Sei sulla pagina 1di 84

N.

Gregory Mankiw

Principles of

Macroeconomic
s

Sixth Edition

16

Saving, Investment,
and the Financial System
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Premium
PowerPoint
Slides by
Ron

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?

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Money
the set of assets in an economy that people
regularly use to buy goods and services from
other people

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

What Money Is and Why Its Important


Without money, trade would require barter,
the exchange of one good or service for another.
Every transaction would require a double
coincidence of wantsthe unlikely occurrence
that two people each have a good the other wants.
Most people would have to spend time searching
for others to trade witha huge waste of
resources.
This searching is unnecessary with money,
the set of assets that people regularly use to buy
goods & services from other people.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The 3 Functions of Money


Medium of exchange: an item buyers give to sellers
when they want to purchase goods & services
In the absence of money, there will be huge number of
prices. Number of prices =
money, the number of prices will be same as the
number of goods

Unit of account: the yardstick people use to post


prices and record debts
Store of value: an item people can use to transfer
purchasing power from the present to the future
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The 2 Kinds of Money


Commodity money:
takes the form of a commodity
with intrinsic value
Examples: gold coins,
cigarettes in POW camps
Fiat money:
money without intrinsic value,
used as money because of
govt decree
Example: the U.S. dollar
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Money Supply


The money supply (or money stock):
the quantity of money available in the economy
What assets should be considered part of the
money supply? Two candidates:
Currency: the paper bills and coins in the
hands of the (non-bank) public
Demand deposits: balances in bank accounts
that depositors can access on demand by
writing a check

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Measures of the U.S. Money Supply


M1: currency & demand deposits,
M1 = $1.9 trillion (February 2011)
M3: everything in M1 plus time deposits,
M3 = $8.9 trillion (February 2011)

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Central Banks & Monetary Policy


Central bank: an institution that oversees the
banking system and regulates the money supply
Monetary policy: the setting of the money
supply by policymakers in the central bank
Federal Reserve (Fed): the central bank of the
U.S.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Structure of the Fed


The Federal Reserve System
consists of:
Board of Governors
(7 members),
located in Washington, DC
12 regional Fed banks,
located around the U.S.
Ben S. Bernanke
Federal Open Market
Chair of FOMC,
Committee (FOMC),
Feb 2006 present
includes the Bd of Govs and
presidents of some of the regional Fed banks
The FOMC decides monetary policy.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11

Clicker question
Ben Bernanke
A. Has a beard.
B. Is greying.
C. Is the Chairman of the Federal Open Market
Committee.
D. Is all of the above.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

12

Bank Reserves
In a fractional reserve banking system,
banks keep a fraction of deposits as reserves
and use the rest to make loans.
The Central Bank establishes reserve
requirements, regulations on the minimum
amount of reserves that banks must hold against
deposits.
Banks may hold more than this minimum amount
if they choose.
The reserve ratio, R
= fraction of deposits that banks hold as reserves
= total reserves as a percentage of total deposits13

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Bank T-Account
T-account: a simplified accounting statement
that shows a banks assets & liabilities.
Example:
FIRST NATIONAL BANK
Assets
Liabilities
Reserves $ 10 Deposits $100
Loans $ 90

Banks liabilities include deposits,


assets include loans & reserves.

In this example, notice that R = $10/$100 = 10%.


2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14

Banks and the Money Supply: An Example


Suppose $100 of currency is in circulation.
To determine banks impact on money supply,
we calculate the money supply in 3 different cases:
1. No banking system
2. 100% reserve banking system:
banks hold 100% of deposits as reserves,
make no loans
3. Fractional reserve banking system

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15

Banks and the Money Supply: An Example


CASE 1: No banking system
Public holds the $100 as currency.

