Ch10 the Money Supply and the Federal Reserve System

8/15/2019 Ch10 the Money Supply and the Federal Reserve System

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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ra !air Karl Case, Ra !air

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Prepared by: FernandoPrepared by: FernandoQuijano and Yvonn QuijanoQuijano and Yvonn Quijano

The Money Supply and theThe Money Supply and theFederal Reserve SystemFederal Reserve System


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#n $%er%ie& of 'one #n $%er%ie& of 'one

( Money Money is an thing that is generallis an thing that is generallaccepte) as a me)ium of e*change+accepte) as a me)ium of e*change+

( 'one is not income, an) mone is'one is not income, an) mone isnot &ealth+ 'one isnot &ealth+ 'one is

( a means of pa ment,a means of pa ment,

( a store of %alue, an)a store of %alue, an)

( a unit of account+a unit of account+


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( 'one as a means of pa ment, or me)ium'one as a means of pa ment, or me)iumof e*change, is more efficient than barter+of e*change, is more efficient than barter+

( Barter Barter is the )irect e*change of goo)s an)is the )irect e*change of goo)s an)ser%ices for other goo)s an) ser%ices+ser%ices for other goo)s an) ser%ices+

( # barter s stem re-uires a # barter s stem re-uires a doubledoublecoincidence of wantscoincidence of wants for tra)e to ta.efor tra)e to ta.e

place+ 'one eliminates this problem+place+ 'one eliminates this problem+( 'one is a lubricant in the functioning of a'one is a lubricant in the functioning of a

mar.et econom +mar.et econom +


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( 'one as a'one as a store of valuestore of value refers to mone asrefers to mone asan asset that can be use) to transportan asset that can be use) to transportpurchasing po&er from one time perio) topurchasing po&er from one time perio) to

another+another+

( 'one is easil portable, an) easil e*change)'one is easil portable, an) easil e*change)for goo)s at all times+ hefor goo)s at all times+ he liquidity propertyliquidity propertyof money of money ma.es mone a goo) me)ium ofma.es mone a goo) me)ium ofe*change as &ell as a store of %alue+e*change as &ell as a store of %alue+


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( 'one also ser%es as a'one also ser%es as a unit of account unit of account , or a, or astan)ar) unit that pro%i)es a consistent &a ofstan)ar) unit that pro%i)es a consistent &a of-uoting prices+-uoting prices+

( Commodity moniesCommodity monies are items use) as moneare items use) as monethat also ha%e intrinsic %alue in some otherthat also ha%e intrinsic %alue in some otheruse+ ol) is one form of commo)it mone +use+ ol) is one form of commo)it mone +

( Fiat Fiat , or, or tokentoken , mone is mone that is, mone is mone that isintrinsicall &orthless+intrinsicall &orthless+

( Legal tender Legal tender is mone that a go%ernment hasis mone that a go%ernment has

re-uire) to be accepte) in settlement of )ebts+re-uire) to be accepte) in settlement of )ebts+


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'easuring the 1uppl of 'one'easuring the 1uppl of 'onein the nite) 1tatesin the nite) 1tates

( he t&o most common measures ofhe t&o most common measures ofmone aremone are M M " an)" an) M M 2+2+

( M M 11 , or, or transactions money transactions money is mone thatis mone thatcan be )irectl use) for transactions+ 3tcan be )irectl use) for transactions+ 3tinclu)es currenc hel) outsi)e ban.s, plusinclu)es currenc hel) outsi)e ban.s, plus)eman) )eposits, plus tra%eler4s chec.s,)eman) )eposits, plus tra%eler4s chec.s,plus other chec.able )epositsplus other chec.able )eposits

( M M " is a stoc. measure5it is measure) at" is a stoc. measure5it is measure) ata point in time5a point in time5 on a specific day on a specific day + $n+ $n

une 26, 2000,une 26, 2000, M M " &as 7","08+8 billion+" &as 7","08+8 billion+


7/22© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ra !air Karl Case, Ra !air

'easuring the 1uppl of 'one'easuring the 1uppl of 'onein the nite) 1tatesin the nite) 1tates

( M M 22 , or, or broad money broad money , inclu)es near, inclu)es nearmonies, or close substitutes formonies, or close substitutes fortransactions mone +transactions mone +

( M M 22 M M " 9 sa%ings accounts 9 mone mar.et" 9 sa%ings accounts 9 mone mar.etaccounts 9 other near moniesaccounts 9 other near monies

