1 international finance 2003 © natasha beliaeva activator 1. why do you accept money in exchange...
TRANSCRIPT
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1International Finance 2003
© Natasha Beliaeva
Activator
1. Why do you accept money in exchange for a good or service?
2. What gives money its value?
Represents purchasing power, acceptable form of currency, other people will accept it, etc…
Government says so, domestically and internationally accepted, represents value of goods and services
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Jerry Maguire
http://www.youtube.com/watch?v=OaiSHcHM0PA&list=PLD34B596F99A0DE3C&index=9&feature=plpp_video
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Money and BankingEvolution of Money
Money – most basic of all financial assets, used to buy goods and services– Something that is regularly accepted in exchange for
goods and services
Three Functions of money:
1. Medium of exchange
2. Unit of Account
3. Store of Value
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Functions of MoneyMedium of Exchange – acts as a payment for goods and services; buyers give sellers in exchange for products
Barter system – economy that relies on the exchange of product for product– The direct exchange of goods and services for other goods and
services.
Double coincidence of wants – situation where two people simultaneously have a product that the other wants
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Jail economy video
http://www.youtube.com/watch?v=uvcMvn9azxc&list=PLD34B596F99A0DE3C&index=10&feature=plpp_video
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Unit of Account
Unit of Account– an expression of value; a way for comparing the values of goods and services– Keep track of debts and investments
Fossil – $89.95 Bulova – $399.95 Rolex - $11,995
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Store of Value – money holds its value if you decide to store it instead of spend it– Helps people convert purchasing power from present to
future value by gaining interest
Functions of Money
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The Kinds of Money
Commodity money – money that has an alternative use as a commodity, which has intrinsic value
Intrinsic value – item would have value if not used as money– Gold, silver, cigarettes (WW2), tulip bulbs (1600’s Europe), etc
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The Kinds of Money
Fiat – order/decree; government issued money– Paper dollars– Money that is intrinsically worthless
Legal tender - is money that a government has required to be accepted in settlement of debts
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Liquidity – ease with which an asset can be converted into money as a medium of exchange– Liquid – checking account– Nonliquid - House
Functions of Money
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Money in the U.S. EconomyMoney supply/stock – quantity of money (paper and digital) in the economy– October 2010 – 9.61 Trillion in M1– Currency – paper bills and coins in the hands of the public
(800 Billion)– Demand deposits – balances in bank accounts, that can be accessed
by writing a check• Checking accounts, travelers checks
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Money in the U.S. EconomyM1 – money that people can gain access to easily and immediately; checkable demand deposits. – Highly liquid – physical currency (minted coins and printed paper,
demand deposits (checking accounts, traveler’s checks)
M2 – consists of M1 plus accounts that are not as liquid– Slightly less liquid - Savings accounts, certificates of deposits (CDs),
money market, mutual funds, etc.
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Banking
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Banking
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The Federal Reserve (“The Fed”) – the central bank of the U.S.Created in 1913 by Congress, Federal Reserve ActCentral Bank – institution designed to oversee the banking system and regulate the quantity of money in the economy.Monetary policy – “money”, directly affects the nation’s money supply (expansionary or contractionary)– Dollar is officially a “Federal Reserve Note”
The Federal Reserve
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Central Bank is in Washington D.C.Run by a 7 member board of governorsAppointed by the president, confirmed by the Senate to 14 year termsBoard is led by the chairmanCurrent chairman – Ben Bernanke
Structure of the Federal Reserve
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Fed is comprised of Twelve Federal District Reserve Banks– One Federal Reserve Bank for each district– Each FRB monitors economic and banking conditions in its
district
Structure of the Federal Reserve
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The Fed’s Organization
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Federal Reserve Bank Atlanta – Atlanta District
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The Federal Open Market Committee
Structure and function:Run by the 7 member board of governors (Washington D.C.) and 5 of the 12 regional bank presidentsAll attend, only 5 vote, President of New York Fed always votes (financial capital of the world
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The Federal Open Market Committee
Power and Influence:Increase or decrease the $ money $ supplyOpen-market operation – buying and selling U.S. government bonds
Increase money supply – buy government bonds from the public (quantitative easing)Decrease money supply – sell government bonds to the public
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Think of a dam…
A dam controls the flow of water downriver.Releasing too much water would cause flooding.Too little water would cause a drought.
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The Fed is like a dam...
The Fed is like a dam...
The river is the $ supply.