Money supply = $100.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16

Banks and the Money Supply: An Example


CASE 2: 100% reserve banking system
Public deposits the $100 at First National Bank (FNB).
FNB holds
100% of
deposit
as reserves:

FIRST NATIONAL BANK


Assets
Liabilities
Reserves $100 Deposits $100
Loans $ 0

Money supply
= currency + deposits = $0 + $100 = $100
In a 100% reserve banking system,
banks do not affect size of money supply.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17

Banks and the Money Supply: An Example


CASE 3: Fractional reserve banking system
Suppose R = 10%. FNB loans all but 10%
of the deposit:
FIRST NATIONAL BANK
Assets
Liabilities
Reserves $100
10 Deposits $100
Loans $ 0 90

Depositors have $100 in deposits,


borrowers have $90 in currency.
Money supply = C + D = $90 + $100 = $190 (!!!)
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

18

Banks and the Money Supply: An Example


CASE 3: Fractional reserve banking system
How did the money supply suddenly grow?
When banks make loans, they create money.
The borrower gets
$90 in currencyan asset counted in the
money supply
$90 in new debta liability that does not have
an offsetting effect on the money supply
A fractional reserve banking system
creates money, but not wealth.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

19

Banks and the Money Supply: An Example


CASE 3: Fractional reserve banking system
Borrower deposits the $90 at Second National Bank.
Initially, SNBs
T-account
looks like this:

SECOND NATIONAL BANK


Assets
Liabilities
Reserves $ 90
9 Deposits $ 90
Loans $ 0 81

If R = 10% for SNB, it will loan all but 10% of the


deposit.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

20

Banks and the Money Supply: An Example


CASE 3: Fractional reserve banking system
SNBs borrower deposits the $81 at Third National
Bank.
THIRD NATIONAL BANK
Initially, TNBs
Assets
Liabilities
Reserves $ $8.10
81 Deposits $ 81
T-account
0
looks like this: Loans $ $72.90
If R = 10% for TNB, it will loan all but 10% of the
deposit.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

21

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
$
example,
100.00
$100 of
Original deposit =
$
reserves
FNB lending = 90.00
generates
SNB lending =
$
$1000 of
TNB. lending = 81.00
money.
..
$
72.90.
..

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

22

The Money Multiplier


It refers to the factor by which money supply
expands based on a given monetary base. In
other words, it refers to the mathematical
relationship between the monetary base and
money supply of an economy.
Money multiplier explains the increase in the
amount of money in circulation based on the
banks' ability to lend money out of their
depositors' funds.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23

The Money Multiplier


The money multiplier equals 1/R.
In our example,
R = 10%
money multiplier = 1/R = 10
$100 of reserves creates $1000 of money

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

24

Bank
Bank
deposits
deposits
currency
currency
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

25

Money Creating Transactions in a Bank

Granting a loan:
Commercial banks create money when they make
loans to businesses and the public
Buying government securities:
Is simply loaning out X-sum of rupees equivalent
to the value of the bonds, which in turn, increase
bank's asset by X-rupees and demand deposits by
X-rupees
By earning profits

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

26

Credit creation by banking system


Balance sheet of Banking system
Liabilities

Assets
Bank A

Primary deposits

100 Loans

Reserves
New deposits

10

Bank B

90 loans

Reserves

90
81

Bank C
New deposits

81 loans

: Reserves
Total deposits

72.9

8.1
:

of banking system 1000 total assets


2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1000
27

Credit Creation

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

28

Economy
Two Sectors

Rs

Public

Bank
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

29

Public

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

30

Rs
Bank
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

31

Assumptions
Fractional reserve banking system
Demand deposit only
No excess reserves
No cash leakage

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

32

Illustration

Required reserve
ratio (RRR) =25%
Jack put Rs.200 into
the bank as an initial
demand deposit

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

33

First Round

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

34

First Round

Rs.200
Public

Rs

Bank

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

35

First Round

Rs.200
Rs

Publi
c

Bank

Rs.150
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36

Second Round

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

37

Second Round
Rs.200

Rs.150

Publi
c

Rs

Bank
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

38

Second Round
Rs.200
Rs.150

Publi
c

Rs

Bank
Rs.112.50
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

39

Third Round

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

40

Third Round
Rs.200
Rs.150

Rs.112.50

Publi
c

Rs

Bank
Rs.112.5
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41

Third Round
Rs.200
Rs.150
Rs.112.50

Publi
c

Rs

Bank
Rs.84.40
Rs.112.50
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

42

Nth Round

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

43

Nth Round

Publi
c

Rs.200
Rs.150
Rs.112.50
Rs.84.4
R
0 s.63.30
.
.
.
.
Rs.84.40
Rs.112.50
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Rs

