Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

13
Copyright McGraw-Hill/Irwin, 2005

C HAPTE R

Money and Banking

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FUNCTIONS OF MONEY
Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Medium of Exchange
Unit of Account Store of Value
Copyright McGraw-Hill/Irwin, 2005

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MONEY SUPPLY
Functions of Money What Backs the Money Supply

Definition
Currency
Token Money Federal Reserve Notes Little Intrinsic Value

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Checkable Deposits
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Commercial Banks Thrift Institutions

Copyright McGraw-Hill/Irwin, 2005

MONEY SUPPLY
Functions of Money What Backs the Money Supply

Plus...

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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Near-monies Savings Deposits Money Market Deposit Accounts (MMDAs) Smaller Time Deposits Money Market Mutual Funds (MMMFs)
Copyright McGraw-Hill/Irwin, 2005

MONEY SUPPLY
Functions of Money What Backs the Money Supply

Plus...

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Large Time Deposits

Illustrated
Next Slide
Copyright McGraw-Hill/Irwin, 2005

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MONEY SUPPLY
Functions of Money What Backs the Money Supply

Currency (coins & paper money) plus Checkable deposits

M1 M2 M3

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

equals M1
$1236

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2003 Data (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

MONEY SUPPLY
Functions of Money What Backs the Money Supply

Currency (coins & paper money) plus Checkable deposits

M1 M2 M3

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

equals M1 plus Savings deposits,

including MMDAs plus Small time deposits plus Money market mutual fund (MMMF) balances equals M2
$1236

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$5899 2003 Data (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

MONEY SUPPLY
Functions of Money What Backs the Money Supply

Currency (coins & paper money) plus Checkable deposits

M1 M2 M3

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

equals M1 plus Savings deposits,

including MMDAs plus Small time deposits plus Money market mutual fund (MMMF) balances equals M2 plus Large time deposits
Copyright McGraw-Hill/Irwin, 2005

$1236

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$5899 2003 Data (billions of dollars) $8595

equals M3

WHAT ABOUT CREDIT CARDS?

Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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Copyright McGraw-Hill/Irwin, 2005

WHAT BACKS THE MONEY SUPPLY?

Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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Money as Debt Value of Money Acceptability Legal Tender Relative Scarcity Money and Prices Purchasing Power of Money D = 1/Price Level Inflation and Acceptability
Copyright McGraw-Hill/Irwin, 2005

WHAT BACKS THE MONEY SUPPLY?

Functions of Money What Backs the Money Supply

So, What Backs the Money Supply?

Appropriate Fiscal Policy Intelligent Management of the Money Supply Monetary Policy
Copyright McGraw-Hill/Irwin, 2005

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Stable Value! through...

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THE DEMAND FOR MONEY

Functions of Money What Backs the Money Supply

Transactions Demand, Dt
varies directly with nominal GDP

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Asset Demand, Da
varies inversely with the interest rate Liquidity Preference
Copyright McGraw-Hill/Irwin, 2005

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illustrated...

THE DEMAND FOR MONEY

Functions of Money What Backs the Money Supply
Rate of interest, i (percent)

Transactions Demand, Dt

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

10 7.5

2.5

Dt
0 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars) Previous Slide End Show 13 - 13 Next Slide

Copyright McGraw-Hill/Irwin, 2005

THE DEMAND FOR MONEY

Functions of Money What Backs the Money Supply
Rate of interest, i (percent)

Transactions Demand, Dt

+
Rate of interest, i (percent)

Asset Demand, Da

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

10 7.5

10 7.5

2.5

2.5

Dt
0 0 50 100 150 200 250 300

Da
0 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars) Previous Slide End Show 13 - 14 Next Slide

Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

THE DEMAND FOR MONEY

Functions of Money What Backs the Money Supply
Rate of interest, i (percent)

Transactions Demand, Dt

+
Rate of interest, i (percent)

Asset Demand, Da

=
Rate of interest, i (percent)

Total demand for money, Dm

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

10 7.5

10 7.5

10 7.5

2.5

2.5

2.5

Dt
0 0 50 100 150 200 250 300

Da
Amount of money demanded (billions of dollars)

Dm
Amount of money demanded (billions of dollars)

0 0 50 100 150 200 250 300

0 0 50 100 150 200 250 300

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Copyright McGraw-Hill/Irwin, 2005

THE DEMAND FOR MONEY

Functions of Money What Backs the Money Supply
Rate of interest, i (percent)