( $n une 26, 2000,$n une 26, 2000, M M 2 &as 7:,;;



he Pri%ate Ban.ing 1 stemhe Pri%ate Ban.ing 1 stem

( 'ost of the mone in the nite) 1tates'ost of the mone in the nite) 1tatesto)a is =ban. mone ,> or mone hel) into)a is =ban. mone ,> or mone hel) inchec.ing accounts rather than currenc +chec.ing accounts rather than currenc +

( Financial intermediariesFinancial intermediaries are ban.sare ban.san) other financial institutions that actan) other financial institutions that actas a lin. bet&een those &ho ha%eas a lin. bet&een those &ho ha%emone to len) an) those &ho &ant tomone to len) an) those &ho &ant toborro& mone +borro& mone +



Ho& Ban.s Create 'oneHo& Ban.s Create 'one

( o see ho& ban.s create mone , consi)ero see ho& ban.s create mone , consi)erthe origins of the mo)ern ban.ing s stemthe origins of the mo)ern ban.ing s stem( ol)smiths functione) as &arehouses &hereol)smiths functione) as &arehouses &here

people store) gol) for safe.eeping+people store) gol) for safe.eeping+( pon recei%ing the gol), a gol)smith &oul)pon recei%ing the gol), a gol)smith &oul)

issue a receipt to the )epositor+ #fter a time,issue a receipt to the )epositor+ #fter a time,these receipts themsel%es, rather than the gol)these receipts themsel%es, rather than the gol)

that the represente), began to be tra)e) forthat the represente), began to be tra)e) forgoo)s+goo)s+

( #t this point, all the receipts issue) &ere #t this point, all the receipts issue) &erebac.e) "00 percent b gol)+bac.e) "00 percent b gol)+


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Ho& Ban.s Create 'oneHo& Ban.s Create 'one

( Kno&ing there &ere more receiptsKno&ing there &ere more receiptsoutstan)ing than there &ere ounces ofoutstan)ing than there &ere ounces ofgol), people might start to )eman) gol)gol), people might start to )eman) gol)for receipts+for receipts+

( # # runrun on a gol)smith @or a mo)ernA)aon a gol)smith @or a mo)ernA)aban. occurs &hen man peopleban. occurs &hen man peoplepresent their claims at the same time+present their claims at the same time+



he Creation of 'onehe Creation of 'one

( Ban.s usuall ma.e loans up to the pointBan.s usuall ma.e loans up to the point&here the can no longer )o so because&here the can no longer )o so becauseof the reser%e re-uirement restriction @orof the reser%e re-uirement restriction @orup to the point &here their e*cess reser%esup to the point &here their e*cess reser%esare ?ero +are ?ero +

e x c e s s r e s e r v e s a c t u a l r e s e r v e s r e q u≡ −



he !e)eral Reser%e 1 stemhe !e)eral Reser%e 1 stem

( hehe Federal Open Market CommitteeFederal Open Market Committee(FOMC)(FOMC) sets goals regar)ing the monesets goals regar)ing the monesuppl an) interest rates an) )irects thesuppl an) interest rates an) )irects theoperations of the $pen 'ar.et es. inoperations of the $pen 'ar.et es. inDe& or.+De& or.+

( hehe Open Market esk Open Market esk is an office in theis an office in theDe& or. !e)eral Reser%e Ban. fromDe& or. !e)eral Reser%e Ban. from&hich go%ernment securities are bought&hich go%ernment securities are boughtan) sol) b the !e)+an) sol) b the !e)+



!unctions of the !e)!unctions of the !e)

( Clearing interban. pa ments+Clearing interban. pa ments+

( Regulating the ban.ing s stem+Regulating the ban.ing s stem+

( #ssisting ban.s in a )ifficult financial #ssisting ban.s in a )ifficult financial

position+position+( 'anaging e*change rates an) the nation4s'anaging e*change rates an) the nation4s

foreign e*change reser%es+foreign e*change reser%es+

he !e) performs important functions forhe !e) performs important functions forban.s inclu)ingban.s inclu)ing



!unctions of the !e)!unctions of the !e)

( Control of mergers bet&een ban.s+Control of mergers bet&een ban.s+

( E*amination of ban.s to ensure that theE*amination of ban.s to ensure that theare financiall soun)+are financiall soun)+

( 1etting of reser%e re-uirements for all1etting of reser%e re-uirements for allfinancial institutions+financial institutions+

( Lender of last resort!Lender of last resort!

he !e) performs important functions forhe !e) performs important functions forban.s inclu)ingban.s inclu)ing



he !e)4s Balance 1heethe !e)4s Balance 1heet

( #lthough it is unrelate) to the mone #lthough it is unrelate) to the monesuppl , the !e)4s gol) counts as an assetsuppl , the !e)4s gol) counts as an asseton its balance sheet+on its balance sheet+

