Transcript Slide 1

Money, Banks, and the the Central Bank
Lecture notes 5
Instructor: MELTEM INCE
What is Money?
Money is any commodity or token that is generally
acceptable as a means of payment.
A means of payment is a method of settling a debt.
 Money has three other functions:
 Medium of exchange
 Unit of account
 Store of value
What is Money? What is Money?
Medium of Exchange
 A medium of exchange is an object that is generally
accepted in exchange for goods and services.
 In the absence of money, people would need to exchange
goods and services directly, which is called barter.
Unit of Account
 A unit of account is an agreed measure for stating the
prices of goods and services.
Store of Value
 money can be held for a time and later exchanged for goods
and services.
What is Money?
Depository Institutions
A depository institution is a firm that accepts deposits from
households and firms and uses the deposits to make loans to
other households and firms.
The deposits of three types of depository institution
make up the nation’s money:
 Commercial banks
 Thrift institutions
 Money market mutual funds
Depository Institutions
Commercial Banks
 A commercial bank is a private firm that is licensed to
receive deposits and make loans.
 A commercial bank’s balance sheet summarizes its
business and lists the bank’s assets, liabilities, and net
worth.
 Reserves are the cash in a bank’s vault and deposits at
Federal Reserve Banks.
Depository Institutions
The thrift institutions are
 A savings and loan association (S&L) is a depository
institution that accepts checking and savings deposits and that
make personal, commercial, and home-purchase loans.
 A savings bank is a depository institution owned by its
depositors that accepts savings deposits and makes mainly
mortgage loans.
 A credit union is a depository institution owned by its
depositors that accepts savings deposits and makes consumer
loans.
A money market fund is a fund operated by a financial institution
that sells shares in the fund
How Banks Create Money
Reserves: Actual and Required
 The fraction of a bank’s total deposits held as reserves is
the reserve ratio.
 The required reserve ratio is the fraction that banks are
required, by regulation, to keep as reserves. Required
reserves are the total amount of reserves that banks are
required to keep.
 Excess reserves equal actual reserves minus required
reserves.
The Deposit Multiplier
The deposit multiplier is the amount by which an
increase in bank reserves is multiplied to calculate the
increase in bank deposits.
Deposit multiplier 
Change in deposits
Change in reserves
Deposit multiplier 
1
Desired reserve ratio
The Quantity Theory of Money
The quantity theory of money is the proposition that in the long
run, an increase in the quantity of money brings an equal
percentage increase in the price level.
MV = PY
The equation of exchange states that the quantity of money (M)
multiplied by the velocity of circulation (V) equals GDP