micro economics chapter 14

Functions of Money• Medium of exchange • Used to buy/sell goods • Unit of account • Goods valued in dollars • Store of value • Hold some wealth in money form • Money is liquid... Money D

Money, Banking, and Financial Institutions

14

Functions of Money

• Medium of exchange

• Used to buy/sell goods

• Unit of account

• Goods valued in dollars

• Store of value

• Hold some wealth in money form

• Money is liquid

Refers to ability to use an asset as a

medium of exchange The easier it is to convert to a medium of exchange, the more liquid

Money Definition M1

• Currency & coins

• Checkable deposits

• Only the most liquid assets are included

• Coins are token money

• Excludes money held by government and banks

Money Definition M2

• M2 = M1 + near-monies (easily

converted to be used as medium of exchange)

• Savings deposits including money market deposit accounts (MMDA)

• Small-denominated time deposits

• Money market mutual funds (MMMF)

Money Definitions

What “Backs” the Money Supply

• Money as debt

• Stable value of money

• Acceptability

• Legal tender

• Relative scarcity

What “Backs” the Money Supply

• Prices affect purchasing power of

money – inverse relationship

unacceptable

• Stabilizing money’s purchasing power

• Intelligent management of the money supply – monetary policy

• Appropriate fiscal policy

Federal Reserve - Banking System

• Historical background

• Board of Governors

banking system.

Federal Reserve - Banking System

• 12 Federal Reserve Banks

• Serve as the central bank

• Quasi-public banks

•Public control, private ownership

• Banker’s bank

Federal Reserve – Banking System

Commercial Banks

Thrift Institutions (Savings and Loan Associations, Mutual Savings Banks, Credit Unions)

The Public (Households and

12 Federal Reserve Banks Board of Governors Federal Open Market Committee

Federal Reserve – Banking System

The 12 Federal Reserve Banks

Federal Reserve – Banking System

• Federal Open Market Committee

• Conducts open market operations

• Includes Board of Governors and 5 presidents of Federal Reserve

Banks

Federal Reserve Functions

• Issue currency

• Set reserve requirements

• Lend money to banks

• Check collection

• Fiscal agent for U.S government

• Supervise banks

Federal Reserve Independence

• Established by Congress as independent agency

• Protects the Fed from political pressures

• Enables Fed to take actions to increase interest rates to stem inflation as needed

The Financial Crisis of 2007 and

2008

• Mortgage Default Crisis

• Many causes

• Government programs encouraged home ownership

• Declining real estate values

• Bad incentives provided by mortgage-backed bonds

The Financial Crisis of 2007 and

2008

• Securitization- the process of slicing up

and bundling groups of loans into new

securities

• As loans defaulted the system collapsed

• AIG sold collateralized default swaps to

insure loans

• “Underwater” homeowners abandoned

homes and mortgages

The Financial Crisis of 2007 and

2008

• Failures and Near-Failures of

Financial Firms

• Countrywide-second largest lender

• Washington Mutual-largest lender

• Wachovia

• Other firms came close

The Financial Crisis of 2007 and

2008

• Troubled Asset Relief Program

(TARP)

emergency loans

Post-crisis U.S Financial Services

• Wall Street Reform and Consumer

Protection Act

• Passed to help prevent many of the

practices that led to the crisis

• Critics say it adds heavy regulatory

costs