Bank

44

Nth Round

Publi
c

Rs.200
Rs.150
Rs.112.5
Rs.84.4
Rs.63.30
.
.
.
.
Rs.84.40
Rs.112.50
Rs.150

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Rs.

Bank

45

Credit Creation
1st round : Rs.200
2nd round : Rs.150
3rd round : Rs.112.50
4th round : Rs.84.40
5th round : Rs.63.30

6th round : .
7th round : .
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

46

Credit Creation

Total
?
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

47

Calculation of Credit Creation

1
Bank multiplier =
Required reserve ratio
Total deposit increment
= initial deposit x banking multiplier
Rs.
Bank

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

48

Rs.

Bank
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

49

Remember

Required reserve
ratio (RRR) =25%
Jack put Rs.200 into
the bank as an initial
demand deposit
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

50

1
Bank multiplier =
Required reserve ratio

1
25%

=4
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

51

Total deposit increment


= initial deposit x banking multiplier
Total deposit increment
= Rs.200 x 4
= Rs.800
The maximum amount
of deposit created
is

Rs.800

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

52

Rs.200

RRR=25%

Multiplier = 4

Bank

Rs.800
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

53

ACTIVE LEARNING

Banks and the money supply

While cleaning your apartment, you look under the


sofa cushion and find a $50 bill (and a half-eaten
taco). You deposit the bill in your checking account.
The Feds 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?

2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

54

ACTIVE LEARNING

Answers

You deposit $50 in your checking account.


A. What is the maximum amount that the
money supply could increase?
If banks hold no excess reserves, then
money multiplier = 1/R = 1/0.2 = 5
The maximum possible increase in deposits is
5 x $50 = $250
But money supply also includes currency,
which falls by $50.
Hence, max increase in money supply = $200.
2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

55

ACTIVE LEARNING

Answers

You deposit $50 in your checking account.


A. What is the maximum amount that the
money supply could increase?
Answer: $200
B. What is the minimum amount that the
money supply could increase?

Answer: $0
If your bank makes no loans from your deposit,
currency falls by $50, deposits increase by $50,
money supply does not change.
2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

56

Clicker question
In a 100% reserve banking system, the money
multiplier is
A. 0.
B. 10.
C. 1.
D. 100.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

57

A More Realistic Balance Sheet


Assets: Besides reserves and loans, banks also
hold securities.
Liabilities: Besides deposits, banks also obtain
funds from issuing debt and equity.
Bank capital: the resources a bank obtains by
issuing equity to its owners
Also: bank assets minus bank liabilities
Leverage: the use of borrowed funds to
supplement existing funds for investment
purposes
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

58

A More Realistic Balance Sheet


MORE REALISTIC NATIONAL BANK
Assets
Reserves $ 200
Loans $ 700
Securities $ 100

Liabilities
Deposits $ 800
Debt $ 150
Capital $ 50

Leverage ratio: the ratio of assets to bank capital


In this example, the leverage ratio = $1000/$50 = 20
Interpretation: for every $20 in assets,
$ 1 is from the banks owners,
$19 is financed with borrowed money.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

59

Leverage Amplifies Profits and Losses


MORE REALISTIC NATIONAL BANK
Assets
Reserves $ 200
Loans $ 700
Securities $ 150

Liabilities
Deposits $ 800
Debt $ 150
Capital $ 100

In our example, suppose bank assets


appreciate by 5%, from $1000 to $1050.
This increases bank capital from $50 to
$100, doubling owners equity.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

