2016 ft ulecture02notemonetary
- 1. The Monetary System DO MANH HONG Obirin University, Tokyo Japan (dohong@obirin.ac.jp) 2016 Academic Year. Principles of Macroeconomic (part II) Foreign Trade University, Hanoi Vietnam 1
- 2. CONTENT ① Learning Objectives and Key Points Context and purpose, Objectives and Key Points ② The Meaning of Money Definition of money, the Functions of Money, the Kinds of Money, etc. ③ The Federal Reserve System Definition of Central Bank, The Fed Organization, etc. ④ Banks and the Money Supply The simple Case of 100% Reserve Banking, Money Creation, the Money Multiplier, etc. 2
- 3. ① Context, Objectives and Key Points Context: Explanation of money and price in long-run What money is? How the Federal Reserve controls the quantity of money? The causes and costs of inflation or influences of money to the rate of inflation in long-run 3
- 4. Key Points: 1. The term money refers to assets that people regularly use to buy goods and services... 2. Money serves three functions... 3. Commodity money, Fiat money are two kinds of money 4. Money in the U.S. economy takes form of currency & various types of deposits 5. The Federal Reserve is the Central bank of the US, responsible for regulating the US’smoney 6. The Fed controls the money supply primarily through open-market operations. When the FED purchases bonds on the open market it will result in an increase in the money supply. If it sells bonds on the open market, it will result in a decrease in the money supply. 7. When banks loan out some of their deposits, they increase the quantity of money in the economy. The’s FED control is important 4
- 5. ② The Meaning of Money 5 Definition of money: The set of asset n an economy that people use to buy goods and services from other people The functions of money: Medium of exchange: an item that buyers give to sellers when they want to purchase goods and services Unit of account: the yardstick (measure) people use to post prices and record debts Store of value: an item that people can use to transfer purchasing power from the present to the future
- 6. ② The Meaning of Money 6 Definition of liquidity: the ease with which an asset can be converted into the economy’s medium of exchange Money is the most liquid asset available Other assets (such as stocks, bonds, and real estate) vary in their liquidity When people decide in what forms to hold their wealth, they must balance the liquidity of each possible asset against the asset’s usefulness as a store of value
- 7. ② The Meaning of Money 7 The kinds of money: Commodity money: money that takes the form of a commodity with intrinsic value Fiat money: Money without intrinsic value that is used as money because of government decree
- 8. ② The Meaning of Money 8 Money in the U.S. economy The quantity of money circulating in the U.S. is called the money stock Money Supply = currency, demand deposits, and other monetary assets Currency = the paper bills and coins in the hands of the public Demand deposits= balances in bank accounts that depositors can access on demand by writing a check
- 9. Table 1. Money in the U.S Economy 9
- 10. ② The Meaning of Money 10 Notice: Currency only makes up about 30% of the value of M1, and 70% in the form of checking deposits. The majority of the money in the economy is actually made up of account balances rather than stacks of currency in a vault The assets included in M1 and M2 differ in terms of liquidity. There are other measures of the money supply (M3, L), which include less liquid assets like large time deposits
- 11. ③ The Federal Reserve System 11 Fed = the central bank of the United States Central bank = an institution designedto oversee the banking system and regulate the quantity of money in the economy In the case of Japan, it is called as the Bank of Japan (BOJ) The Fed‘s organization (www.federalreserve.gov) The BOJ’s organization (www.boj.or.jp)
- 12. ③ The Federal Reserve System 12 First job of the Fed is the regulation of banls to ensure the health of the nation’s banking system The Fed monitors . each bank’s financial condition and facilitates bank transactions by clearing checks The Fed also makes loans to banks when they want (or need ) to borrow Second job of the Fed is to control the quantity of money available in the economy
- 13. ③ The Federal Reserve System 13 The Federal Open Market Committee (FOMC) FOMC = 7 members of the BoG and 5 of the 12 regional Federal Reserve District Bank presidents The primary way in which the Fed increases or decreases the supply of money is through open market operations (which involve the purchase of sale of U.S. government bonds)
- 14. ③ The Federal Reserve System 14 Open market Operations If Fed wants to increase the supply of money, it creates dollars and use them to purchase government bonds from the public through the nation’s bond markets If Fed wants to lower the supply of money, it sells government bonds from its account to the public. Money is then taken out of the hands of the public and the supply of money falls
- 15. ④ Banks and the Money Supply 15 The simple case of 100% reserve banking Example: Suppose that currency is the only form of money and the total amount of currency is $100 A bank is created as a safe place to store currency; all deposits are kept in the vault until the depositor withdraws them Reserves = deposits that banks have received but not loaned out Under the example described above, we have 100% reserve banking