Transactions Demand, Dt

10 7.5

10

Rate of interest, i (percent)

Rate of interest, i (percent)

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

2.5

ADD THE MONEY SUPPLY TO FIND THE EQUILIBRIUM RATE OF INTEREST D D

10 7.5 7.5 5 5 2.5 2.5

Asset Demand, Da

Total demand for money, Dm Sm

ie
Dm
Amount of money demanded (billions of dollars)

0 50 100 150 200 250 300

0 0 50 100 150 200 250 300

0 0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Equilibrium Interest Rate

Copyright McGraw-Hill/Irwin, 2005

THE MONEY MARKET

Functions of Money

Rate of interest, i (percent)

What Backs the Money Supply

Sm
10 7.5 5 2.5 0

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

ie

Suppose the money supply is decreased from $200 billion, Sm, to $150 billion Sm1.

Dm
0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

THE MONEY MARKET

Functions of Money

Rate of interest, i (percent)

What Backs the Money Supply

Sm1
10 7.5 5 2.5 0

Sm
A temporary shortage of money will require the sale of some assets to meet the need.

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

ie

Dm
0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

THE MONEY MARKET

Functions of Money

Rate of interest, i (percent)

What Backs the Money Supply

Sm
10 7.5 5 2.5 0

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

ie

Suppose the money supply is increased from $200 billion, Sm, to $250 billion Sm2.

Dm
0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

THE MONEY MARKET

Functions of Money

Rate of interest, i (percent)

What Backs the Money Supply

Sm Sm2
10 7.5 5 2.5 0

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

ie

A temporary surplus of money will require the purchase of some assets to meet the desired level of liquidity.

Dm
0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

THE MONEY MARKET

Functions of Money

Rate of interest, i (percent)

What Backs the Money Supply

Sm Sm2
A temporary surplus of money will require Bonds are assumed the purchase of some 7.5 as a typical asset assets with to meet the deie sired level of liquidity. 5 lower prices associated
2.5 0 10

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

with higher interest rates Dm

0 50 100 150 200 250 300

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Amount of money demanded (billions of dollars)

Copyright McGraw-Hill/Irwin, 2005

Functions of Money What Backs the Money Supply

THE FEDERAL RESERVE AND THE BANKING SYSTEM Centralization and Public Control
Board of Governors Assistance & Advice Federal Open Market Committee (FOMC) The 12 Federal Reserve Banks Central Bank Role Quasi-Public Banks Bankers Banks Commercial Banks & Thrifts
Copyright McGraw-Hill/Irwin, 2005

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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THE FEDERAL RESERVE AND THE BANKING SYSTEM

Functions of Money What Backs the Money Supply

Federal Open Market Committee 12 Federal Reserve Banks

Board of Governors

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

Commercial Banks

Thrift Institutions
(Savings & loan associations, mutual savings banks, credit unions)

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The Public
(Households and businesses)
Copyright McGraw-Hill/Irwin, 2005

FED Functions & the Money Supply

Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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Issuing Currency Setting Reserve Requirements & Holding Reserves Lending Money to Banks & Thrifts Discount Rate Providing for Check Collection Acting as Fiscal Agent Supervising Banks Controlling the Money Supply
Copyright McGraw-Hill/Irwin, 2005

FED Functions & the Money Supply

Functions of Money What Backs the Money Supply

Federal Reserve Independence Recent Developments

Relative Decline of Banks and Thrifts Financial Services Industry Consolidation Among Banks and Thrifts Convergence of Services Provided by Financial Institutions Globalization of Financial Markets Electronic Transactions

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

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Copyright McGraw-Hill/Irwin, 2005

medium of exchange unit of account store of value M1, M2, M3 token money Federal Reserve Notes checkable deposits commercial banks thrift institutions near-monies savings account money market deposit account (MMDA) time deposits
Copyright McGraw-Hill/Irwin, Inc. 2005

money market mutual fund (MMMF) legal tender transactions demand asset demand total demand for money money market Federal Reserve System Board of Governors Federal Open Market Committee (FOMC) Federal Reserve Banks financial services industry electronic transactions
BACK END

Coming up next...
Functions of Money What Backs the Money Supply

Demand for Money

The Money Market The Federal Reserve & the Banking System FED Functions & the Money Supply Key Terms

How Banks and Thrifts Create Money

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Chapter 14
Copyright McGraw-Hill/Irwin, 2005