Too much $ causes inflation.
Too little $ can cause a recession.
Federal Reserve
Money Supply
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Three monetary policy tools 1. Open-market operations2. Reserve requirements 3. Interest Rates
(Federal Funds Rate)
The Fed’s Tools of Monetary Control
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Money Supply and Lending
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Money Supply and Lending
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Picture This
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Open-Market Operations – the purchase and sale of U.S. government bonds by the Fed– Most often used tool of the FedIncrease the Money Supply– Buy bonds from the banks – credit the banks with money, increases the money
supply• Easy money policy - expansionary monetary policy, goal is to expand the
economy by lowering interest rates, increase inflation, encourages banks to lend money to consumers , discourage saving
Open-Market Operations
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– Decrease money supply– Sell bonds to the bank, withdrawal money, decrease the money supply
• Tight money policy – contractionary monetary policy, goal is to slow the economy by raising interest rates, contracting the economy, cause inflation to slow, discourage borrowing, encourage saving, restricts the money supply
Open-Market Operations
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Open-Market OperationsExpansionary Monetary Policy
Contractionary Monetary Policy
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Fed Bond Buying
http://www.youtube.com/watch?v=Syk19wfGJRo
http://www.youtube.com/watch?v=8nmTIjbTy3E
http://www.youtube.com/watch?v=YdD1V2CgauY
http://www.youtube.com/watch?v=A3_ymwSDcQQ
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Brainstorm - FED
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Fractional-reserve system – banks hold only a fraction of deposit reserves as opposed to 100% of depositsReserve – money deposit that banks have received but not loaned out
Fractional Reserve System
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Reserve Requirements – regulations on the minimum amount of reserves that banks must hold against deposits– Banks must have a supply of reserves to protect against "runs" or "panics.“ (
it’s a wonderful life video clip) Modern Bank Runs– 10% on M1 – Influences how much money banks can create from each deposit (reserves)– Increase in RRR, banks must hold more reserves, can loan out less– Decrease in RRR, banks must hold less reserves, can loan out more
Reserve Requirements
Country 1968 1978 1988 1998
United Kingdom
20.5 15.9 5.0 3.1
Turkey 58.3 62.7 30.8 18.0
Germany 19.0 19.3 17.2 11.9
United States
12.3 10.1 8.5 10.3
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Required Reserve Ratio – set by the Fed, minimum amount that must be held by the bank– Established by the Federal Reserve, currently 1/10 or 10%
of M1– $1000 deposit, the bank would hold $100 in reserve and
have $900 for lendingRequired Reserves– the portion/percentage of a money deposit that must be held by the bank– May not be loaned out– Protect the bank against withdrawals on demand deposits
Excess Reserves – bank reserves in excess of the reserve requirement set by the Fed – They are reserves of cash more than the required amounts– May be loaned out or used for withdrawals on demand
depositsLoans - portion of deposit that is loaned out to borrowers– Money supply does not increase until banks actually lend
money into circulation
Money Creation
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Banking Simulation
Name Deposit Amount Required Reserves
Excess Reserves
Total
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Banking Simulation
Loans
Name Loan Amount
Total
Total Deposits ___________
Total Reserves ___________
Excess Reserves ___________
Total Loans ___________
Remaining Excess Reserves _______
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T Account – simplified accounting statement that shows changes in the banks assets and liabilities– Reserves and loans are assets to bank– Deposits are liabilities to the bank