- 16. ④ Banks and the Money Supply 16 The financial position of the bank can be describes with a T - account The money supply in this economy is unchanged by the creation of a bank This means that, if banks hold all deposits in reserve, banks do not influence the supply of money FIRST NATIONAL BANK Asset Liabilities Reserves $100,00 Deposits $100,00
- 17. ④ Banks and the Money Supply 17 Money creation with fractional reserve banking Fraction-reserve banking = a banking system in which banks hold only a fraction of deposits as reserves Reserve-ration... = the fraction of deposits that banks hold as reserves
- 18. 18 Example: same as before, but First National decides to set its reserve ratio equal to 10% and lend the remainder of the deposits The bank’s T-account would be: FIRST NATIONAL BANK Assets Liabilities Reserves $100.00 Deposits $100.00 Loan $90
- 19. 19 When the bank makes these loans, the money supply changes Before: MS = $100 worth of deposits After: deposits are still equal to $100, but borrowers now also hold $90 of currency from the loans Therefore, when banks hold only a fraction of deposits in reserve, banks create money Note that, while new money has been created, so has debt. There is no new wealth created by this process
- 20. ④ Banks and the Money Supply 20 The money multiplier The creation of money does not stop at this point Assuming that reserve ratio of this bank is 10%, its T-account would be: SECOND NATIONAL BANK Assets Liabilities Reserves $9.00 Deposits $90.00 Loans $81.00
- 21. ④ Banks and the Money Supply 21 The money multiplier = the amount of money the banking system generates with each dollar of reserves Money Multiplier = 1 1 - MPC
- 22. ④ Banks and the Money Supply 22 The Fed’s tools of monetary control Open market operations.= the purchase and sale of U.S. government bonds by the Fed If the sale or purchase of government bonds affects the amount of deposits in the banking system, the effect will be made larger by the money multiplier Open market operation are easy for the Fed to conduct and are therefore the tool of monetary policy that the Fed uses most often
- 23. ④ Banks and the Money Supply 23 The Fed’s tools of monetary control Reserve requirements= regulations on the minimum amount that banks must hold against deposits This can affect the size the money supply through changes in the money multiplier The Fed usesthis tool because of the disruption in the banking industry that would be caused by frequent alterations of reserve requirements
- 24. ④ Banks and the Money Supply 24 The Fed’s tools of monetary control Discount rate= the interest rate on the loans that the Fed makes to banks When a bank cannot meet its reserve requirement, it may borrow reserves from the Fed A higher discount rate discourages banks from borrowing from the Fed and likely encourages banks to hold onto larger amounts of reserves. This in turn decreases the MS
- 25. ④ Banks and the Money Supply 25 The Fed’s tools of monetary control Discount rate A lower discount rate encourages banks to increase the quantity of reserves (and borrow from the Fed). This will increase the money supply The Fed also uses discount rate.to help financial institutions that are in trouble
- 26. ④ Banks and the Money Supply 26 Problems in controlling the money supply The Fed does not control the amount of money that consumers choose to deposit in banks The Fed does not control the amount that bankers choose to lend Therefore, in a system of fractional-reserve banking, the amount of money in the economy depends in part on the behavior of depositors and bankers Because the Fed cannot control or perfectly predict this behavior, it cannot perfectly control the money supply
- 27. 27 Case study: Bank Runs and the Money Supply Bank runs create a large problem under fractional- reserve banking Because the bank only hold a fraction of its deposits in reserve, it will not have the funds to satisfy all of the withdrawal requests from its depositors Today, deposits are guaranteed through the Federal Depository Insurance Corporation (FDIC)
- 28. 28 FYI: The Federal Funds Rate The FFR is the short term interest rate that banks charge one another for loans When the FFR rises or falls, other interest rates often move in the same direction In recent years, the Fed has set a target for the federal funds rate
Editor's Notes
- #8: Key points 3. Commodity money, such a gold, is money that has intrinsic value: It would be valued even if it were not used as money. Fiat money, such as paper dollars, is money without intrinsic value: It would be worthless if it were not used as money 4. In the US economy, money takes the form of currency and various type of bank deposits, such as checking accounts 5. The Federal Reserve, the central bank of US, is responsible for regulating the US money system. The Fed chairman is appointed by the president and confirmed by Congress every 4 years 6. The Fed controls the money supply primarily through open market operations. The purchase of government bonds increases the money supply, and the sale of government bonds decreases the money supply. The FED can also expend the money supply by lowering reserve requirements of decreasing the discount rate, and it can contract the money supply by raising reserve requirements or increasing the discount rate. 7. When banks loan out some of their deposits, they increase the quantity of money in the economy. Because of this role of Banks in determining the money supply, the fed’s control of the money supply is imperfect