Why does money have value

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Why does money have value?

• Because it is an accepted median of exchange.

2
Money reduces barter time.

• Life is made up of 24 hour days.
• In which we pursue
• W Work
• L Leisure
• B Barter
• 24 W B L

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The Functions of Money

• 1. As a Median of Exchange.
• 2. Provides a Unit of Account.
• 3. As a Store of Value.

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History of Money in the U.S.

• 1. First and Second bank of the US.
• 2. Free banking.
• 3. National Bank Act.
• 4. The Federal Reserve System -- The FED.

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When does money become "worthless?"

• Hyperinflations.
• Gresham's Law.

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The Money Supply is a stock variable.
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The U.S. money supply

• M1 is Currency plus Checkable Accounts.
• Federal Reserve Notes and Coins are Currency
• Checkable deposits are at banks and other
  financial institutions.
• M1, M2, M3, L.

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What does Liquidity mean?

• Are credit cards money?
• Are the checks in your checking account money?

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The Credit Market is the market for Loanable
Funds.

• The Supply of Loanable Funds -- Saving.
• The Demand for Loanable Funds -- Borrowing.
• These are flows.

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The Credit Market
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Financial Intermediaries are the Credit Market

• Banks, Saving Associations, Credit Unions,
  Insurance Companies, Pension funds, Stock, Bond,
  Commodity Markets, etc.

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The functions of Financial Intermediaries.

• Creating Liquidity
• Minimizing the cost of borrowing.
• Minimizing the cost of monitoring borrowers
• Pooling Risk

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Financial Regulations

• Deposit insurance
• Reserve Requirements
• Capital Requirements

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What is a bank these days?

• Why have there been so many mergers and what does
  it mean?
• What has happened to banks in Japan?

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What is the Role of Money in Our Economy?

• Money is a stock.
• GDP is a flow.

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Money flows through the economy.

• GDP PY
• V PY/M
• MV PY

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The Equation

• The exchange equation.
• The Quantity Theory of Money.
• If M 1 trillion and GDP was 10 trillion, what
  would V be?

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The Quantity Theory of Money.

• Assume
• V and Y are not influenced by M, then
• The percent change in M is equal to the percent
  change in P.

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What is the Money Supply?

• Currency held by the Public plus Checkable
  Deposits.
• What is the currency in the vault?

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The Money Supply is controlled by the FED
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The FED

• Twelve District Banks
• Board of Governors
• FOMC
• The seven governors and five district
  presidents.
• Directs the buying and selling U.S. government
  bonds.

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Reserves

• What are (legal) reserves?
• Reserves are
• vault cash and deposits at the FED
• Fractional reserve banking.

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What are

• Required reserves?
• Excess reserves?
• The required reserve ratio?

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What is a Bank?

• What is a bank balance sheet?
• What are Assets and Liabilities?

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Bank Balance Sheet

• Assets Liabilities Res. Checking
  Deposits Vault Cash Saving Deposits
• Deposits at the FED Other Borrowing
• Loans and Investments
• Securities
• Other Assets Net Worth

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How do banks create money?
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A Dollar in Circulation. Nothing in Williamson's
Bank.

• Williamson's Bank Cash Held MoneyAssets Liabil
  ities By Public SupplyRes. 0 Dep. 0 1 1
• Loans 0

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A check from Williamson's Bank
Williamson's Bank Trust??? Date
_______ Pay to the Order of ___________________
________ ______________________________________
_ Dollars _________________
Signature
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A Deposit in Williamson's Bank

• Williamson's Bank Cash Held MoneyAssets Liabil
  ities By Public SupplyRes. 1 Dep. 1 0 1
• Loans 0

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A loan application from Williamson's Bank
Loan Application Williamson's Bank Trust???
Date _______ IOU One Dollar 1.00
___________________ Signature
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A Loan from Williamson's Bank.The Money Supply
Increases.

• Williamson's Bank Cash Held MoneyAssets Liabil
  ities By Public SupplyRes. 1 Dep. 2 0 2
• Loans 1

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A Cash Withdrawal from Williamson's Bank

• Williamson's Bank Cash Held MoneyAssets Liabil
  ities By Public SupplyRes. 0 Dep. 1 1 2
• Loans 1

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A Cash Deposit from Williamson's Bank

• Williamson's Bank Cash Held MoneyAssets Liabil
  ities By Public SupplyRes. 1 Dep. 2 0 2
• Loans 1

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Two Dollars are Requested to be Withdrawn from
Williamson's Bank.
What Happens?
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What is the fractional reserve system?
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Bank Balance Sheet

• Assets Liabilities Res. 25,000 Deposits
  100,000
• Loans 75,000

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Bank Balance Sheet

• Assets Liabilities Res. 25,000 Deposits
  100,000 1,000 1,000
• Loans 75,000

Money Supply 101,000
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Bank Balance Sheet

• Assets Liabilities Res. 25,000 Deposits
  100,000 250 1,000
• Loans 75,750

Cash Held by Public 750
Money Supply 101,750
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If that 750 is deposited in a bank,the process
starts over.
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The Deposit multiplier.

• (1/rr) ?R ?D
• (1/25) 1,000 4,000
• 4 1,000 4,000
• rr ?D ?R
• 25 4,000 1,000

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The simple money multiplier

• ?M (1/rr)?R

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Bank Balance Sheet

• Assets Liabilities Res. 26,000 Deposits
  104,000
• Loans 78,000

Cash Held by Public 0
Money Supply 104,000
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Why the money deposit multiplier does not always
work.

• The public holds more currency.
• That is, the money received in a loan does not
  all get back into the banking system.
• Banks hold more excess reserves.

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Currency

• When it is in banks, it is vault cash and part of
  reserves.
• When it is outside of banks, it is part of the
  money supply.
• The FED cannot control where the currency is.

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Did you learn?

• What is money?
• What is the size of M1 and M2?
• Why is M a stock and GDP is a flow?
• What are credit markets for?
• What does the Quantity Theory say is the possible
  relationship between M and P?
• What is the difference between the supply of
  money and the demand for money?
• What are reserves and why do banks have them?
• How do banks "create" money?