Money and Banking

Characteristics of MoneyMedium of ExchangeUnit of AccountStore of Value

Problem with Barter – Need Coincidence of Wants

Is it money?Criteria Credit Card Debit Card

Medium of exchange?

Unit of account?

Store of value?

YesNo

Substance used for money must be◦Plentiful (but not too much) in supply◦Uniform & hard to duplicate◦Durable◦Portable◦Divisible

History of moneyCowrie Shells

Metals

Paper Mone

y

Fiat Money

Fiat money: Money by lawNo intrinsic value as opposed to

commodity moneyTraded because people BELIEVE

in its worthOur dollar bill printed by the US

Treasury

The Pennyhttps://www.youtube.com/watch?v=_tyszHg9

6KI

What about checks?

Or Tide,http://www.foxnews.com/us/2012

/03/12/police-take-on-rising-wave-tide-detergent-theft/?intcmp=obnetwork

History of BanksSafekeeping

◦Temples◦Granaries

Source of Loans◦Rich families

Money-making venture◦Goldsmiths◦1600s: development of checques, paper

money and state banks

Banks’ RolePlace of Safe DepositPlace to borrow fundsMoney-making

◦Savers earn interest◦Banks Profit

Loan interest received (5%)

- Savings interest paid (1.5%)

Bank profits (3.5%)

Types of Banks

Full Reserves Fractional reserves

100% of deposit on hand

Fully redeemable for all at anytime

Bank as Guardian

No policy role

Portion on handPartially redeemable

for some – Bank Run risk

Bank as Business

Policy role in money creation

How loans create money

Reserve

@20% = $100

Deposits

$500

Loans

$400

Money Creation

Bankers 20% required reserve Buyers

+$1000 deposit• Keep $200 + loan $800

$800 deposit◦ Keep $160 + loan $640

$640 deposit◦ Keep $130 + loan $510

$510 depositEtc, etc, etc

$800 purchase

$640 purchase

$510 purchase

Etc, etc,etc

What makes a good loan?LenderWhy lend money?

BorrowerWhy borrow money?

- Make a profit- High interest rate

Urgent expensePotential income gainCheaper than renting or leasing

Value of the assetLender owns until borrower pays off

Value of the assetDoes it mean future greater income?

Ability to repay- Track record or Credit score- Proof of income- Other expenses/debts

Ability to repay- Consider future income- What else you may want to

spend money on. Avoid being “house poor

- Length of loan- (longer the loan lower the

interest rate but the more interest collected)

- Length of loan- (longer the loan the lower

the monthly payment but the more interest paid)

MicrolendingPBS Pakistan,

http://www.youtube.com/watch?v=qI9G7yGJ-ds

Grameen Bank (1976) ◦Group-based Credit ◦Trust-based◦Small deposits/small loans◦97% of members are women

2006 Nobel PrizeKIVA

US BankingLocal BanksNational Bank1792-1811 Bank of the United States1907 Financial Panic and JP Morgan1913 The Federal Reserve System

◦Decentralized-central bank 1933 FDIC, Glass-Steagall Act, Gold

Standard ended1999 Glass-Steagall overturned

Federal Reserve

System of 12 regional banksPolitically independentControls nation’s money supplyBoard of Governors & FOMCBanker’s BankFDIC up to $250,000

Monetary Policy

Open Market Operations by FOMC

Discount RateReserve Requirement

◦Quantitative easing from bank of England

Open Market Operations

Action taken daily

Buy or sell government debt◦ Increases or decreases Money Supply◦ Influences federal funds interest rate

Benefits and Problemshttp://www.marketplace.org/topics/

business/whiteboard/uncle-ben-goes-shopping

Discount RateAction taken less than daily usu

monthly

Changes the interest rate at which banks can borrow from the Fed

Benefits and Problems

Required Reserve Ratio

Rarely Changed

Adjusts the percentage of deposits required to be kept by banks

Benefits and Problems

How does the FOMC decide?Green book

◦Forecasts aggregate demand and prices

Blue book◦Presents policy options and impacts

of each

Beige book◦Data and anecdotal information

Countering the Business Cycle

Expansionary Actions-During recession

Contractionary Actions-When fearing inflation during boom

Monetary Policy

◦ Lower RR◦ Lower Discount Rate◦ Buy Bonds

◦ Find a way to get more money into the economy

Monetary Policy◦ Raise RR◦ Raise Discount Rate◦ Sell Bonds

◦ Find a way to pull money out of the economy

Expansionary – Money InBuy Bonds lowers interest rate on bonds encourages borrowing

Lower Discount Rate encourages banks to lend more

Lower Required Reserve Ratio increases money mulitplies

Expansionary Policy

PROS CONS

Works within private investment and consumption patterns

No change in US debt

Banks may not lendPeople and firms may

not borrow“Pushing on a string”

Lags but shorter than fiscal

(3-12 months vs 1-3 years)

Contractionary – Money OutSell Bonds raises interest rate on bonds discourages borrowing

Raise Discount Rate discourages banks from lending

Raise Required Reserve Ratio decreases money multiplier

Contractionary Policy

PROS CONS

Works within private investment and consumption patterns

No change in US debt

Can work quickly

Can over adjust“Fool in the shower”

Lags but shorter than fiscal

(3-12 months vs 1-3 years)