1. Eco 200 – Principles of Macroeconomics Chapter 13: Money and Banking

2. Money Money = any item that is generally accepted as a means of payment for goods and services Common functions of money: medium of exchange unit of account store of value standard of deferred payment Money does not always serve in the last three of these functions.

3. Evolution of money Commodity money Token money Fiat money (legal tender) Electronic transfers Gresham’s law – “bad money drives out good”

4. Monetary aggregates: M1 M1 = those items that serve as a medium of exchange M1 = currency (including coins) + checkable deposits + traveler’s checks Note that credit does not serve as money

5. M2 and M3 M2 = M1 + savings deposits + small denomination (< $100,000) time deposits + retail money market mutual fund balances M3 = M2 + repurchase agreements + Eurodollar deposits

6. Global money Sales among industrialized countries usually conducted in the currency of the seller Sales between industrialized and developing countries are usually conducted in the developed country’s currency Currencies of industrialized countries dominate international transactions International reserve currency – used to settle debts between governments (dollar, pound, euro, and yen are most commonly used)

7. Composite currencies ECU – introduced in 1979 – value tied to weighted average of national currencies of EU – (replaced by the euro) Special drawing rights – average of the values of the dollar, euro, yen, and pound – created in 1970 by the IMF

8. Banking Commercial banks – traditionally offered only checking accounts Thrift institutions – traditionally offered only savings accounts Financial deregulation in the 1980s eliminated the last remaining distinctions between commercial banks and thrift institutions

9. Financial intermediation Direct finance – loans made directly from lenders to borrowers Financial intermediation – banks (and other financial intermediaries) accept deposits and make loans Financial intermediaries receive profits fr5om the difference in interest rates on loans and deposits Reasons for financial intermediation: economies of scale lowers transaction costs Savers and borrowers have different time horizons

10. U.S. Banking Dual banking system: national and state chartered banks Multistate branching is a recent phenomenon

11. Bank failures High failure rates in the 1930s and 1980s Federal Deposit Insurance Corporation (FDIC) – created in 1933 – insures deposits up to $100,000

12. International banking Eurocurrency markets – deposits held in currencies that differ from the currency of the country in which the bank is located Eurocurrency deposits are not subject to U.S. banking laws and offer higher interest rates (along with higher risk) International banking facilities – since 1981- bookkeeping systems that allow U.S. banks to participate in offshore banking activities

13. Fractional reserve banking system Banks create money whenever a loan is issued. Reserve requirement (set by Federal Reserve Board) = fraction of deposits that must be held as reserves Reserves = vault cash + deposits at Fed Banks may loan their excess reserves Required reserves = reserve requirement x deposits Excess reserves = total reserves – required reserves

14. T-accounts and deposit multiplier Initial assumptions: no currency holdings no excess reserves Deposit expansion multiplier = 1/reserve requirement (shown on board) Actual expansion is less due to: excess reserve holdings currency holdings