ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 15: Money,
Banking, and Central Banking
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
1
1
Money

Money
 Any
medium that is universally accepted
in an economy both by sellers of goods and
services and by creditors as payment for
debts
15-2
Table 15-1 Types of Money
15-3
The Functions of Money

The functions of money
 Medium
 Unit
of exchange
of accounting
 Store
of value (purchasing power)
 Standard
of deferred payment
15-4
The Functions of Money (cont'd)

Medium of Exchange
 Any
item that sellers will accept
as payment

Barter
 The
direct exchange of goods and services
for other goods and services without the use
of money
15-5
The Functions of Money (cont'd)

Medium of exchange
 Money
facilitates exchange by reducing
transaction costs associated with means-ofpayment uncertainty.


Permits specialization, facilitates efficiencies
Barter
 Simply

a direct exchange
Double coincidence of wants
15-6
The Functions of Money (cont'd)

Unit of Accounting
A
measure by which prices are expressed
 The
common denominator of the
price system
A
central property of money
15-7
The Functions of Money (cont'd)

Store of Value
 The
A
ability to hold value over time
necessary property of money
 Money
allows you to transfer value (wealth)
into the future.
15-8
The Functions of Money (cont'd)

Standard of Deferred Payment
A
property of an item that makes it desirable
for use as a means of
settling debts maturing in the future
 An
essential property of money
15-9
Liquidity

Liquidity
 The
degree to which an asset can be
acquired or disposed of without much danger
of any intervening loss in nominal value and
with small transaction costs
 Money
is the most liquid asset.
15-10
Figure 15-1 Degrees of Liquidity
The cost of holding money (its opportunity cost)
is the alternative interest yield obtainable by
holding some other asset.
Money is not backed by gold, silver, or even the
federal government. It is backed by the
confidence of those willing to accept it.
15-11
Monetary Standards,
or What Backs Money (cont'd)

Transactions Deposits
 Checkable
and debitable account balances in
commercial banks and other types of financial
institutions, such as credit unions and mutual
savings banks
 Any
accounts in financial institutions
on which you can easily transmit debit-card
and check payments without
many restrictions
15-12
Monetary Standards, or What Backs Money

Fiduciary Monetary System
A
system in which currency is issued by the
government and its value rests on the public’s
confidence that it can be exchanged for goods
and services
Latin fiducia means “trust” or
“confidence.”
 The
 Currency
and transactions deposits are
money because of their acceptability and
predictability of value.
15-13
Defining Money

Money is important
 Changes
in the rate at which the money supply
increases or decreases affect important economic
variables (at least in the short run) such as inflation,
interest rates, employment, and the level of real GDP.

Money Supply
 The
amount of money in circulation
 Economists
use two basic approaches to define and
measure money.

The transactions approach

The liquidity approach
15-14
Defining Money (cont'd)

Transactions Approach
A
method of measuring the money
supply by looking at money as a medium of
exchange

Liquidity Approach
A
method of measuring the money supply by
looking at money as a temporary store of
value
15-15
Defining Money (cont'd)

The transactions approach to measuring
money: M1
 Currency
 Checkable
 Traveler’s
(transaction) deposits
checks not issued by banks
15-16
Defining Money (cont'd)

M1
 Currency

Minted coins and paper currency not deposited in
financial institutions

The bulk of currency “in circulation” actually does
not circulate within the U.S. borders.
15-17
Defining Money (cont'd)

M1
 Transactions

Any deposits in a thrift institution or a commercial
bank on which a check may be written or debit
card used
 Thrift

deposits
Institution
Financial institutions that receive most of their
funds from the savings of the public
15-18
Defining Money (cont'd)

M1
 Traveler’s

Checks
Financial instruments purchased from a bank or a
nonbanking organization and signed during
purchase that can be used as cash upon a second
signature by the purchaser
15-19
Defining Money (cont'd)

The liquidity approach to measuring
money: M2

Near Moneys
 Assets
that are almost money
 Highly
liquid
 Easily
converted to cash
 Time
deposits are an example
15-20
Defining Money (cont'd)

The liquidity approach: M2 is equal to M1
plus
1.
Savings and small denomination
time deposits
2.
Balances in retail money market
mutual funds
3.
MMDAs
15-21
Defining Money (cont'd)

M2
 Savings

Deposits
Interest-earning funds that can be withdrawn at
any time without payment of a penalty
 Depository

Institutions
Accept deposits from savers and lend those funds
out
15-22
Defining Money (cont'd)

M2
 Money
Market Deposit Accounts (MMDAs)

Accounts issued by banks yielding a market rate of
interest with a minimum balance requirement and
a limit on transactions

They have no minimum maturity
15-23
Defining Money (cont'd)

M2
 Time
Deposit

A deposit in a financial institution that requires
notice of intent to withdraw or must be left for an
agreed period

Early withdrawal may result in a penalty
 CD

(Certificate of Deposit)
Time deposit with fixed maturity
15-24
Defining Money (cont'd)

M2
 Money
Market Mutual Funds

Funds obtained from the public that investment
companies hold in common

Funds used to acquire short-maturity
credit instruments

CD’s, U.S. government securities
15-25
Figure 15-2 Composition of the U.S. M1
and M2 Money Supply, 2007, Panel (a)
15-26
Figure 15-2 Composition of the U.S. M1
and M2 Money Supply, 2007, Panel (b)
15-27
Defining the U.S. Money Supply

The M2 definition of money correlates best with
economic activity, although some business
people and policymakers prefer MZM.

