Chapter 14-Macro

Macro

McEachern
2011

ECON

1

2010-

CHAPTER
Designed by
Amy McGuire, B-books, Ltd.
Chapter 14

Money and the
Financial
System

Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved

1

The Evolution of Money
 No exchange
 No money
 Specialization
 Exchange: Barter
 Barter
 Double coincidence of
wants
 Agree on exchange rate

LO1
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One Red Paper Clip???

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 The earliest money
 Good – easily traded later
 High degree of
acceptability
 Functions of money
 Medium of exchange
 Commodity money
 Unit of account
 Store of value
 Retains purchasing
power over time

LO1
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4

 Properties of the ideal money
 Durable
 Portable
 Divisible
 Uniform quality
 Low opportunity cost
 Relatively stable in value

LO1
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LO1

Exhibit 1
Six Properties of Ideal Money

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Coins
 Coinage
 Amount and quality of the
metal
 By count
 Problems
 Getting clipped
 Counterfeiting
 Token money
 Face value > cost of coinage
 Seigniorage – profit from
coinage

LO1
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7

Money and Banking
 Banks = Goldsmith
 Safekeeping
 Earn interest
 Checks
 Extend loans
 Create medium of
exchange, money
 Public confidence
 Fractional reserve banking
system

LO1
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Representative Money and
Fiat Money
 Bank notes
 IOUs
 Paper money
 As good as gold
 Representative money
 Represented gold in
the bank’s vault
 Fiat money
 From the power of the
state
 Legal tender

LO1
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The Value of Money
 Purchasing power of money
 Rate of exchange for goods and
services
 Higher price level in economy
 Smaller purchasing power
 Purchasing power of $ in a year
 100 ÷Price index in same year
 Evolution over time
 Steady decline since 1960

LO1
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LO1 Purchasing Power of $1 Measured

Exhibit 2

in 1982–1984 Constant Dollars

An increase in the price level over time reduces what $1.00 buys. The price level
has risen every year since 1960, so the purchasing power of $1.00 (measured in
1982-1984 constant dollars) has fallen from $3.38 in 1960 to $0.47 in 2009.
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When Money Performs Poorly
 Hyperinflation in Zimbabwe
 Prices grow by the hour
 Not reliable store of value
 Exchange for stable
currency
 Barter

LO1
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Financial Institutions
in the U.S.
 Depository institutions
 Commercial banks
 Loans to businesses
 Thrift institutions
 Savings banks
 Credit unions
 Loans to households

LO2
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The Fed
 Before 1863: State banks
– Chartered by states
 National Banking Act of 1863
– National banks
– Issue notes
– Regulated
 Dual banking system
 19th century
LO3 – Panic ‘runs’
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The Fed

LO
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 1913 Federal Reserve System
– Central bank
– Monetary authority
– 12 Federal Reserve districts
 National banks
– Had to join the Fed
 State banks
– Voluntary membership to
the Fed
3

15

The Twelve Federal Reserve
Districts

Exhibit 3

LO3

The map shows by color the area covered by each of the 12 Federal Reserve
districts. Black dots note the locations of the Federal Reserve Bank in each district.
Identified with a star is the Board of Governors headquarters in Washington, D.C.
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The Fed

LO3
Chapter 14

 Powers of the Fed
– Issue bank notes
– Buy and sell government
securities
– Extend loans to member banks
– Clear checks in the banking
system
– Reserve requirement for member
banks
 Banker’s bank

17

 Board of Governors
– 7 members
• Appointed by the President
• Confirmed by the Senate
• 14-year nonrenewable term
• Insulated from political pressure
• 1 chair: 4 years
– Set and implement monetary policy
LO4 – Oversees the 12 reserve banks
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 Federal Open Market Committee
FOMC
– Open-market operations
• The Fed buys, sells
government securities
– 7 board governors
– 5 presidents of reserve banks
– Advise the board

LO4
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http://www.federalreserve.gov/monetarypolicy/fomc.htm

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Exhibit 4

LO

Organization Chart of the Federal
Reserve System

4

Members of the Board of Governors: appointed by the president, confirmed by the
Senate. Seven board members also belong to the 12-member Federal Open Market
Committee, which advises the board. The Board of Governors controls the Reserve
Banks in each of the 12 districts, which in turn control the US banking system.
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LO
Chapter 14

 Regulating the money supply
– Open-market operations
– Discount rate
– Reserve requirements
 Deposit insurance
– Federal Deposit Insurance
Corporation, FDIC
• $250,000 per depositor per bank
• 90% banks
4

22

The Panic of 1907

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Who is the Federal Reserve

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 Goals
– High level of employment
in economy
– Economic growth
– Price stability
– Interest rate stability
– Financial market stability
– Exchange rate stability

LO4
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 Before 1930s: Own corporate stock; bonds
 After 1930s
– Banking = heavily regulated
• Loans, government securities
• Ceiling on interest rates for deposits
 1970s: Inflation
• Increase interest rates
• Withdrawals
 Money market mutual fund
• Limited check writing

LO4
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 Money market deposit accounts
– $8 billion in 1978
– $200 billion in 1982
 Deposit insurance
 Unregulated interest rates
 Wider variety of assets
 Moral hazard problem

LO4
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 Savings banks
– Wild gambles
– Insolvency
– Collapse of a growing number of banks
– 1989 what was then largest financial bailout
– 3,418 in 1984
– 1,220 in 2008
 Credit unions
– Declined 34%

LO4

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LO4

Exhibit 5

Failures of U.S. Savings Banks Peaked in 1989

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 Demise of commercial banks
– Risky decisions
– Unsound loans
– Failures, mergers, acquisitions
– 14,496 in 1984
– 7,085 in 2008

LO4
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LO4

Exhibit 6
Failures of U.S. Commercial Banks
Peaked in 1988

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 Large number of U.S. banks
– Past restrictions on bank branches
 Branching restrictions
– Inefficiencies
– Bank failures (Great Depression)
 Bank holding company
– Owns several banks
– Offers other services
 Bank mergers
– Expand geographically

LO4
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Number of Commercial Banks Declined
over the Last Two Decades, but the
Number of Branches Continues to Grow

Exhibit 7

LO4

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 U.S. banks
– Domestic deposits
– Mergers and acquisitions
– National banks
 Worldwide assets
– No U.S. bank
• J.P. Morgan Chase,
Bank of America,
and Citibank were
13th through 15th,
respectively.

LO4
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Largest U.S. Banks Based on
Total Domestic Deposits

Exhibit 8(a)

LO4

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World’s Largest Banks Based on
Total Assets

Exhibit 8(b)

LO4

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Chapter 14-Macro

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