value Enables people to transfer purchasing power from the present to the future In order to buy things later, people store some of their wealth as money The money you place in a safe or checking account will be available to you in a few weeks, months or years from now. Other means of storing wealth with art, jewelry, stocks

3.Medium of Exchange Fundamental use in paying for goods and services in market economy It is readily acceptable as payment. Money allows society to escape from the complications of barter.

The Components of the Money Supply MONEY, M1 = CURRENCY + CHECKABLE DEPOSITS 1.CURRENCY -(coins and paper money) in the hands of the public* Government and government agencies supply coins and paper money. All coins in circulation in the U.S. are token money (the value of the metal contained in the coin itself is less than the face value of the coin). Most currency is paper money (Federal Reserve Notes) issued by the Federal Reserve System. 2.CHECKABLE DEPOSITS -All checkable deposits (all deposits in commercial banks and “thrift” or savings institutions on which checks of any size can be drawn). Commercial banks and savings institutions (thrifts) provide checkable deposits. *To avoid double counting, currency resting in banks are excluded by M1.

Money Definition M2 MONEY, M2 = M1 + near-monies: savings deposits, including MMDAs small time (less than $100,000) deposits + MMMFs held by individuals 1.SAVINGS DEPOSITS including MMDAs (money market deposit accounts) 2.SMALL (less than $100,000) TIME DEPOSITS (funds become available at their maturity) 3.MONEY MARKET MUTUAL FUNDS (MMMF) held by individuals

Money Definition MZM MZM (money zero maturity) focuses exclusively on monetary balances that are immediately available, at zero cost, for household and business transactions. Economists make two (2) adjustments to M2 to obtain MZM: 1.Subtract small time deposits because the maturity (time until repayment) is 6 mos., 1 year or some other length beyond instant maturity. Withdrawal prior to maturity require substantial financial penalty. 2.Add MMMF (money market mutual fund) balances owned by businesses. These are immediately available for purchases.

Money MZM Money MZM = M2 – small ($100,000 or less) time deposits + MMMFs held by businesses. It is slightly larger than M2. Advantages of MZM: includes currency, checkable deposits, MMDAs, and MMMFs. Used on a daily basis to buy goods, services and resources.

What Backs The Money Supply? Essentially, the money supply in the U.S. is backed by (guaranteed) by the ability of the government to keep the value of money relatively stable. Following are four (4) ways in which the money supply is guaranteed: 1. Money as Debt Paper money (just a piece of paper) is the circulating debt of the Federal Reserve Banks. Checkable deposits (merely a bookkeeping entry) are the debts of commercial banks and thrift institutions. The government has chosen to “manage” the money supply in an attempt to provide enough money for business activity that will promote full employment, price-level stability and economic growth.

What Backs The Money Supply 2.Value of Money – why are currency and checkable deposits money? Acceptability – Currency and checkable deposits are money because people accept them as money. They are confident it can be exchanged for real goods and services. Legal Tender – The government has designate currency as “legal tender”; look at your paper money and read the statement “This note is legal tender for all debts, public and private.” Private firms and government may refuse to accept cash for debt and specify payment in noncash forms such as checks, cashier’s checks, money orders or credit cards.

What Backs The Money Supply, Cont’d. Relative scarcity – The value of money depends upon supply and demand. Money derives it value from its scarcity relative to its utility (want-satisfying power). The demand for money depends upon the total dollar volume of transactions plus the amount of money individuals and businesses want to hold for future transactions. As long as there is a reasonable constant demand for money, the supply of money will determine the domestic value or purchasing power of the monetary unit.

Federal Deposit Insurance Corporation (FDIC) What Does FDIC Cover? Let’s begin by saying what FDIC does not cover. FDIC does not cover money placed in stocks, bonds, mutual funds, life insurance, annuities, U.S. Treasury obligations, or uninsured bank deposits. FDIC does cover up to $250,000 in deposits for one owner at one insured bank. There are different categories of owners that may allow one to increase coverage. For example, joint accounts are covered up to $500,000. The FDIC coverage is per bank, meaning if one owner has $250,000 deposited at ten different banks all deposits would be covered.

