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CH 29 Monetary System
CH 29 Monetary System
29
Economics
P RINCIP LES OF
N. Gregory Mankiw
In this chapter,
look for the answers to these questions:
§ What assets are considered “money”? What are
the functions of money? The types of money?
§ What is the Federal Reserve?
§ What role do banks play in the monetary system?
How do banks “create money”?
§ How does the Federal Reserve control the money
supply?
1
The 3 Functions of Money
§ Medium of exchange:
§ Unit of account:
§ Store of value:
Fiat money:
2
Measures of the U.S. Money Supply
§ M1:
M1 = $1.4 trillion (June 2008)
§ M2: everything in M1 plus
§ Monetary policy:
3
Bank Reserves
§ In a fractional reserve banking system,
Bank T-account
§ T-account: a simplified accounting statement
that shows a bank’s assets & liabilities.
§ Example: FIRST NATIONAL BANK
Assets Liabilities
4
Banks and the Money Supply: An Example
CASE 1: No banking system
Public holds the $100 as currency.
Money supply =
Money supply =
Depositors have
Borrowers have
THE MONETARY SYSTEM 14
5
Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
How did the money supply suddenly grow?
When banks make loans,
The borrower gets
§ $90 in currency (an asset counted in the
money supply)
§ $90 in new debt (a liability)
6
Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
The process continues, and money is created with
each new loan.
In this
Original deposit = $ 100.00
example,
FNB lending = $ 90.00
SNB lending = $ 81.00
TNB lending = $ 72.90
.. ..
. .
Total money supply =
ACTIVE LEARNING 1
Banks and the money supply
While cleaning your apartment, you look under the
sofa cushion find a $50 bill (and a half-eaten taco).
You deposit the bill in your checking account.
The Fed’s reserve requirement is 20% of deposits.
A. What is the maximum amount that the
money supply could increase?
B. What is the minimum amount that the
money supply could increase?
20
7
ACTIVE LEARNING 1
Answers
21
8
The Fed’s 3 Tools of Monetary Control
2. Reserve Requirements (RR):
9
The Federal Funds Rate
§ On any given day, banks with insufficient
reserves can borrow from banks with excess
reserves.
§ the federal funds rate
20 Fed funds
prime
15 3-month Tbill
mortgage
(%)
10
0
1970 1975 1980 1985 1990 1995 2000 2005
10
Problems Controlling the Money Supply
§ If households
§ If banks
11