MZM (money-at-zero-maturity)

MZM entails adding deposits without set
maturities to M1.

MZM includes all MMFs but excludes all
deposits with fixed maturities.
15-28
Financial Intermediation and
Banks

Most nations have a banking
system that encompasses two types
of institutions.
1.
One type consists of private
banking institutions.
2.
The other type of institution is a
central bank.
15-29
Financial Intermediation
and Banks (cont'd)

Central Bank
A
banker’s bank, usually an official institution
that also serves as a country’s treasury’s
bank
 Central
banks normally regulate commercial
banks.
15-30
Financial Intermediation
and Banks (cont'd)

Financial Intermediation
 The
process by which financial institutions
accept savings from businesses, households,
and governments and lend the savings to
other businesses, households, and
governments
15-31
Financial Intermediation
and Banks (cont'd)

Direct finance
 Individuals
purchase bonds from
a business

Indirect finance
 Individuals
 The
hold money in a bank
bank lends the money to a business
15-32
Figure 15-4 The Process of
Financial Intermediation
15-33
Financial Intermediation
and Banks (cont'd)

Question
 Why
might people wish to direct their funds through a
bank instead of lending directly to a business?

Answers
 Asymmetric
 Adverse
 Moral
information
selection
hazard
 Larger
scale and lower management costs
15-34
Financial Intermediation
and Banks (cont'd)

Asymmetric Information
 Information
possessed by one party in a
financial transaction but not by the other

Adverse Selection
 The
likelihood that borrowers may use their
borrowed funds for high-risk projects
15-35
Financial Intermediation
and Banks (cont'd)

Moral Hazard
 The
possibility that a borrower might engage in riskier
behavior after a loan has been obtained

Larger scale and lower management costs
 People
can pool funds in an intermediary, reducing
costs, risks.
 Pension
funds and investment companies are
examples.
15-36
Financial Intermediation
and Banks

Assets
 Amounts
 The

owned
uses of funds by financial intermediaries
Liabilities
 Amounts
owed
 The
sources of funds for financial
intermediaries
15-37
Table 15-2 Financial Intermediaries and
Their Assets and Liabilities
15-38
Financial Intermediation
and Banks (cont'd)

Payment Intermediaries
 Institutions
that facilitate transfers of funds
between depositors who hold transactions
deposits with those institutions
15-39
Figure 15-5
How a
Debit-Card
Transaction
Clears
15-40
Financial Intermediation
and Banks (cont'd)

Capital Controls
 Legal
restrictions on the ability of a nation’s
residents to hold and trade assets
denominated in foreign currencies

International Financial Intermediation
 Financing
investment projects in more than
one country
15-41
Table 15-3
The World’s Largest Banks
15-42
Banking Structures
Throughout the World

The ways that banks around the world differ
 Size
 United States has banks of various sizes
 Europe and Japan have a few large banks
 Legal
 Universal banking
 Limits on financial services such as insurance and bank
stock ownership
 Importance in financial system
 Major importance
 Part of a varied financial system (United States)
15-43
Banking Structures
Throughout the World (cont'd)

Universal Banking
 An
environment in which banks face few or no
restrictions on their powers to offer a full range of
financial services and to own shares of stock in
corporations

World Index Fund
A
portfolio of bonds issued in various nations whose
individual yields generally move in offsetting
directions, thereby reducing the overall risk of losses
15-44
Banking Structures
Throughout the World (cont'd)

Central banks and their roles
1.
Perform banking functions for their nations’
governments
2.
Provide financial services for private banks
3.
Conduct their nations’ monetary policies
15-45
The Federal Reserve System

The Fed
 The
Federal Reserve System; the central
bank of the United States
 The
most important regulatory agency in the
U.S. monetary system
 Established
in 1913 by the Federal Reserve
Act
15-46
The Federal Reserve System (cont'd)

Organization of the Fed
 Board

of Governors
7 members, 14-year terms
 Federal

25 branches
 Federal

Reserve Banks (12 Districts)
Open Market Committee (FOMC)
BOG plus 5 presidents of district banks
15-47
Figure 15-6 Organization of the Federal
Reserve System
15-48
Figure 15-7
The Federal Reserve System
15-49
The Federal Reserve System (cont'd)

Depository institutions
 7,500
commercial banks
 1,300
savings and loans
 11,000

credit unions
All may purchase Fed services
15-50
The Federal Reserve System (cont'd)

Functions of the Fed
1.
Supplies the economy with fiduciary currency
2.
Provides a payment-clearing system
3.
Holds depository institutions’ reserves
4.
Acts as the government’s fiscal agent
5.
Supervises depository institutions
6.
Acts as a “lender of last resort”
7.
Regulates the money supply
15-51
Figure 15-8 The Volume and Value
of Federal Reserve Check Clearings Since
1985
15-52
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 15: Money,
Banking, and Central Banking
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
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