Unit IV

INTRO:

Throughout this chapter, we get into the uses of money and its involvement in the bank. To be honest, I was quite ignorant to the functions of banks in the economy and thought it was just a place to hold all my money. Although I may have not COMPLETELY comprehended this unit, I have learned a lot of the different functions of money that I have overlooked before and the bank's role in the economy.

USES OF MONEY:

This unit breaks down of the purpose of money. Money can be used as each of the following:

• Medium Exchange
• This includes bartering or trading, and was used in a neolithic society.
• Unit of Account: 
• Establish economic wealth
• Store of Value
• money holds value over a period of time.

TYPES OF MONEY:

Money, after all, is not all just cash and coins. In fact, this unit shows how many other objects, that you wouldn't expect, to be acceptable as money. This includes:

• Fiat Money
• Think of the U.S. Dollar. Why is it money? Because our government says so. If they wanted, they could even say bottle caps are our new currency. This is Fiat Money. 
• Commodity Money
• Gold and silver. They are considered high in value because of its material, making it commodity money. I mean, why else would a bunch of families travel across the country when they heard of the gold rush in California? 
• Representative Money-
• Have you or a friend ever needed money and decide to borrow, lets say $5, from someone else? If you have one of THOSE friends, then you probably had to write them out an I.O.U. note. This I.O.U. note is actually an example of representative money, because it is suppose to back up the $5 that you now owe that person. Bringing back the U.S. Dollar, its face value that represents is quantity, exceeds the material substance, the paper.

CHARACTERISTICS OF MONEY:

What's there to say? Money is green and crispy. Well, lets think a little bit more logical through all these -abilitys. (You see what I did there?)

• Durability
• Portability
• Divisibility
• Uniformity
• Scarcity
• Acceptability

MONEY SUPPLY:

• M1 Money
• consists of currency in circulation, coins and paper money, checkable deposits/demand deposits (or checks), and traveler's check.
• M2 Money
• consists of M1 money plus savings accounts plus money market accounts plus deposists held by banks outside the U.S.
• Fractional Reserve Banking
• The process by banks upholding a small portion of their deposits in reserve and loaning out the excess.
• Banks keep cash on hand (required reserves) to meet depositer's needs.
• Banks must keep reserve deposits in their vaults or at the federal reserve bank.
• Total reserves (total funds held by bank) = required reserves (rr) + excess reserves (er)
• Banks can legally lend only to the extent of their excess reserves
• Reserve ratio= rr/er

SIGNIFICANCE OF A FRACTIONAL RESERVE SYSTEM

• Banks can create money by lending more than their reserves.
• Required reserves do not prevent Bank panics, because banks must keep their required reserves (FDIC)
• Reserve requirement gives the FED control over how much money banks can create.

FUNCTIONS OF THE FED (FEDERAL RESERVE BANK)

• To control the money supply through monetary policy (circulation of currency and adjusting the interest rate).
• Issue Paper money
• Serve as a clearing house for checks.
• Regulating Banking Activities.
• Serve as a bank for banks.

BALANCE SHEET

• Statement of assets and claims summarizing the financial position of a firm or a bank at some point in time and must ALWAYS balance out. 

RESERVE REQUIREMENT

• The percentage of the demand deposits that the bank is required to keep at vault cash or on reserves as federal funds in the banks account with the federal reserve.   
• In most cases, the FED sets the reserve requirement to 10%.
• It is the least used tool to changing monetary policy.

MONETARY MULTIPLIER

• Shows us the impact of a change in demand deposits in loans and eventually the money supply.
• Indicates the total percentage of money created in the banking system by each $1 addition to the monetary base. (Bank reserves and currency in circulation)
• Monetary multiplier = 1/rr

REVIEW (do not remember why I labeled it as so...)

• rr= amount of deposit * required reserve ration
• er= total reserves - rr
• Maximum amount a single bank can lend * monetary multiplier
• Total change in loans= amount single bank can lend * monetary multiplier
• Total change in the money supply= total change in loans + $ amount of FED action
• Total change in demand deposits = total change in loans + any cash deposited

WAYS OF STABALIZING THE ECONOMY

• Fiscal policy
• Congress can Tax or Spend
• Money Policy
• FED
1. OMO (Open Market Operations)- Buy or sell bonds/securities to commercial banks or public. [prefered due to flexibility]
2. Reserve Requirement
3. Discount Rate- The interest rate charged to commercial banks for overnight loans.
4. Federal Funds rate - interest rate change by one commercial bank for overnight loans to another commercial bank; Rate is negotiated by banks themselves.
• The FED has several tools to manage the money supply by manipulating the excess reserves held by banks, a practice known as monetary policy.

• Monetary Policy Option	Expansionary (“easy” money)	Contractionary (“tight” money)
  OMO	Buy back bonds from public.	Sell bonds to public.
  RR	Decrease reserve ratio.	Increase reserve ratio.
  Discount Rate	Decrease discount rate	Increase discount rate.
  Federal Funds Rate	Decrease federal fund rate.	Increase Federal Fund Rate
  Money Supply	Increase Money Supply	Decrease Money Supply.

LOANABLE FUNDS MARKET

• The market where savers and borrowers exchange funds at the real rate of interest.
• The demand for loanable funds, or borrowing comes from households, firms, government, and the foreign sector.
• The demand for loanable funds, or savings comes from households, firms, government, and the foreign sector. The supply of bearable funds is also the demand for bonds. 

CHANGE IN THE DEMAND FOR LOANABLE FUNDS

• Demand for loanable funds= borrowing (i.e. supplying bonds)
• More borrowing = more demand for loanable funds (-->)
• Less borrowing = less demand for loanable funds (<--)
• ex) government deficits spending= more borrowing= more demand for loanable funds.

CHANGE IN SUPPLY OF LOANABLE FUNDS

• Remember that supply of loanable funds = saving (i.e. demand for bonds)
• More saving = more supply of loanable funds (-->)
• Less saving = less supply of loanable funds (<--)
• ex) Government budget surplus = more saving= more supply of loanable funds.

PRIME RATE

• the rate that banks charge to their most credit worthy customers.