2. is whatever is generally accepted in exchange for goods and services — accepted not as an object to be consumed but as an object that represents a temporary abode of purchasing power to be used for buying still other goods and services.” — Milton Friedman (1992)

3. What is Money? 1.A medium of exchange : U sed to buy and sell goods and services. Avoids barter 2. A store of value: Allows transfer of purchasing power from one period to another. 3.A unit of account (measure of value): Converts worth to a monetary value. 4.A standard of deferred payment: Makes future payments possible.

4. 1.Commodity Money : has value itself, gold, silver, cowrie shells 2.Fiat money: no intrinsic value, just because

5. A Cowrie Shell Used as currency from 700 BC through the 20 th Century Scarce – found off Maldives Islands in the Indian Ocean Durable – remained “clean, dainty, stainless, polished, and milk-white” Supply was controlled by Portuguese, Dutch, then English

6. Two basic measurements of the money supply are M1 and M2: The components of M1 are: Currency Checking Deposits (including demand deposits and interest-earning checking deposits) Traveler's checks M2 (a broader measure of money) includes: M1, Savings, Time deposits under $100,000, and, Money mutual funds The Supply of Money

7. 6 of 61 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Measuring the Money Supply, 2012 M1 = $10,408.7 billion M2 = $2,444.9 billion

8. The Composition of Money in the U.S. The size and composition of the two most widely used measures of U.S. money supply (M1 & M2) are shown above. Money Supply, M1 (in billions) Currency (in circulation) Demand deposits and other checkable deposits Traveler’s checks Total M1 $1090.0 1351.1 3.8 $2,444.9 Money Supply, M2 (in billions) M1 Savings deposits a Small time deposits Money market mutual funds Total M2 $2,444.9 6,692.0 631.0 640.1 $10,408.7 $2,444.9 $10,408.7 a Including money market deposit accounts. Source: http://www.federalreserve.gov. The M1 and M2 Money Supply of the U.S –––––––––– (as of 2012) ––––––––––

9. 1. __ A $100 bill 4. __ A $50 traveler’s check 10. __ A $10,000 treasury bill 6. __ A quarter 2. __ A 6-month certificate of deposit 5. __ A $5,000 American Express credit line 7. __ A $1 off coupon clipped from the paper 8. __ A $100 balance in a checking account 3.__ A $10,000 retirement account invested in stocks 9. __ A $200 balance in a savings account a b c b aa a ccc

10. Function: 1.accept and maintain deposits. 2.make loans.

11. Types:. 1.Commercial Banks. 2.Savings and Loans 3.Credit Unions 4.Savings Banks.

12. The Functions of Commercial Banking Institutions Assets Vault cash Reserves at the Fed Loans outstanding U.S. government securities Other securities Other assets Total Checking deposits Savings and time deposits Borrowings Other liabilities Net worth Consolidated Balance Sheet of Commercial Banking Institutions April 2009 (billions of $) Liabilities $ 40 672 7,051 1,265 1,412 1,630 $ 12,070 $ 600 6,851 2,400 928 1,291 $ 12,070 Banks provide services and pay interest to attract checking, savings, and time deposits (liabilities). Most of these deposits are invested and loaned out, providing interest income for the bank. Banks hold a portion of their assets as reserves (either as cash or deposits with the Fed) to meet their daily obligations toward their depositors.

13. 12 of 61 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Balance Sheet for a Safe and Secure Bank The items on a bank’s balance sheet of greatest economic importance are its reserves, loans, and deposits.. The left side of the balance sheet always equals the right side. AssetsLiabilities Loans$5 millionDeposits$10 million Government securities $4 million Reserves$2 millionNet worth$1 million

14. 13 of 61 © 2013 Pearson Education, Inc. Publishing as Prentice Hall Balance Sheet for a Bank about to go Bankrupt The left side of the balance sheet no longer equals the right side. AssetsLiabilities Loans$3 millionDeposits$10 million Government securities $4 million Reserves$2 millionNet worth$1 million

15. Banks maintain only a fraction of their assets (deposits) as reserves to meet the requirements of depositors. an decrease in required reserves lets banks make more loans, expand the money supply

16. 1.Printing Money 2.Making Loans a. Key Ingredients: Deposits – Household savings Required Reserves – money held at the bank or at the FRS (around 10%) Excess Reserves – loan able funds = Deposits – Required Reserves A depository institution can make loans up to the value of its excess reserves

17. Main Street Bank Situation: Demand deposits = $50,000 Reserve requirement =10 % Actual reserves at bank = $10,000 Excess Reserves: Demand deposits = $50,000 Reserve requirement= 10 % Actual reserves = $10,000 - Required reserves = $5,000 = Excess reserves = $5,000

18. Excess Reserves ($5,000) can be loaned By making a loan, the bank has created money. The original deposits are still in Main Street Bank, but now there is an additional $5,000 out floating around.

19. The Bank of the James which has a reserve ratio of 10 percent on its deposits, has calculated the following numbers as of the end of business today: total deposits = $13,500,000; reserve account = $3,750,000; and vault cash = $2,250,000. Determine the following for this bank: Actual reserves = __________________ Required reserves = _________________ Excess reserves = __________________ 3,750,000 + 2,250,000 = 6,000,000 13,500,000 x.10 = 1,350,000 6,000,000 -1,350,000 = 4,650,000

20. How much in new loans can Madison Heights National Bank make if its deposits are $45,000,000, vault cash is $5,500,000, and reserve account balance is $7,750,000? MHNB’s reserve requirement is 8%. New loans = _____________________ 5,500,000 + 7,750,000 = 13,250,000 45,000,000 x.08 = 3,600,000 13,250,000 -3,600,000 = 9,650,000 9,650,000