Money Creation
T-Account for a Typical Bank
ASSETS LIABILITIES
Reserves 10 100 Deposits
Loans 90
Total 100 100 Total
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Example
Assets
Required Reserves: 5,000
Excess Reserves: 30,000
Loans: $15,000
Liabilities
Demand Deposits: $50,000
1. What is the reserve requirement?
2. Assume that a withdrawal is made in the amount of $3,000 from the demand deposits.
1. How much will the reserves change?
2. Does the M1 money supply change?
3. As a result of the withdrawal, what is the new value of the excess reserves?
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Rules for Free Response
1. 1 pt of extra credit for each correct answer on next test
2. One copy for me (all names of group)3. One copy for you (check your answers)4. No phones during free response
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Money multiplier formula – helps determine the amount of money that the banking system generates with each dollar of reservesMM = 1/RRR– 1/.10 = 10– 1/.05 = 20
Money Creation– Initial Cash Deposit (principal) x (MM)– The higher the RRR, the less banks have to loan out (vice versa)– 100(10) = 1000– 100(20) = 2000
Money Multiplier
M o n ey m u ltip lie r =1
R eq u ired rese rv e ra tio
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A
Person B
Person C
Totals
Money Multiplier
$200 $1800$2000
$1800 $180 $1620
$1620 $162 $1458
$5420 $542
• Initial Cash Deposit (1 ÷ RRR)• 2000 X 10 = $20,000
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Fractional Reserve System Video
http://www.youtube.com/watch?v=WMTyKduYrUk&list=PL58EB0BBFE9FC05FF&index=31&feature=plpp_video
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RRR and Money Multiplier Worksheet
RRR Required Reserves
Excess Reserves
1%
5%
10%
15%
25%
$10
$50
$100
$150
$250
990
950
900
850
750
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B
Person C
Person D
Person E
Totals
Money Multiplier
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B 900 90 810
Person C
Person D
Person E
Totals
Money Multiplier
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B 900 90 810
Person C 810 81 729
Person D
Person E
Totals
Money Multiplier
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B 900 90 810
Person C 810 81 729
Person D 729 72.9 656.10
Person E
Totals
Money Multiplier
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B 900 90 810
Person C 810 81 729
Person D 729 72.9 656.10
Person E 656.10 65.61 590.49
Totals
Money Multiplier
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Personal Deposit
Deposit (Money Supply)
Required Reserves (Assets)
Excess Reserves (Liabilities)
Person A $1,000 100 900
Person B 900 90 810
Person C 810 81 729
Person D 729 72.9 656.10
Person E 656.10 65.61 590.49
Totals 4095.10 409.51
Money Multiplier
3. From person A to B the money supply rose to $1900
4. In only 5 rounds of spending the money supply rose from $1000 to 4095.10
5. What would happen if the bank continued to loan excess reserves? The money could potentially grow to $10,000
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RRR and Money Multiplier Worksheet
RRR Initial Deposit
Multiplier Increase in Money Supply
1%
5%
10%
15%
25%
$1000
$1000
$1000
$1000
$1000
100
20
10
6.6
4
$100,000
$20,000
$10,000
$6,666
$4,000
• 1%• Did not grow as much• Hyperinflation• Lack of growth in the economy
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A $2000 deposit is made in the bank and the RRR is 12%.1. How much must be held as required reserves?2. How much will be available in excess reserves?3. How much could the initial deposit increase the money supply if
the RRR was 12%?4. How much could the initial deposit increase the money supply if
the RRR was 10%?5. How much could the initial deposit increase the money supply if
the RRR was 5%?6. Which RRR yielded the greatest amount? Explain why.
RRR and Money Multiplier Review
2000 x .12 = $240
2000 – 240 = $1760
MM = 1/.12 = 8.3
2000 x 10 = $20,000
2000 x 20 = $40,000
5%. The lower the RRR, the higher the excess reserves available to loan out, which subsequently add a greater amount to the money supply.
2000 x 8.3 = $16,666.67
MM = 1/.10 = 10
MM = 1/.05 = 20
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Discount Rate – interest rate on loans the Fed makes to banks; currently .75%– Fed is the lender of last resort– Banks borrow from Fed when it has low
reserves; too many loans, high withdrawals– Lower discount rate encourages borrowing– Higher discount rate discourages borrowing
Federal Funds Rate – short-term interest rate that banks charge each other for loans– Currently 0 - .25%
Interest Rates
Discount Rate
Federal Funds Rate
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(Federal Funds Rate)
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The FederalReserve “The FED”
Board of Governors (7)Washington D.C
12 District Banks
Federal Open Market Committee (FOMC)
Monetary Policy
2. Required Reserve Ratio (RRR)
3. Interest RatesDiscount Rate/Federal Funds Rate1. Open Market Operations
Sell Bonds = Decrease MSBuy Bonds – Increase MS
Increase RRR – Decrease MSDecrease RRR – Increase MS
Decrease IR - Increase MS Decrease IR – Decrease MS
Buying and selling of government bonds
Percentage of demand deposits that must be held in reserves (10%)
DR – I.R. charged by the FedFFR - I.R. charged on overnight
lending from bank to bank
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Tight Monetary Policy (Tight, Contractionary) Loose Monetary Policy (Easy, Expansionary)
Tight vs. Loose Monetary Policy
The Fed sells bonds (securities) to the banks, taking money out of the economy.
