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Bitcoin

Ted Talk

14 - 14 - 44

Anything widely used and freely accepted as payment for goods and services

What Is Money?

14 - 14 - 55

The Functions of Money

Medium of Exchange

Store of Value

Unit of Account/

Measure of Value

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Portability

Divisibility

Durability

Recognizable

Relative scarcity

What Is Money?

14 - 14 - 77

The Cost of Producing U.S. Coins

Golden Dollar 10.03 cents

Half Dollar 9.93 cents

Quarter 4.29 cents

Dime 1.88 cents

Nickel 3.13 cents

Penny .81 cents

Source: http://www.usmint.gov/faqs/circulating_coinsSource: http://www.usmint.gov/faqs/circulating_coins

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Commodity – money with intrinsic value

Representative – convertible or commodity-backed money

Fiat – value derived from official status, acceptability

Kinds of Money

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Just How Much Is a Ton of Money Worth?The Time Value of Money

Dollar Bills $908,000

Quarters $40,000

Pennies $3,632

Source: State of Michigan Office of Financial and Insurance Services, Source: State of Michigan Office of Financial and Insurance Services, www.cis.state.mi.us/ofic/consumer/kids/ton_money www.cis.state.mi.us/ofic/consumer/kids/ton_money

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The Money Supply

M1: SpendableCurrency

Demand deposits

M2: Spendable plus Convertible(M1 + near money)

Time deposits

Money market mutual funds

Savings deposit

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More than half of the M1 is currency

The rest is demand deposits

The Monetary Role of BanksThe Monetary Role of Banks

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What Banks DoWhat Banks Do

•Financial Intermediary

•Bank Reserves

•T - Account

Assets & Liabilities

•Reserve Ratio

•Required Reserve Ratio

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The Problem of Bank RunsThe Problem of Bank Runs

•Customer Deposits > Bank Reserves

•Why does this usually work?

•Bank Run

•Why?

•Bank Failure

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Bank RegulationBank Regulation

•Deposit Insurance

•FDIC

•Capital Requirements

•Reserve Requirements

•The Discount Window

14 - 14 - 151519641964 19691969 19741974 19841984 19841984 19891989 19941994 20012001

5.45.4

5.05.0

4.44.4

4.04.0

3.43.4

3.03.0

2.42.4

2.02.0

1.41.4

1.01.0

00

0.40.4

Mo

ne

y S

upp

ly (

trill

ion

s)M

on

ey

Sup

ply

(tr

illio

ns)

Money Supply Growth

M-1M-1

M-2M-2

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Determining the Money SupplyDetermining the Money Supply

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How Banks Create MoneyHow Banks Create Money

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Reserves, Bank Deposits, andReserves, Bank Deposits, and the Money Multiplier the Money Multiplier

•“Leaks”

•Excess Reserves

•rr = reserve ratio

•Loan Expansion = Excess Reserves / rr

MM = 1/rrMM = 1/rr

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The Money Multiplier in RealityThe Money Multiplier in Reality

•Monetary Base

•Money Multiplier

Each dollar of bank reserves backs Each dollar of bank reserves backs several dollars of bank deposits, several dollars of bank deposits, making the money supply larger making the money supply larger than the monetary base.than the monetary base.

14 - 14 - 2020

Table 25.1 How Banks Create MoneyRay and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

Assumes a reserve ration of 10%Assumes a reserve ration of 10%

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Figure 25.3 Effect on the Money Supply of Turning Cash into a Checkable Deposit at First Street BankRay and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

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Insert Federal Reserve here

The Money Market(Supply and Demand for Money)

23

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Demand for Money

Transactions Demand – medium of exchange demand; directly related to changes in nominal GDP

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Demand for Money cont.

Asset Demand – store of value demand; inversely related to the interest rate

14 - 14 - 2626

Demand for Money cont.

Total Money Demand – transaction + asset directly related to nominal GDP

The Demand for MoneyAt any given time, people demand a certain amount of liquid assets (money) for everyday purchases

The Demand for money shows an inverse relationship between nominal interest rates

and the quantity of money demanded1. What happens to the quantity demanded of money when interest rates increase?

Quantity demanded falls because individuals would prefer to have interest earning assets instead2. What happens to the quantity demanded when interest rates decrease?Quantity demanded increases. There is no incentive

to convert cash into interest earning assets 27

Nominal Interest Rate

(ir)

Quantity of Money(billions of dollars)

20%

5%

2%

0

DMoney

Inverse relationship between interest rates and the quantity of money demanded

28

The Demand for Money

Quantity of Money(billions of dollars)

20%

5%

2%

0

DMoney

What happens if price level increase?

29

The Demand for Money

DMoney1

Money Demand Shifters1. Changes in price level2. Changes in income3. Changes in taxation

that affects personal investment

Nominal Interest Rate

(ir)

The Demand for MoneyAt any given time, people demand a certain amount of liquid assets (money) for everyday purchases

The Demand for money shows an inverse relationship between nominal interest rates

and the quantity of money demanded1. What happens to the quantity demanded of money when interest rates increase?

Quantity demanded falls because individuals would prefer to have interest earning assets instead2. What happens to the quantity demanded when interest rates decrease?Quantity demanded increases. There is no incentive

to convert cash into interest earning assets 30

200

DMoney

SMoneyThe FED is a nonpartisan

government office that sets and adjusts the money supply to

adjust the economy

This is called Monetary Policy.

The U.S. Money Supply is set by the Board of Governors of the Federal Reserve System (FED)

31

The Supply for Money

20%

5%

2%

Quantity of Money(billions of dollars)

Interest Rate (ir)

32

Why are there so many interest rates?

33