Slide1: M O N E Y & B A N K I N G


Slide2: M A C R O E C O N O M I C S THE MEANING OF MONEY Assets regularly used for making transactions Anything widely accepted for payment M o n e y What is money?


Slide3: M A C R O E C O N O M I C S The Functions of Money Medium of exchange: What buyers give to sellers to make purchases. Unit of account: A benchmark for a common measurement of value. Store of value: Transferring purchasing power to the future. M o n e y


Slide4: M A C R O E C O N O M I C S Measuring the Money Supply M1 (most liquid category) Currency Checkable deposits (demand deposits) Traveler’s checks M2 Everything in M1 Savings deposits Small time deposits * Money market mutual funds* *(less than $100,000) M o n e y


Slide5: M A C R O E C O N O M I C S Who controls the money supply in the United States? M o n e y THE FEDERAL RESERVE


Slide6: M A C R O E C O N O M I C S - The central bank of the United States. - A system of banker’s banks. - Most important function: to control the money supply. - Created in 1913. - Administered by its Board of Governors. THE FEDERAL RESERVE The Federal Reserve


Slide7: M A C R O E C O N O M I C S INTRODUCTION The Bond Market Introduction: The Bond Market


Slide8: M A C R O E C O N O M I C S Introduction: The Bond Market Treasury issues bonds. Federal Reserve buys and sells bonds. Money supply and interest rates change. An overview . . .


Slide9: M A C R O E C O N O M I C S Bonds (U.S. Treasury Securities) What are they? Introduction: The Bond Market - A loan to the federal government. - Issued by the Treasury. - A promise to pay principle plus interest at a future date. - It happens when G > T


Slide10: Recall the Circular Flow Model


Slide11: M A C R O E C O N O M I C S Financial Market (securities brokers) Introduction: The Bond Market


Slide12: Focus on the center of the Circular Flow Model


Slide13: M A C R O E C O N O M I C S Financial Market (Bond dealers) Government (U.S. Treasury) Introduction: The Bond Market The bond market: A financial market where securities brokers (bond dealers) buy and sell bonds.


Slide14: M A C R O E C O N O M I C S Bonds . . . What are they? Where do they come from? What is a bond market? Bonds and the Federal Reserve. Introduction: The Bond Market


Slide15: M A C R O E C O N O M I C S Introduction: The Bond Market A financial market where securities brokers (bond dealers) . . . Buy bonds from: the U.S. treasury, banks, households, firms, other bond dealers, the Federal Reserve. Sell bonds to: banks, households, firms, other bond dealers, the Federal Reserve.


Slide16: M A C R O E C O N O M I C S Bonds . . . What are they? Where do they come from? What is a bond market? Bonds and the Federal Reserve. Introduction: The Bond Market


Slide17: M A C R O E C O N O M I C S Primary Bond Dealers Government Introduction: The Bond Market FOMC


Slide18: M A C R O E C O N O M I C S Introduction: The Bond Market Securities brokers ( primary bond dealers) . . . … buy bonds from the Federal Open Market Committee. … sell bonds to the Federal Open Market Committee. As of December 1995, there were 37 primary dealers. Trading volumes averaged about $200 billion per day during December 1995.


Slide19: M A C R O E C O N O M I C S Introduction: The Bond Market Some of the primary government securities dealers reporting to the Federal Reserve Bank of New York October 1998 Bear, Stearns & Co., Inc. Chase Securities Inc. Citicorp Securities, Inc. Credit Suisse First Boston Corporation Daiwa Securities America Inc. Goldman, Sachs & Co. J. P. Morgan Securities, Inc. Lehman Brothers Inc. Merrill Lynch Government Securities Inc. Morgan Stanley & Co. Incorporated


Slide20: M A C R O E C O N O M I C S MONETARY CONTROL TOOLS Open Market Operations The Discount Rate Reserve Requirements The Federal Reserve


Slide21: M A C R O E C O N O M I C S TOOLS: Open Market Operations The Fed’s principle tool for controlling the money supply. Federal Reserve buying and selling of U. S. government securities to manage the nation’s money supply. Open market Operations


Slide22: M A C R O E C O N O M I C S Suppose the Federal Reserve purchases a $1000 bond from a bond dealer Assume: reserve requirement = .10 TOOLS: Open Market Operations


Slide23: M A C R O E C O N O M I C S Morgan Stanley & Co. Incorporated (primary bond dealer) TOOLS: Open Market Operations


Slide24: M A C R O E C O N O M I C S TOOLS: Open Market Operations The Deposit Expansion Process


Slide25: M A C R O E C O N O M I C S $ 1000.00 $ 900.00 $ 100.00 $ 900.00 TOOLS: Open Market Operations


Slide26: M A C R O E C O N O M I C S $ 1000.00 $ 900.00 $ 100.00 $ 900.00 $ 810.00 $ 90.00 $ 810.00 $ 729.00 $ 81.00 $ 10,000.00 $ 9000.00 $ 1000.00 TOOLS: Open Market Operations


Slide27: M A C R O E C O N O M I C S TOOLS: Open Market Operations The Federal Reserve purchase of a $1000 bond creates $10,000 of new money in the economy.


Slide28: M A C R O E C O N O M I C S TOOLS: Open Market Operations We can use a simple formula to find the maximum increase in the money supply.


Slide29: M A C R O E C O N O M I C S TOOLS: Open Market Operations The deposit expansion multiplier = = = 10


Slide30: M A C R O E C O N O M I C S TOOLS: Open Market Operations Thus, Ms = deposit expansion multiplier x initial deposit $10,000 = 10 x $1000 Indicates the maximum expansion of the money supply when a new deposit is made.