60

Leverage Amplifies Profits and Losses


MORE REALISTIC NATIONAL BANK
Assets
Reserves $ 200
Loans $ 700
Securities $ 50

Liabilities
Deposits $ 800
Debt $ 150
Capital $ 0

Instead, if bank assets decrease by 5%,


bank capital falls from $50 to $0.
If bank assets decrease more than 5%, bank
capital is negative and bank is insolvent.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

61

Leverage Amplifies Profits and Losses


Capital requirement: a govt regulation that
specifies a minimum amount of capital, intended
to ensure banks will be able to pay off depositors
and debts.
The capital requirement essentially specifies a
minimum leverage ratio that banks must maintain
Capital requirements have been increased around
the world in response to the financial crisis of the
Great Recession.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

62

Leverage and the Financial Crisis


In the financial crisis of 20082009, banks
suffered losses on mortgage loans and mortgagebacked securities due to widespread defaults.
Many banks became insolvent:
In the U.S., 27 banks failed during 20002007,
166 during 20082009.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

63

Leverage and the Financial Crisis


Many other banks found themselves with too little
capital, because the market began to expect that
their profits would be poor. Consequently, the
value of their stock was bid down.
In order to reconcile their balance sheets, banks
responded by reducing lending. This caused a
credit crunch.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

64

The beginning of a credit crunch


MORE REALISTIC NATIONAL BANK
Assets
Reserves $ 200
Loans $ 500
Securities $ 100

Liabilities
Deposits $ 760
Debt $ 0
Capital $ 40

Capital declines.
Assets must shrink so that the bank maintains the
minimum leverage ratio.

Banks can accomplish this by calling in loans (and


perhaps selling securities).
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

65

The Governments Response


To ease the credit crunch, the Federal Reserve
and U.S. Treasury injected hundreds of billions of
dollars worth of capital into the banking system.
This unusual policy temporarily made U.S.
taxpayers part-owners of many banks.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

66

The Governments Response


The policy succeeded in recapitalizing the
banking system.
In other words, the government increased the
amount of capital in the banks balance sheets.
The precise procedure by which it accomplished
this will be left for later courses.
In order to reconcile their balance sheets, banks
increased the amount of loans that they made.
This policy helped restore lending to normal levels
in 2009.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

67

The Feds Tools of Monetary


Control
Earlier, we learned
money supply = money multiplier bank reserves
The Fed can change the money supply by
changing bank reserves or
changing the money multiplier.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

68

How the Fed Influences


Reserves
Open-Market Operations (OMOs):
the purchase and sale of U.S. government
bonds by the Fed.
If the Fed buys a government bond from a
bank, it pays by depositing new reserves in that
banks reserve account.
With more reserves, the bank can make more
loans, increasing the money supply.
To decrease bank reserves and the money
supply, the Fed sells government bonds.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

69

How the Fed Influences


Reserves
If the Fed buys a bond, the bank swaps its bond
for an equivalent amount in currency.
The bond cant be broken up and loaned out, but
the equivalent amount in currency can.
Some of the currency is retained as reserves, the
rest is loaned out and expands according to the
money multiplier.
This is how the Fed can increase the money
supply by swapping its cash for a bond held by a
bank.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

70

How the Fed Influences


Reserves
The Fed makes loans to banks, increasing their
reserves.
Traditional method: adjusting the discount rate
the interest rate on loans the Fed makes to
banksto influence the amount of reserves
banks borrow
New method: Term Auction Facilitythe Fed
chooses the quantity of reserves it will loan, then
banks bid against each other for these loans.
The more banks borrow, the more reserves they
have for funding new loans and increasing the
money supply.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

71

How the Fed Influences the Reserve Ratio


Recall: reserve ratio = reserves/deposits,
which inversely affects the money multiplier.
The Fed sets reserve requirements: regulations
on the minimum amount of reserves banks must
hold against deposits.
Reducing reserve requirements would lower the
reserve ratio and increase the money multiplier.
Since 10/2008, the Fed has paid interest on
reserves banks keep in accounts at the Fed.
Raising this interest rate would increase the
reserve ratio and lower the money multiplier.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

