Lecture 4 the monetary system

LECTURE 6: The Monetary System Lecture Objectives The Meaning of Money • Money – Set of assets in an economy – To That regularly buypeople goods and servicesuse from other people • The functions of money – Medium of exchange – Unit of account – Store of value The Meaning of Money • Medium of exchange – Item that buyers give to sellers • • When they want to purchase goods and Unit of account – Yardstick people use to post prices and • services record debts Store of value – Item that people can use to transfer purchasing power The Meaning of Money • Liquidity – Ease with which an asset can be converted into the economy’s medium of exchange • • The kinds of money Commodity money – Money that takes the form of a commodity • with intrinsic value Intrinsic value – Item would have value even if it were The Meaning of Money • The kinds of money • Fiat money – Money without intrinsic value – Used as money because of government decree • Money in the economy • Money stock – Quantity of money circulating in the economy The Meaning of Money • Money in the economy • Currency – Paper bills and coins in the • public Demand deposits – Balances in bank accounts • hands of the • Depositors can access on demand check by writing a Measures of money stock Figure Two measures of the money stock for economy The two most widely followed measures of the money stock are M1 and M2 This figure shows the size of each measure in 2007 Banks and the Money Supply • Money creation: fractional reserve banking – Banking system – Banks hold only a fraction of deposits as reserves – Reserve ratio • Fraction of deposits that banks hold as reserves • Bank must hold – reserve requirement • – Minimum set by the Fed Bank may hold additional excess reserves 16 Banks and the Money Supply • Money creation: fractional reserve – Reserve ratio = 1/10 (10 percent, R) banking FIRST NATIONAL BANK Assets Reserves Loans • Liabilities $10.00 Deposits $100.00 $90.00 Banks hold only a fraction of deposits in reserve – Banks create money – Increase in money 17 Banks and the Money • Supply The money multiplier SECOND NATIONAL Assets Reserves Loans BANK Liabilities $9.00 Deposits $90.00 $81.00 THIRD NATIONAL BANK Assets Reserves Loans Liabilities $8.10 Deposits $81.00 $72.90 18 Banks and the Money • Supply The• money multiplier Original deposit = $100.00 • [= × $100.00] First National lending = $ • 90.00 Second National lending = $ 81.00 [= × $90.00] • [= × $81.00] • • Third National lending = $ Total money supply = $1,000.00 72.90 … 19 Banks and the Money Supply • • The money multiplier – Amount of money the banking system generates with each dollar of reserves – Reciprocal of the reserve ratio = 1/R The higher the reserve ratio – The smaller the money multiplier 20 Banks and the Money Supply • The tools of monetary control Open-market operations – Purchase and sale of government bonds – To increase the money supply • buys government bonds – To reduce the money supply • sells government bonds – The preferred tool 21 Banks and the Money Supply • The tools of monetary control Reserve requirements – Regulations on minimum amount of reserves • That banks must hold against deposits – An increase in reserve requirement • Decrease the money supply – A decrease in reserve requirement • Increase the money supply – Used rarely – disrupt business of banking 22 Banks and the Money Supply • The tools of monetary control The discount rate – Higher discount rate • Reduce the money supply – Smaller discount rate • Increase the money supply 23 Banks and the Money Supply • Problems in controlling the money supply • The Central Bank – Does not control the amount of money • That households choose to hold • as deposits in banks The Central Bank – Does not control the amount • That bankers choose to lend 24 Presentation ideas: • https://www.nasdaq.com/articles/nigerias -central-bank-reschedules-monetary-polic y-committee-meeting-2020-01-13 • https://www.nasdaq.com/articles/nigerias -central-bank-reschedules-monetary-polic y-committee-meeting-2020-01-13 ... and the Money Supply • • The money multiplier – Amount of money the banking system generates with each dollar of reserves – Reciprocal of the reserve ratio = 1/R The higher the reserve ratio – The. .. Countries • In USA: The Federal Reserve System (Fed) • In Australia: The Reserve Bank of Australia (RBA) In Vietnam: The State Bank of Vietnam • SELF-STUDY The Central Bank • The primary tool -... Decrease the money supply – A decrease in reserve requirement • Increase the money supply – Used rarely – disrupt business of banking 22 Banks and the Money Supply • The tools of monetary control The