Principles of Macroeconomics

Money and Banking

Money Money = any item that is generally

accepted as a means of payment for goods and services

Common functions of money: medium of exchange unit of account store of value standard of deferred payment

Money does not always serve in the last three of these functions.

Evolution of Money Commodity money Token money Fiat money (legal tender)

Monetary aggregates: M1 M0= A measure of the money supply which

combines any liquid or cash assets held within a central bank and the amount of physical currency circulating in the economy. In the United Kingdom, the M0 supply is also referred to as narrow money.

M1 = those items that serve as a medium of exchange

M1 = currency (including coins) + checkable deposits + traveler’s checks

Note that credit does not serve as money

M2 and M3 M2 = M1 + savings deposits +

small denomination (< $100,000) time deposits + retail money market mutual fund balances

M3 = M2 + repurchase agreements + Eurodollar deposits

Global money Sales among industrialized countries usually

conducted in the currency of the seller Sales between industrialized and developing

countries are usually conducted in the developed country’s currency

Currencies of industrialized countries dominate international transactions

International reserve currency – used to settle debts between governments (dollar, pound, euro, and yen are most commonly used)

Composite currencies ECU – introduced in 1979 – value

tied to weighted average of national currencies of EU – (replaced by the euro)

Special drawing rights – average of the values of the dollar, euro, yen, and pound – created in 1970 by the IMF

Banking Commercial banks – traditionally

offered only checking accounts Thrift institutions – traditionally

offered only savings accounts Financial deregulation in the 1980s

eliminated the last remaining distinctions between commercial banks and thrift institutions

Financial intermediation Direct finance – loans made directly from lenders

to borrowers Financial intermediation – banks (and other

financial intermediaries) accept deposits and make loans

Financial intermediaries receive profits fr5om the difference in interest rates on loans and deposits

Reasons for financial intermediation: economies of scale lowers transaction costs Savers and borrowers have different time

horizons

Bank failures High failure rates in the 1930s and

1980s Federal Deposit Insurance

Corporation (FDIC) – created in 1933 – insures deposits up to $100,000

International banking Eurocurrency markets – deposits held in

currencies that differ from the currency of the country in which the bank is located

Eurocurrency deposits are not subject to U.S. banking laws and offer higher interest rates (along with higher risk)

International banking facilities – since 1981- bookkeeping systems that allow U.S. banks to participate in offshore banking activities

Fractional reserve banking system Banks create money whenever a loan is

issued. Reserve requirement (set by Federal Reserve

Board) = fraction of deposits that must be held as reserves

Reserves = vault cash + deposits at Fed Banks may loan their excess reserves Required reserves = reserve requirement x

deposits Excess reserves = total reserves – required

reserves

T-accounts and deposit multiplier

Initial assumptions: no currency holdings no excess reserves

Deposit expansion multiplier = 1/reserve requirement (shown on board)

IMF - Overview The International Monetary Fund (IMF) is an organization of 186

countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.

The IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty.

Overview With its global membership of 186 countries, the IMF is

uniquely placed to help member governments take advantage of the opportunities—and manage the challenges—posed by globalization

The IMF tracks global economic trends and performance, alerts its member countries when it sees problems on the horizon, provides a forum for policy dialogue, and passes on know-how to governments on how to tackle economic difficulties

The IMF provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty

Key IMF ActivitiesThe IMF supports its membership by providing:

I. policy advice to governments and central banks based on analysis of economic trends and cross-country experiences;

II. research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets;

III. loans to help countries overcome economic difficulties; IV. concessional loans to help fight poverty in developing

countries; and V. technical assistance and training to help countries

improve the management of their economies.

Objectives of the IMFI. To promote international monetary

cooperationII. To facilitate the expansion and balanced

growth of International TradeIII. To promote exchange rate stabilityIV. To make its resources available to its

members who are experiencing BOP problems

V. To establish a multilateral system of payments

Conditionality IMF lends to its member countries,

ensuring that, members are pursuing policies that will improve external payment problems.

Commitment to implement corrective measures.

To repay in a timely manner.

MembershipI. The IMF currently has a near-global membership of

186 countries. To become a member, a country must apply and then be accepted by a majority of the existing members.

II. Upon joining, each member of the IMF is assigned a quota, based broadly on its relative size in the world economy.

Organisation The IMF has a management team and 17 departments

that carry out its country, policy, analytical, and technical work.

The current management team:

Christine Lagarde, a French national, became the IMF's tenth Managing Director in November 2012. Previously, she was the Finance Minister of France

John Lipsky, an American, has been First Deputy Managing Director since September 2006. Before coming to the IMF, he worked for JPMorgan Investment Bank.

Takatoshi Kato, a Japanese national, became Deputy Managing Director of the IMF in February 2004. Previously, he advised the president of Tokyo-Mitsubishi Bank.