April 9, 2018
Unit 4: Money
Uses of money
1. Medium
of exchange - barter/trade
2. Unit
of account - economic value
a. Am
I getting my money’s worth?
3. Store
of value – what is the money’s value over time?
Types of money
1. Commodity
money – a product
a. EX:
golden silver
2. Representative
Money – Money that has no value
a. EX:
IOU’s
3. Fiat
Money – it is money because the government says so.
Characteristics of Money
1. Durability
– Able to last / withstand
2. Portability
– carry money from place to place
3. Divisibility
– money can be divided into smaller units
4. Uniformity
– same or identical
a. EX:
old money is the same as the new money
5. Scarcity
6. Acceptability
Money Supply – Monetary Policy controlled by the Fed.
Government
- M1
Money: Cash, currency, coins, checkable or demand deposits(checking account)
o
75% of businesses
o
Traveler’s check
- M2
Money: M1 Money + savings account
- M3
Money: M2 Money + Money Market Accounts + CD’s
Liquidity – Easily to convert to cash
Balance Sheet:
- summarizes the financial position of a bank at a certain time
|
ASSETS:
- RR (Required Reserves): % of
DD in vault
- ER (excess Reserves):
remaining of DD for loans
- Property
- Securities or Bonds
(investments)
- Loans
|
LIABILITIES:
-DD (Demand Deposits);
Checkable Deposits
- Net Worth (Owners Equity)
bank owners wealth
|
Assets = Liabilities + Net Worth
DD (demand deposits) = RR (required reserves) + ER (excess reserves)
MM (money multiplier) = ER (excess reserves) x [1/RR (required reserves)]
Fractional Reserve Banking System: Where a fraction of the total money supply is held in reverse as currency.
Basics: How Do Banks Get Money?
- From the public as deposits. The public wants safety and sometimes a return in the form of interest rates.
- Since the deposits are the property of the public, banks must record them as "liabilities" for the bank and are labeled as "demand deposits". they are also known as "checkable accounts" but that tern is being used less with the demise of "checkbooks".
- Banks, once in operation, can invest funds in the form of Federal Bonds, purchased from the Fed. The bonds earn the bank interest rate. The bond amounts are "assets" for banks.
What Do Banks Do With The Money?
- lend it the public in order to profit from the interest charges on the loans. This money creates a "money multiplier" or "monetary multiplier".
Do Banks Lend All of the Money? No
- Not all of the Demand Deposits, Since some of the public comes to the bank each day and wants to withdraw some of the Demand Deposits, banks must keep some cash "in the vault". This "reserve" is used to satisfy withdrawal requests.
- Banks that belong to the Federal Reserve System must keep a "Required Reserve" percentage set by the Fed. the Required Reserve is approximately 10? of Demand Deposits, and since almost all banks in the US are part of the Fed System, this has become the national standard.
- The remaining amount becomes the "excess reserves". The excess are then used by the banks as loans to the public.
- Banks can lend all of the Bond Assets they hold and so not have to put any percentage into the Required Reserves.
What Happens to the Loans?
- When a person borrows from a bank it will be assumed that the money is spent somewhere. The next assumption is that the funds end up in a bank account as someone else's checkable Deposits in a second bank. The second bank then pulls out the Required Reserves, The remaining Excess Reserves become a new loam which another person can use the money ends up in a third bank. The process "multiplies".
- Note however, that with each new loan, some is removes and held a Required Reserves. The loam amount will shrink with each new loan. How many times can the process occur?
- No one knows at which point any given amount of deposits shrink to a point where borrowing will end, but estimates are made using the "money multiplier". the formula is based on the amount being drained out by the Reserve Requirement. The greater the Reserve Requirement, the quicker the loan amount will shrink and end the line of loans.
- The general formula is given as 1/rr, with "rr" standing for the Required Reserve percentage, known here as the reserve ratio. If the rr is 10%, then every original loan of 1 dollar will create 10 dollars of loans in the banking system (1/.1). A 5% rr gives a multiplier of 20(1/.05) and a reserve of 20% lowers the multiplier to only 5(1/.20).
AP and Bank T-Accounts
- Banks keep all of the accounting for this lending in a T-Account of Assets and Liabilities.
- The Assets and Liabilities are always equal to show bank solvency,
- The T-Account is a chart, with Assets on the Left and Liabilities of the Right.
You forgot to mention the loanable funds market where buyers and savers meet to exchange funds at the real interest rate.
ReplyDeleteyou forgot to mention another importance of the Federal Reserve Banking System which is the fact the bank cannot loan out all its money, and also the fact they must keep a fraction of their deposits they get in which is the called the Reserve Requirement.
ReplyDelete