Money and Prices Purchasing Power of the Dollar When money loses its purchasing power, it loses its role as money. A reciprocal relationship exists between the general PL and the purchasing power of the dollar. A rising price index means reduced purchasing power value of the dollar, vice versa. $V = 1/P Value of the dollar = 1/PL (expressed as an index number (in hundredths) Example: If PL rose from 100 to 120 (20% inflation) Value of the dollar =.83 (100/120)

Inflation and Acceptability If you think back to your history lessons, in the 1920’s, Germany in the 1920’s had very rapid inflation. In 1919, there were about 50 billion marks in circulation. Four years later, there were 496,585,345,900 marks in circulation!!! The result? The German mark was worth an infinitesimal fraction of its 1919 value. People will use money as a store of value only as long as there is no sizable deterioration in the value of that money because of inflation. When the value of the dollar is declining rapidly, sellers will not know what to charge and buyers will not know what to pay for goods and services.

Whose job is it to stabilize money’s purchasing power? The Federal Reserve has a critical role in maintaining the purchasing power of the dollar (2-3% annual inflation). The President and Congress must apply fiscal policies to support the efforts of the nation’s monetary authorities to hold down inflation.

The Federal Reserve The Federal Reserve System was created in 1913 as a result of an unusually acute banking crisis in Congress purposely established the Fed as an independent agency so could be protected from political pressures and could effectively control the money supply and maintain price stability.

Ben Bernanke, C hairman to 1/31/14 [1590 on SAT]

Federal Reserve System Framework of the Federal Reserve System and the Relationship to the Public Commercial Banks Thrift Institutions (Savings and Loan Associations, Mutual Savings Banks, Credit Unions) The Public (Households and Businesses) 12 Federal Reserve Banks Board of Governors Federal Open Market Committee

Structure of the Fed Board of Governors –7 members appointed by the President and approved by the Senate for 14-year terms –Regulatory and supervisory role –Sets general policy for member banks –Conducts monetary policy –Annual report to Congress

Federal Reserve System The 12 Federal Reserve Banks are quasi-public banks, which blend private ownership and public control. Source: Federal Reserve Bulletin

The 12 Federal Reserve Banks Quasi-Public Banks Each Federal Reserve Bank is owned by the private commercial banks in its district. Despite their private ownership, the Federal Reserve Banks are in practice pubic institutions. They are not motivated by profit. In general, they do not deal with the public, but rather interact with the government an commercial banks and thrifts.

The 12 Federal Reserve Banks Bankers’ Banks The Federal Reserve Banks are “bankers’ banks.” They perform the same functions for banks and thrifts (i.e., credit unions) as those institutions perform for the public. Just as banks and thrifts accepts deposits and make loans to the public, the central banks accept the deposits and make loans to banks and thrifts. Normally, these loans average only about $150MM/day.

Lender of Last Resort In emergency circumstances, the Federal Reserve Banks become the “Lender of Last Resort” to the banking system and can lend out as much as needed to ensure that banks and thrifts meet their cash obligations.

Federal Open Market Committee [FOMC] main policy-making arm -Fed’s main policy-making arm Board of Governors -includes 7 Board of Governors, NY Fed President who is vice chairman, & is the second most important in the system second most important in the system -The 4 other bank presidents -The 4 other bank presidents rotate other 11 every 3 years. among the other 11 every 3 years. other 7 bank presidents are -other 7 bank presidents are non-voting members non-voting members meet every 6 weeks or 8 times a year ] -they meet every 6 weeks or 8 times a year ] -The Fed has primarily used FOMC operations thru 17 primary dealers. The New York Fed publishes the list of primary dealers on its website, along with procedures to become a primary dealer.

The FOMC Meeting Room in Washington DC 27-foot oval mahogany table The FOMC meets around a 27-foot oval mahogany table in a 23-foot ceiling1,000-pound chandelier room with a 23-foot ceiling with a 1,000-pound chandelier. Home of 7 Board of Governors

The entire committee [12 members + other 8 bank presidents] examine regional, national and international economic info to assess the strengths and weaknesses of the economy. announcement1:15 p.m. After discussing the economy, the voting members vote on the direction of monetary policy. A policy directive describes the committee’s assessment of the economy and the new target fed funds rate. An announcement is made about 1:15 p.m..

The Fed issues currency Congress has authorized the Federal Reserve Banks to put into circulation Federal Reserve Notes, which constitute the economy’s paper money supply.

Destroy/Issue paper notes The Fed clears 40%; Banks clear rest electronically.

Store cash and coinStore cash and coin Maintain currency’s qualityMaintain currency’s quality Detect counterfeitsDetect counterfeits

The Fed handles The Fed handles billions of electronic transactions billions of electronic transactions

FINALLY…the most important… and…ultimate responsibility for the Fed … is to control the money supply