MODULE 22-29 Notes
OBJECTIVES
• You will learn the following
- Relationship between savings and investment spending
- Purpose of the four principal types of financial assets
•Stocks
•Bonds
•Loans
•Bank deposits
- How investors achieve diversity
MATCHING UP SAVINGS AND INVESTMENTS
• Physical capital
- Factories, shopping malls, large pieces of machinery, etc.
• Usually paid for by borrowing
• Where does this funding come from?
• Savings = Spending
- Savings - investments spending identity
• In a simple economy (No government intervention)
- All money spent by a person or firm ends up pockets of others as income
• Total income = Total spending = C + I
• So... C + S = C + I
Lets add Government activity
• The government spends on goods services, and transfers and collects tax revenues
• If the budget is balanced...
- Tax revenue = Government spending + transfer payment
- Budget balance (BB) = Tax revenue - G - Transfers
- If BB is > 0, there is a surplus and government is saving money
- If BB is < 0, there is a deficit and the government is borrowing money.
THE FINANCIAL SYSTEM
• Financial markets is where households invest their current savings and their current savings and their accumulated savings (WEALTH) by purchasing financial assets
• FINANCIAL ASSET
- Paper claim that entitles the buyer to the future income from the seller.
THREE TASKS OF THE FINANCIAL SYSTEM
0. Reducing transaction cost
1. Reducing risk
- Financial Risk
- Diversification
3. Providing Liquidity
- Liquid assets
- Illiquid Assets
WHAT IS MONEY?
• Money
- Something that you can turn into a good or service
• Three roles of money
- Medium of exchange
• Gimmie a dollar for a pack of gum
- Store of value
• Retains its value over short periods of time
- Unit of account
• A way of evaluating the "measurements" of goods and services
MEDIUM OF EXCHANGE
• Your employer exchanges dollars for an hour of your labor
• Your exchange those dollars for a grocers pound of apples
• The grocer exchanges those dollars for an orchards apples crop, and on and on
STORE OF VALUE
• So long as prices are not rapidly increasing, money is a decent way to store value. You can put money under your mattress or in a checking account and still useful, with essentially the same value a week or month later
• If i were the town cheese maker, I must quickly get rid of my cheese because if I wait long, moldy cheese loses value quickly.
UNIT OF ACCOUNT
• Units of currency (Dollars, Euro yen...) Measures the relative worth of goods and services just as inches and meters measure distance
• In the barter system all goods are measured in terms of other goods
• Prices in a barter economy: A Ib of cheese dozen eggs = beer or something
• With money the value of cheese and all other goods and services is measured in terms of a monetary unit.
TYPES OF MONEY
• Commodity money
- Something used as money, normally gold of silver, that has intrinsic value to
others
• Commodity backed money
- Medium of exchange with no intrinsic value guaranteed by a promise that it
could be converted into valuable goods on demand
• Fiat money
- Money whose value derives entirely from its official status as a means of
exchange.
MEASURES THE MONEY SUPPLY
• How much money is out there?
• Two different measures on the amount of money supply. M1 and M2
- M1 = Currency and coin in circulation+checking deposits+Travelers checks
- M2 = M1 + Savings accounts + Short term CD, money market accounts.
Notes 11-1-11
BANKING AND MONEY CREATION AND THE FEDERAL RESERVE
MODULE 25
MONETARY ROLE OF BANKS
• More than half of the M1 is currency
• The rest is in demand deposits
- How do you figure M1
• If a large part of (about half) of the money supply is accounted for by checking deposits into banks, the banks must pay a crucial role in the supply of money in the economy.
M1 = currency + coin + traveler's checks + Checking deposits
WHAT BANKS DO
• Banks offer a safe place for depositors to put money and they offer lending services to borrowers who need money.
• A saver is paid interest on his or her savings, and a borrower is charged interest on his or her borrowing.
• Another way of thinking about it is that banks take liquid assets (Savings) to finance the investment of illiquid assets (Homes and capital equipment).
BANK RUNS
• Depositors put their money in banks to earn interest and to keep it safe. But when the public begins to fear that the bank itself might fold, or if they fear for the stability for the entire financial system, they may want to withdraw their money.
• If everyone goes to the bank to withdraw their deposits, it creates a bank run.
• The bank keeps only a small percentage of the total deposits on reserve, so a bank run can lead to a self-fulfilling prophesy of the bank's failure.
• This can be very damaging to communities and it can spread across the economy
• This is one of the primary reasons for regulating banks.
BANK REGULATIONS
2. Deposit insurance(FDIC)
3. Capital requirements
4. Reserve Requirements
5. Discount window
DEPOSIT INSURANCE
• The US Government created the FEDERAL DEPOSIT INSURANCE Corporation. The FDIC provides DEPOSIT INSURANCE, a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account. Currently the FDIC guarantees the first $250,000 of each account.
CAPITAL REQUIREMENTS
• To reduce the incentive for excessive risk-taking, regulators require that the owners of banks hold substantially more assets then the value of bank deposits
• That way, the bank will still have assets longer than its deposits even if some of its loans go bad, and losses will accrue against the bank owners' assets not the government
• Bank's capital = assets - liabilities
• For example, main Street Bank has capital of $200,000, equal to 9% of the total value of its assets. In proactive, banks' capital is required to equal at least 7% of the value of their assets.
RESERVE REQUIREMENT
• The Federal Reserve establishes the required reserve ratio for banks. This policy insures that the banks will have a certain fraction of all deposits on hand in the even that customers wish to withdraw money.
• In the unites States the required reserve ratio for checkable bank deposits is 10%
THE DISCOUNT WINDOW
• The Federal Reserve stands ready to loan money to banks in an arrangement known as the DISCOUNT WINDOW.
• This helps a bank that finds itself in a short-term punch because many depositors might be withdrawing their cash in a short period of time.
MODULE 26
History and structure of the Federal Reserve System
FEDERAL RESERVE
• The Federal Reserve is a central bank--An institution that oversees and regulates the banking system, and controls the monetary base.
• The creation of the federal Reserve System in 1913 marked the beginning of the modern era of American Banking
• Though banks were federally regulated since 1964, there were still fundamental problems delivering money from large banks in big cities to smaller banks in rural communities. If a rural bank in Indiana was low on reserves, the bank may fail before money could be delivered to the bank. This bank failure could spark run on several banks, devastating local communities.
END OF THE NATIONAL BANKING SYSTEM
• In 1913 the national banking system was eliminated and the Federal Reserve System was created as a way to compel all deposit--taking institutions to hold adequate reserves and to open their accounts to inspection of regulators
• The panic of 1907 convinced many that the time for centralized control of bank reserves had come.
• In additions, the Federal Reserve was given the sole right to us sue currency in order to make the money supply sufficiently responsive to satisfy economic conditions around the country.
• The creation of the Fed didn't stop bank runs and didn't stop the Great Depression. A series of economic downturns and damaging bank and instigated new laws from Congress that attempted to stabilize the banking industry and provide safeguards for the public and their deposits.
• However when the Great Depression became a distant became a distant memory and bank runs became much less common, Congress let some of the regulations of the 1930's lapse
• Some of these legal lapses created problems of the 1980s and in 2008.
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