THP ECON Macro ch14

Macro
McEachern ECON 2010-2011
Designed by
CHAPTER
Amy McGuire, B-books, Ltd.

14 Money and the
Financial System
Chapter 14 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
 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
 Properties of the ideal money

 Durable
 Portable
 Divisible
 Uniform quality
 Low opportunity cost
 Relatively stable in value
LO1
LO1 Exhibit 1
Six Properties of Ideal Money
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
LO1 The Hassle of Small Change
 Pennies
 Cost: 1.5 cents per coin
Case Study
 Nickels
 Cost: 5.5 cents per coin
 Rising metal prices
 Lower cost alloy
 Abolish the penny
 Penny = 5 cents;
withdraw nickels
LO1 The Hassle of Small Change
 Production of pennies
 Increased
Case Study
 6.8 billion pennies
in 2003
 To 8.2 billion
pennies in 2006
 Demand for pennies
 Hoarding
 Sales tax
 Zinc producers -
lobby
Money and Banking
 Banks = Goldsmith
 Safekeeping
 Earn interest
 Checks
 Extend loans
 Create medium of
exchange, money
 Public confidence
 Fractional reserve banking
system
LO1
Representative Money and
Fiat Money
 Bank notes
 IOUs
 Paper money
 As good as gold
 Representative
money
 Fiat money
 From the power of
the state
 Legal tender
LO1
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
LO1 Purchasing Power of $1 Measured
in 1982–1984 Constant Dollars
Exhibit 2
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.
When Money Performs Poorly
 Hyperinflation in Zimbabwe
 Prices grow by the hour
 Not reliable store of value
 Exchange for stable
currency
 Barter
LO1
LO1 When Monetary Systems Break Down
 Too much money in circulation
 Increase demand for hard currency
Case Study
 Hoarding the hard currency
 Not enough money in circulation
 Hoarding currency
 Vouchers; Barter
 Bank panics
 Strict price control
 Barter
Financial Institutions
in the U.S.
 Depository institutions
 Commercial banks
 Loans to businesses
 Thrift institutions
 Savings banks
 Credit unions
 Loans to households
LO2
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’
The Fed
 1913 Federal Reserve System

– Central bank
– Monetary authority
– 12 Federal Reserve districts
 National banks
– Had to join the Fed
 State banks
– Voluntary membership to
3 the Fed
LO
LO3 The Twelve Federal Reserve
Districts
Exhibit 3
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.
The Fed
 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
LO3  Banker’s bank
 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
 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
Organization Chart of the Federal
LO4
Reserve System
Exhibit 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.
 Regulating the money supply
– Open-market operations
– Discount rate
– Reserve requirements
 Deposit insurance
– Federal Deposit Insurance
Corporation, FDIC
• $250,000 per depositor per bank
4 • 90% banks
LO
 Goals
– High level of employment
in economy
– Economic growth
– Price stability
– Interest rate stability
– Financial market stability
– Exchange rate stability
LO4
 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
LO4 • Limited check writing
 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
 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
LO4 Exhibit 5
Failures of U.S. Savings Banks Peaked in 1989
 Demise of commercial banks
– Risky decisions
– Unsound loans
– Failures, mergers, acquisitions
– 14,496 in 1984
– 7,085 in 2008
LO4
LO4 Exhibit 6
Failures of U.S. Commercial Banks
Peaked in 1988
 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
LO4 – Expand geographically
LO4 Number of Commercial Banks Declined
over the Last Two Decades, but the
Number of Branches Continues to Grow
Exhibit 7
 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
LO4 13th through 15th,
respectively.
LO4 Largest U.S. Banks Based on
Total Domestic Deposits
Exhibit 8(a)
LO4 World’s Largest Banks Based on
Total Assets
Exhibit 8(b)

THP ECON Macro ch14

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Macro

McEachern ECON 2010-2011

Amy McGuire, B-books, Ltd.

 The earliest money

 Properties of the ideal money

Six Properties of Ideal Money

 Purchasing power of money

 Before 1863: State banks

 1913 Federal Reserve System

 Powers of the Fed

Members of the Board of Governors: appointed by the president, confirmed by the

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