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Macroeconomics
Dr. Karim Kobeissi
Arts, Sciences and Technology University in Lebanon
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Chapter 13: Money, Banking, and The Federal Reserve System
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The Functions of Money
The three functions of money are:
1) Medium of exchange
2) Unit of account
3) Store of value
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The Money Supply
In economics, the money supply or money stock, is
the total amount of monetary assets available in an
economy at a specific time.
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The Money Supply (con)
Money supply data are recorded and published,
usually by the government or the central bank of
the country.
Public and private sector analysts have long
monitored changes in money supply because of its
effects on the price level, inflation, the exchange
rate and the business cycle.
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The Components of the Money Supply
Two definitions of money supply are:
1) M1: Cash and others assets that are highly liquid.
2) M2: A broader definition of money than M1, because
it also includes assets that are highly liquid but not
cash.
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Money Definition: M1
M1 money = Currency + Checkable Deposits
Currencyincludes coins and paper money.
All coins in circulation are token money.
Paper money known as Federal Reserve Notes.
C h e c k a bl e D e p o s i t s ( D e m a n d D e p o s i t s )
- All deposits in depository institutions that can be
withdrawn without prior notice (on demand); most
of these are non-interest bearing .
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Money Definition: M2
M2 = M1 + Near Money
Near Money: includes savings deposits (interest bearing non-
transaction accounts that can be drawn upon demand at
no costs), money market mutual funds and other time
deposits, which are less liquid and not as suitable as
exchange mediums but can be quickly converted into cash
or checking deposits.
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What Backs the Money Supply?
The U.S. money supply is guaranteed by
governments ability to keep the value of money
relatively stable.
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Value of Money
Money has value because of:
1) Its acceptability (the US$
is acceptable everywhere,which isnt the case of
the Lebanese Pound).
2) Legal tender designation.
3) Relative scarcity.
A 'Legal Tender' is any official
medium of payment
recognized by law that can
be used to repay a public or
private debt, or meet a
financial obligation. The
national currency is legal
tender in practically every
country. A creditor is
obligated to accept legal
tender toward repayment
of a debt.
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Money and Prices
The purchasing power of money is the amount of
goods and services a unit of money will buy.
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Money and Prices (con)The purchasing power of
the national currency
(e.g., US$) variesinversely with the pricelevel:
If the price level rises,the purchasing power
of the dollar falls, and
vice versa.
The price level is a certain averageof the prices of a broadly
defined group of commodities. Itis an index that measures thechange in price of goods in aneconomy over time and hencethe purchasing power of the
currency of the country.
In the U.S. the price level isrepresented by the CPI(Consumer Price Index) which
measures changes in the pricelevel of a market basket ofconsumer goods and servicespurchased by households.
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Money and Prices
When the government prints too much money,
the purchasing power of money declines.
Also, runaway inflation (very rapid inflation, which
is almost impossible to reduce) may significantly
reduce the purchasing power of the national
currency and may cause it to cease being used as
a medium of exchange (decrease money
acceptability).
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The Federal Reserve System & The Banking System
A key element of the U.S. banking system is the Federal
Reserve System (the Fed - the Central Bank of the United
States) which represent a system of 12 Federal Reserve
banks, each serving member commercial banks in its own
district.
The Fed, supervised by the Board of Governors , has broad
regulatory powers over the money supply and the credit
structure.
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The Federal Reserve System and The Banking System
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The Federal Reserve System and The Banking System (con)
Board of Governors
The seven-member group that supervises andcontrols the money and banking system of the
U.S..
The 12 Federal Reserve Banks
The 12 banks licensed by the U.S. government tocontrol the money supply and perform otherfunctions.
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The Federal Reserve System and The Banking System
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Fed Functions and Responsibilities
The Fed performs the following functions:
1) Issues currency
2) Sets reserve requirements and holds reserves
3) Lends money to banks and saving institutions
4) Provides the banking system with a means for
collecting checks
5) Acts as a fiscal agent for the Federal government
6) Supervises the operation of banks
7) Controls the money supply
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Fed Reserve Independence
The Federal Reserve is an independent agency
of the government.
This protects the Fed from political pressure so
that it could effectively control the money
supply and interest rates to foster price-level
stability.
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Depositing Reserves in a Federal Reserve Bank
All commercial banks and saving institutions thatprovide checkable deposits must by law keep
required reserves.
Required reservesare an amount of funds equal to
a specified percentage of the banks own deposit
liabilities.
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Depositing Reserves in a Federal Reserve Bank
The reserve ratio is the percentage of deposits that the
Federal Reserve requires a bank to keep on hand at aFederal Reserve bank.
Reserve Banks required reservesratio Banks checkable-deposit liabilities
For example, letsassume that Bank XYZ has $400 million in deposits. If
Bank XYZ is required to keep at least $20 million in an account at a
Federal Reserve bank (XYZ may not use that cash for lending or any
other purpose), then the Federal Reserves reserve ratio is 5%.
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