( he largest of the !e)4s assets, b far,he largest of the !e)4s assets, b far,consists of go%ernment securitiesconsists of go%ernment securitiespurchase) o%er the ears+purchase) o%er the ears+

( # )ollar bill is a liabilit , or 3$ , of the !e)+ # )ollar bill is a liabilit , or 3$ , of the !e)+



Ho& the !e) ControlsHo& the !e) Controlsthe 'one 1upplthe 'one 1uppl

( he re-uire) reser%e ratio establishes a lin.he re-uire) reser%e ratio establishes a lin.bet&een the reser%es of the commercialbet&een the reser%es of the commercialban.s an) the )eposits @mone thatban.s an) the )eposits @mone thatcommercial ban.s are allo&e) to create+commercial ban.s are allo&e) to create+

( 3f the !e) &ants to increase the mone3f the !e) &ants to increase the monesuppl , it creates more reser%es, therebsuppl , it creates more reser%es, therebfreeing ban.s to create a))itional )epositsfreeing ban.s to create a))itional )epositsb ma.ing more loans+ 3f it &ants tob ma.ing more loans+ 3f it &ants to)ecrease the mone suppl , it re)uces)ecrease the mone suppl , it re)ucesreser%es+reser%es+



he iscount Ratehe iscount Rate

( Ban.s ma borro& from the !e)+ heBan.s ma borro& from the !e)+ heinterest rate the pa the !e) is theinterest rate the pa the !e) is thediscount ratediscount rate ++

( Ban. borro&ing from the !e) lea)s to anBan. borro&ing from the !e) lea)s to anincrease in the mone suppl + he higherincrease in the mone suppl + he higherthe )iscount rate, the higher the cost ofthe )iscount rate, the higher the cost ofborro&ing, an) the less borro&ing ban.sborro&ing, an) the less borro&ing ban.s&ill &ant to )o+&ill &ant to )o+



he iscount Ratehe iscount Rate

( 3n practice, the !e) )oes not often use the3n practice, the !e) )oes not often use the)iscount rate to control the mone suppl +)iscount rate to control the mone suppl +

( he )iscount rate cannot be use) tohe )iscount rate cannot be use) to

control the mone suppl &ith greatcontrol the mone suppl &ith greatprecision, because its effects on ban.s4precision, because its effects on ban.s4)eman) for reser%es are uncertain+)eman) for reser%es are uncertain+

( Moral suasionMoral suasion is the pressure e*erte) bis the pressure e*erte) bthe !e) on member ban.s to )iscouragethe !e) on member ban.s to )iscouragethem from borro&ing hea%il from the !e)+them from borro&ing hea%il from the !e)+



$pen 'ar.et $perations$pen 'ar.et $perations

( $pen mar.et operations is the purchase$pen mar.et operations is the purchasean) sale b the !e) of go%ernmentan) sale b the !e) of go%ernmentsecurities in the open mar.etF a tool use)securities in the open mar.etF a tool use)to e*pan) or contract the amount ofto e*pan) or contract the amount ofreser%es in the s stem an) thus thereser%es in the s stem an) thus themone suppl +mone suppl +

( $pen mar.et operations is b far the most$pen mar.et operations is b far the mostsignificant tool of the !e) for controllingsignificant tool of the !e) for controllingthe suppl of mone +the suppl of mone +


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( #n open mar.et #n open mar.et purchase purchase of securities bof securities bthe !e) results in anthe !e) results in an increaseincrease in reser%esin reser%esan) anan) an increaseincrease in the suppl of mone bin the suppl of mone ban amount e-ual to the mone multiplieran amount e-ual to the mone multipliertimes the change in reser%es+times the change in reser%es+

( #n open mar.et #n open mar.et salesale of securities b theof securities b the!e) results in a!e) results in a decreasedecrease in reser%es an)in reser%es an)aa decreasedecrease in the suppl of mone b anin the suppl of mone b anamount e-ual to the mone multiplieramount e-ual to the mone multipliertimes the change in reser%es+times the change in reser%es+


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© 2002 P i H ll B i P bli hi© 2002 P i H ll B i P bli hi P i i l f E i 6/P i i l f E i 6/ K l C R ! iK l C R ! i


( $pen mar.et operations are the !e)4s$pen mar.et operations are the !e)4spreferre) means of controlling the monepreferre) means of controlling the monesuppl becausesuppl because

( the can be use) &ith some precision,the can be use) &ith some precision,( are e*tremel fle*ible, an)are e*tremel fle*ible, an)

( are fairl pre)ictable+are fairl pre)ictable+

Ch10 the Money Supply and the Federal Reserve System

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Transcript of Ch10 the Money Supply and the Federal Reserve System