Transcript Chapter Two POF - 14th Ed
Chapter 2 Money and the Monetary System
© 2011 John Wiley and Sons
Chapter Outcomes
Describe the three ways in which money is transferred from savers to businesses
Identify the major components of the monetary system
Describe the functions of money
Give a brief review of the development of money in the U.S.
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Chapter Outcomes (Continued)
Describe major types of money market securities
Briefly explain the M1, M2, and M3 definitions of the money supply
Explain possible relationships between money supply and economic activity
Comment on developments in the international monetary system
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Process of Moving Savings into Investments
Surplus Economic Unit: generates more money than it spends resulting in excess money
Deficit Economic Unit: generates less money than it spends resulting in a need for additional money
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S avings-Investment Process Direct Transfers:
Savers
Money Securities Indirect Transfers:
Savers
Money Securities
Investment Banking Firm
Money Securities
Business Firm Business Firm Savers
Money Institution Securities
Financial Institution
Money Firm’s Securities
Business Firm
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Participants in the U.S. Monetary System CENTRAL BANK:
Defines and Regulates Money Supply
Facilitates the Transferring of Money BANKING SYSTEM:
Creates Money
Transfers Money
Provides Financial Intermediation
Processes/Clears Checks
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The U.S. Monetary System Central Bank Federal Reserve System Board of Governors Federal Reserve Banks
Defines and regulates money supply Facilitates transfer of money through check processing/clearing
Other Banks
Banking System:
1. Creates money 2. Transfers money 3. Provides financial intermediation 4. Processes/clears checks First Bank Last Bank 7
U.S. Central Bank
Federal Reserve System [often referred to as the “Fed”]
Board of Governors
Federal Reserve Banks
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Central Bank Activities
Defines and regulates money supply
Facilitates the transferring of money through check processing and clearing
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Importance and Functions of Money
Real Assets: direct ownership of land, buildings or homes, equipment, inventories, durable goods, and precious metals
Financial Assets: money, debt securities & contracts, and equity securities backed by real assets & earning power of issuers
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Some Basic Definitions
MONEY: anything generally accepted as payment for goods, services, & debts
BARTER: exchange of goods or services without using money
LIQUIDITY: ease and low cost of exchanging an asset for money
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Functions of Money
MEDIUM OF EXCHANGE: the basic function of money
STORE OF VALUE: money can be held for some period of time, without losing its value, before it is spent
STANDARD OF VALUE: exists when prices and debts are stated in terms of the monetary unit
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Development of Money in the U.S.
Historical Types of U.S. Coins:
FULL-BODIED MONEY: coins that contain the same value in metal as their face value
TOKEN COINS: coins containing metal of less value than their stated value
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Development of Money in the U.S.
Historical Types of Paper Currency:
REPRESENTATIVE FULL-BODIED MONEY: paper money fully backed by a precious metal
FIAT MONEY: legal tender proclaimed to be money by law--not backed by precious metal
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Deposit Money in the U.S.
CREDIT MONEY: money worth more than what it is made of--backed by the credit worthiness of issuer
DEPOSIT MONEY: special type of credit money backed by the depository institution that issued the deposit
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Alternatives to “Paper Checks”
AUTOMATIC TRANSFER SERVICE (ATS) ACCOUNTS: Provide for direct deposits to, and payments from, checkable deposit accounts
DEBIT CARDS: Provide for immediate direct transfer of deposit amounts & can be used to make cash withdrawals from ATMs
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Money Market Securities
Money Markets: markets where debt securities with maturities of one year or less are originated (primary markets) or traded (secondary markets)
Money Market Securities: debt securities with maturities of one year or less
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Money Market Securities
Treasury Bill: short-term debt obligation issued by the U.S. federal government
Negotiable Certificate of Deposit: short-term debt instrument issued by depository institutions that can be traded in the secondary money markets
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Money Market Securities
Commercial Paper: short-term unsecured note issued by a high credit-quality corporation
Banker’s Acceptance: promise of future payment issued by an importing firm and guaranteed by a bank
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Money Market Securities
Repurchase Agreement: short-term debt security where the seller agrees to repurchase the security at a specified price and date
Federal Funds: very short-term loans between depository institutions with excess funds and those needing funds
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Measures of the U.S. Money Supply
M1 Money Supply
M2 Money Supply
M3 Money Supply
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Components of the M1 Definition of the Money Supply
Currency
Traveler’s Checks
Demand Deposits at Banks
Other Checkable Deposits at Depository Institutions
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Components of the M2 Definition of the Money Supply M1 Money Supply plus:
Savings Accounts
Small-Denomination Time Deposits
Money Market Deposit Accounts (MMDAs)
Retail Money Market Mutual Funds (MMMFs)
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Components of the M3 Definition of the Money Supply M2 Money Supply plus:
Large-Denomination Time Deposits
Institutional Money Market Mutual Funds
Repurchase Agreements (Overnight and Term)
Eurodollars (Overnight and Term) Held by U.S. Residents
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Money Supply and Economic Activity
MONETARISTS’ VIEW: amount of money in circulation determines the level of economic activity
KEYNESIANS’ VIEW: change in money supply first causes a change in interest rates which then, in turn, alters the demand for goods and services
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Monetarists’ View
BASIC EQUATION: MS x VM = GDP
GROSS DOMESTIC PRODUCT (GDP): Measures the output of goods and services in an economy
MONEY SUPPLY (MS): Usually defined in terms of M1 or M2
VELOCITY OF MONEY (VM): The rate of circulation of the money supply
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Another View of GDP
BASIC EQUATION: RO x PL = GDP
GROSS DOMESTIC PRODUCT (GDP): Measures the output of goods and services in an economy
REAL OUTPUT (RO): Units of goods and services
PRICE LEVEL (PL): Average price of goods and services
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Two Views of GDP Combined
TWO BASIC EQUATIONS: MS x VM = GDP RO x PL = GDP
THE EQUATIONS COMBINED: MS x VM = RO x PL
NOMINAL GDP INCREASES WITH: >An increase in money supply and/or velocity of money >An increase in real output and/or price level
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International Monetary System
Historically: Tied to the gold standard
Bretton Woods System (1944): Agreement to use fixed or pegged exchange rates tied to the U.S. dollar or gold
Early 1970s: Development of a flexible or floating exchange rate system
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International Monetary System Terms
CURRENCY EXCHANGE RATE: Value of one currency relative to another
EURO: A single currency that replaced the individual currencies of initially twelve member countries of the European Union
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Web Links
www.frbsf.org
www.federalreserve.gov
www.stlouisfed.org
www.treas.gov
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