This pushes up the federal funds rate (interest rate charged from bank to bank).
Banks then have to charge higher interest rates to households and firms causing the price of a bond to fall.
Consumers and businesses are given less incentive to borrow and more incentive to save.
Decreased borrowing leads to decreased spending.
Decreased spending leads to a contractionary economy and slows down the economy.
The Fed buys bonds (securities) from the banks, adding money into the economy.
This brings down the federal funds rate (interest rate charged from bank to bank).
Banks then can charge lower interest rates to households and firms causing the price of a bond to fall.
Consumers and businesses are given the incentive to borrow.
Increased borrowing leads to increased spending.
Spending leads to economic growth and increased employment.
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Free Response Question
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What was the intent of this question?
Part (a) asked students to use the balance sheet of a bank to find the reserve requirement.
Part (b) tested their ability to identify the effect of a cash withdrawal on bank reserves, explain the effect of the cash withdrawal on the money supply, and identify the effect of the cash withdrawal on excess reserves.
Part (c)asked students to identify how a bank with deficient reserves could meet its reserve requirements.
What were common student errors or omissions?
Students had difficulty explaining the effect of a cash withdrawal from a bank on the M1 measure of the money supply and calculating the level of excess reserves after the cash withdrawal.
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1. a. Open market operations
b.
2.
3. $18,0004. 1/.20 = 55. $10000 x 5 = $50,0006. Less, because a smaller amount of each loan gets re-deposited
to be available to be loaned again.
7. Less, because a smaller amount of each deposit gets loaned out to be available to be deposited again.
Chapter 29 – Practice Worksheet
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8. a. 1,000, because there is 1,000 of currency and 0 of deposits.
b. 1,000, because there is now 0 of currency and 1,000 of deposits.
c. 1,000 x (1/0.20) = 5,000, because 1,000 of new reserves can support 5,000 worth of deposits.
d. The total potential increase is 5,000, but 1,000 was currency already in the system. Thus, an additional 4,000 was created by the banks.
e. 1,000 x (1/0.10) = 10,000.
f. Banks can create more money from the same amount of new reserves when reserve requirements are lower because they can lend a larger portion of each new deposit.
g. 1,000 x 1/(0.10+0.10) = 5,000.
h. Yes, they are the same. With regard to deposit creation, it doesn’t matter why banks hold reserves. It only matters how much they hold.
Chapter 29 – Practice Worksheet
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Chapter 29 Homework, pgs. 644-6451. Why is a dollar bill worth anything?
2. What proclamation holds this to be true?
3. What type of currency are dollar bills?
4. What is the more profound reason that a dollar bill has value?
5. Why is the dollar a result of "network effects"?
6. What other forms of currency have been used as a medium of exchange?
7. What gave them acceptability as currency?
8. How did Saddam Hussein deal with the economic sanctions after the gulf war of 1991?
9. What happened to "Saddam dinars"?
10. How did the social conventions of the Kurdish people affect their use of Swiss dinars?
11. What happened to the value of the Swiss dinar as the likelihood of a U.S. invasion approached?
12. Why was the eventual exchange rate for the Swiss dinar higher than the official rate of exchange?
13. What does this story show about paper currency?
14. What is the one of the most important elements of paper money?
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The FederalReserve
“The FED”
Board of Governors (7)
Washington D.C (Public)
12 District Banks(Private)
Federal Open Market Committee (FOMC)
Money Supply
2. Required Reserve Ratio (RRR)
3. Discount Rate/Federal Funds Rate
1. Open Market Operations
Sell Bonds – Decrease
Buy Bonds - Increase
Increase RRR – Decrease
Decrease RRR - Increase
Increase – Decrease
Decrease - Increase
Buying and selling of government bonds
Percentage of demand deposits that must be held
in reserves (.10)
Interest rate charged to member banks by the Fed/I.R. charged on overnight lending from bank
to bank
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Money Multiplier
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Binder Check – Due Monday 4-18-2011
1. Free Responses
2. Notes Ch. 29
3. Daily Tens
4. Terms
5. Fed Webquest
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Test
1. Name
2. Date
3. Class Period
4. ID: A, B, C
5. Chapter 29 Test
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Extra CreditPolitical Cartoons:
What do you think the event(s) or issue(s) are that inspired the cartoons? What are the cartoonists trying to portray in the cartoons? Are there any real people/places/symbols in the cartoon? Who are these people? What do they represent
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