21. What is the amount that must be borrowed by the Smith Mountain Lake Marine Bank to cover its anticipated reserve shortfall if it has a reserve requirement of 12 percent, deposits of $27,500,000, vault cash of $2,500,000, a reserve account of $3,250,000, and it has just made a new loan of $2,500,000 that has not yet cleared? New borrowing = ___________________ 2,500,000 + 3,250,000 = 5,750,000 27,500,000 x.12 = 3,300,000 5,750,000 -3,300,000 = 2,450,000 -50,000

22. If the Excess Reserves are loaned The borrowed money is spent and deposited at another bank. The second bank’s reserves are now up $5,000 - it must keep 10% or $500 - it can then loan out $4,500 ($5,000 – $500) This process can be repeated at each step. 10% of the money is lost at each step The more that is required to be held in reserve, the less money can be created The lower the reserve requirement, the greater the amount of money that can be created

23. Bank New cash deposits: Actual Reserves New Required Reserves Potential demand deposits created by extending new loans Initial deposit (bank A) Second stage (bank B) Third stage (bank C) Fourth stage (bank D) Fifth stage (bank E) Sixth stage (bank F) Seventh stage (bank G) $1,000.00$200.00 160.00 102.40 81.92 65.54 52.43 800.00 $800.00 512.00 128.00640.00 512.00 409.60 327.68 262.14 209.71 Total$5,000.00$1,000.00$4,000.00 All others (other banks)1,048.58209.71838.87 Creating Money from New Reserves When banks are required to maintain 20% reserves against demand deposits, the creation of $1,000 of new reserves will potentially increase the supply of money by $5,000.

24. From the table a deposit of $1000, with a 20% reserve requirement led to a $4000 expansion of the money supply Is there a pattern here? It just takes 3 easy steps

25. 2. Multiply the initial change in the excess reserves by the money multiplier $1000 * 5 = $5000 1. Find the reciprocal of the required reserve 1/20% = 1/1/5= 5 3.Subtract out the initial change $5000 - $1000 = $4000

26. 1.Deposit of $10,000 2.Required reserve 10% 3.Increase in the money supply? How about if the reserve requirement was 20%? 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ a.10,000 c. 100,000 b.9,000 d. 90,000 a.200,000 c. 100,000 b. 40,000 d. 50,000

27. 1.Deposit of $16,000 2.Required reserve 25% 3.Increase in the money supply? How about if the reserve requirement was 20%? How about if the reserve requirement was 10%? 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ 1.________ 2.________ 3.________ a.144,000 c. 80,000 b.48,000 d. 64,000

28. 1. Loan making changes the money supply 2. Increases in loans leads to increased spending which increases the money supply. 3. BUT, decreases in loan making, or even paying back a loan decreases the money supply.

29. Type of Deposit Current Requirement Limits Checkable Deposits $0 - $6 million 0 % 3% $6 - $42.1 million 3 3 Over 42.1 million 10 8-14 Non-checkable non-personal savings and time deposits 0 0-9

30. Type of Deposit Current Requirement Limits Checkable Deposits $0 - $14.5 million 0 % 3% $14.5 - $130.6 million 3 3 Over 130.6 million 10 8-14 Non-checkable non-personal savings and time deposits 0 0-9

31. 200342.16.0 200445.46.6 200547.67.0 200648.37.8 200745.88.5 200843.99.3 200944.410.3 201055.210.7 201158.810.7 201271.011.5 201379.512.4 201489.013.3 2015103.614.5 Effective dateLow-reserve amount (millions of U.S. dollars) Exemption amount (millions of U.S. dollars) Low-Reserve Amounts and Exemption Amounts since 2003 Low-Reserve Amounts and Exemption Amounts since 2003

32. 1.Money is a. valuable because it is backed by gold. b whatever is generally accepted in exchange for goods and services. c. anything that is a liability of a commercial bank d. an object to be consumed. 2. In the US, the purchasing power of money is determined by a. the underlying precious metals that back it. b. the value of the US Treasury bonds that back it. c Federal Reserve policy, which controls the money supply d. Congress which controls the money supply.

33. 3. Which of the following is not a component of M1 a. demand deposits b. large denomination (more than $100) bills. c. interest earning checking deposits d outstanding balances on credit cards. 4. Which of the following assets is most liquid a. a car b funds in a checking account. c. a home d. a municipal bond. 5. Fiat money is money a that has little intrinsic value and is not backed by a commodity. b. that is not included as part of M1. c. that is backed by gold or silver held on reserve by the government d. such as coins that are made from metal.

34. 6. Ordinary commercial banks can expand the supply of money by a. printing up currency when they need it. b. buying and selling government bonds to the general public. c using a portion of their deposits to extend additional loans. d. reducing their vault cash and increasing their deposits with the Fed. 7. Money is used as a unit of account. This means a. money cannot store value for use in the future. b money is used to measure the exchange value and costs of goods, services, assets and resources. c. money has little or no intrinsic value d. money is dependent on the quantity of gold held by the Federal Reserve.

35. 8. Suppose you transfer $1,000 from your checking account to your savings account. How does this affect M1 and M2? a. M1 and M2 are unchanged. b. M1 falls by $1,000 and M2 rises by $1,000. c. M1 is unchanged, and M2 rises by $1,000. d M1 falls by $1,000, and M2 is unchanged. 9. Which of the following compose the reserves of a commercial bank? a. demand deposits and time deposits. b vault cash and deposits of the bank with the Federal Reserve. c. US securities and stock equity d. cash and US securities.

36. 10. Suppose the Fed purchases $100 million of US securities from the public. If the reserve requirement is 20%, the currency holdings of the public are unchanged, and the banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be a a. $100 million decrease in the money supply b. $100 million increase in the money supply c. $200 million increase in the money supply d. $500 million increase in the money supply