72

Problems Controlling the Money Supply


If households hold more of their money as
currency, banks have fewer reserves,
make fewer loans, and money supply falls.
If banks hold more reserves than required,
they make fewer loans, and money supply falls.
Yet, Fed can compensate for household
and bank behavior to retain fairly precise control
over the money supply.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

73

Bank Runs and the Money


Supply
A run on banks:
When people suspect their banks are in trouble,
they may run to the bank to withdraw their funds,
holding more currency and less deposits.
Under fractional-reserve banking, banks dont
have enough reserves to pay off ALL depositors all
at once, hence banks may have to close.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

74

Bank Runs and the Money


Supply
This can happen even if the bank is not bankrupt,
meaning that the assets are equal in value to the
liabilities. The problem is that many of the assets
are in illiquid form, such as loans that cant be
called in instantaneously. These assets cant be
converted to cash quickly enough to satisfy the
demand for withdrawals.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

75

Bank Runs and the Money


Supply
Banks that fear runs may make fewer loans and
hold more reserves to satisfy depositors.
These events increase R, reverse the process of
money creation, cause money supply to fall.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

76

Bank Runs and the Money


Supply
During 19291933, a wave of bank runs and
bank closings caused money supply to fall 28%.
Many economists believe this contributed to the
severity of the Great Depression.
Since then, federal deposit insurance has
helped prevent bank runs in the U.S.
In the U.K., though, Northern Rock bank
experienced a classic bank run in 2007 and was
eventually taken over by the British government.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

77

Clicker question
Reducing R, the reserve requirement
A. Makes monetary policy more powerful and
reduces the likelihood of a bank run.
B. Makes monetary policy less powerful and
reduces the likelihood of a bank run.
C. Makes monetary policy less powerful and
increases the likelihood of a bank run.
D. Makes monetary policy more powerful and
increases the likelihood of a bank run.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

78

The Federal Funds Rate


On any given day, banks with insufficient reserves
can borrow from banks with excess reserves.
The interest rate on these loans is the federal
funds rate.
The FOMC uses OMOs to target the fed funds
rate.
Changes in the fed funds rate cause changes in
other rates and have a big impact on the economy.

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

79

The Fed Funds rate and other rates, 19702011


Fed Funds
Prime
3 Month T-Bill
Mortgage

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

80

Monetary Policy and the Fed Funds Rate


To raise fed funds
rate, Fed sells Federal
funds rate
govt bonds (OMO).
This removes
reserves from the
banking system,
reduces supply of
federal funds,

rf

The Federal
Funds market
S2

S1

3.75%
3.50%

causes rf to rise.

D1
F2 F1
Quantity of
federal funds

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

81

SUMMARY

Money serves three functions: medium of


exchange, unit of account, and store of value.

There are two types of money: commodity


money has intrinsic value; fiat money does not.

The U.S. uses fiat money, which includes


currency and various types of bank deposits.

2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

82

SUMMARY

In a fractional reserve banking system, banks


create money when they make loans. Bank
reserves have a multiplier effect on the money
supply.

Because banks are highly leveraged, a small


change in the value of a banks assets causes a
large change in bank capital. To protect
depositors from bank insolvency, regulators
impose minimum capital requirements.

2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

83

SUMMARY

The Federal Reserve is the central bank of the


U.S., is responsible for regulating the monetary
system.

The Fed controls the money supply mainly


through open-market operations. Purchasing
govt bonds increases the money supply, selling
govt bonds decreases it.

In recent years, the Fed has set monetary policy


by choosing a target for the federal funds rate.

2012
Cengage
2012 Cengage
Learning.
Learning.
All Rights
AllReserved.
Rights Reserved.
May notMay
be copied,
not be copied,
scanned,scanned,
or duplicated,
or duplicated,
in wholeinorwhole
in part,
or in
except
part,for
except
use as
for use as
permitted
permitted
in a license
in a distributed
license distributed
with a certain
with a certain
productproduct
or service
or service
or otherwise
or otherwise
on a password-protected
on a password-protected
website website
for classroom
for classroom
use.
use.

84

Potrebbero piacerti anche