Slide31: M A C R O E C O N O M I C S $ 1000.00 $ 900.00 $ 100.00 $ 900.00 $ 810.00 $ 90.00 $ 810.00 $ 729.00 $ 81.00 $ 10,000.00 $ 9000.00 $ 1000.00 TOOLS: Open Market Operations


Slide32: M A C R O E C O N O M I C S TOOLS: Open Market Operations Buy bonds FRS policy Excess reserves C, I, and AD GDP and P State of economy Prime rate Federal Funds rate Mortgage rates Auto loan rates Credit card rates Recessionary gap . . . Interest rates


Slide33: M A C R O E C O N O M I C S TOOLS: Open Market Operations Greenspan Suggests Rate Cut Is Under Consideration September 24, 1998 Alan Greenspan, the Federal Reserve chairman, suggested Wednesday that the central bank would seriously consider cutting interest rates next week because of the deepening world financial crisis.


Slide34: "We have to bring the existing instabilities to a level of stability reasonably shortly, to prevent the contagion from really spilling over and creating some very significant further difficulties for all of us."


Slide35: M A C R O E C O N O M I C S TOOLS: Open Market Operations September 30, 1998 NEW YORK (CNNfn) - Several of the nation's top banks cut their prime lending rate in a chain reaction Wednesday, one day after the Federal Reserve cut short-term interest rates by a quarter of a percentage point.


Slide36: Chase Manhattan Bank, NationsBank Corp., BankAmerica Corp., Banc One Corp., WellsFargo & Co. and First Chicago NDB Corp. said they cut their prime rate to 8.25 percent from 8.50. Analysts expect virtually all of the nation's banks to follow suit in the next few days. M A C R O E C O N O M I C S TOOLS: Open Market Operations


Slide37: Limits on the Multiplier’s Effect


Slide38: M A C R O E C O N O M I C S $ 1000.00 $ 900.00 $ 100.00 $ 1000.00 $ 900.00 $ 100.00 TOOLS: Open Market Operations 1. Banks may hold more reserves than required. (Banks may fear a run on the bank.) 2. Currency withdrawn from the banking system and kept as cash can limit the creation of new loans. (Households may fear bank failures.)


Slide39: M A C R O E C O N O M I C S TOOLS: Open Market Operations Suppose the Federal Reserve sells a $1000 bond to a bond dealer. Assume: reserve requirement = .10


Slide40: M A C R O E C O N O M I C S TOOLS: Open Market Operations Morgan Stanley & Co. Incorporated (primary bond dealer)


Slide41: M A C R O E C O N O M I C S $ -1000.00 $ -900.00 $ 100.00 TOOLS: Open Market Operations 1. A $1000 check is draw on BankOne. 2. BankOne uses loan payments as a source of funds to cover the check.


Slide42: M A C R O E C O N O M I C S TOOLS: Open Market Operations Buy bonds Sell bonds Recessionary gap . . . FRS policy Excess reserves Interest rates C, I, and AD GDP and P State of economy Inflationary gap . . .


Slide43: M A C R O E C O N O M I C S The Fed adds extra credit to the banking system when it buys securities from bond dealers. The Fed drains credit from the banking system when it sells securities to bond dealers. SUMMARY TOOLS: Open Market Operations


Slide44: M A C R O E C O N O M I C S Where does money come from? THIN AIR Consider this. . . What backs our money? FAITH TOOLS: Open Market Operations


Slide45: M A C R O E C O N O M I C S TOOLS: The Discount Rate MONETARY CONTROL TOOLS Open Market Operations The Discount Rate Reserve Requirements


Slide46: M A C R O E C O N O M I C S TOOLS: The Discount Rate The Discount Rate The interest rate on the loans that the Federal Reserve makes to banks.


Slide47: M A C R O E C O N O M I C S TOOLS: The Discount Rate Excess reserves $ 1000 Interest rates fall Loans


Slide48: M A C R O E C O N O M I C S Discount Rate decrease Recessionary gap . . . Inflationary gap . . . FRS policy Excess reserves Interest rates C, I, and AD State of economy Discount Rate increase Encourages bank borrowing Discourages bank borrowing TOOLS: The Discount Rate


Slide49: M A C R O E C O N O M I C S TOOLS: The Discount Rate Discount rate changes indicate a monetary policy shift.


Slide50: M A C R O E C O N O M I C S TOOLS: Open Market Operations Federal Reserve Cuts Rates Again; Wall Street Surges WASHINGTON -- The Federal Reserve unexpectedly cut interest rates Thursday,warning that a growing wave of fear among investors and lenders was threatening to derail the nation's long economic expansion. October 16, 1998


Slide51: M A C R O E C O N O M I C S TOOLS: Open Market Operations The central bank approved a quarter- point reduction in the discount rate on loans from the Federal Reserve to banks. The cut, to 4.75 percent, was the first change in the largely symbolic discount rate since January 1996. The Federal also reduced funds target for the overnight lending rate between banks by a quarter-point, to 5 percent.


Slide52: M A C R O E C O N O M I C S TOOLS: The Discount Rate From 1980 through 1990 there were 29 discount rate changes The Fed cut the discount rate seven times from December 1990 to July 1992 -- from 7.0 percent at the start to 3.0 percent. From May 1994 to February 1995, when the Fed was concerned inflation, it raised the discount rate four times -- from 3.0 to 5.25 percent.


Slide53: The End