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The Monetary System

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© 2011 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.

PowerPoint Slides prepared by:

Andreea CHIRITESCU

Eastern Illinois University

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The Meaning of Money

  • The functions of money
    • Medium of exchange
    • Unit of account
    • Store of value

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The Kinds of Money

  • Commodity money
    • Money that takes the form of a commodity with intrinsic value
  • Intrinsic value
    • Item would have value even if it were not used as money
  • Gold standard - Gold as money
    • Or paper money that is convertible into gold on demand

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The Kinds of Money

  • Fiat money
    • Money without intrinsic value
    • Used as money because of government decree
  • Fiat
    • Order or decree

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Money in the U.S. Economy

  • Money stock
    • Quantity of money circulating in the economy
  • Currency
    • Paper bills and coins in the hands of the public
  • Demand deposits
    • Balances in bank accounts - depositors can access on demand by writing a check

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Money in the U.S. Economy

  • Measures of money stock
    • M1
      • Demand deposits, Traveler’s checks
      • Other checkable deposits, Currency
    • M2
      • Everything in M1
      • Savings deposits, Small time deposits
      • Money market mutual funds
      • A few minor categories

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Figure 1

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Two Measures of the Money Stock for the U.S. Economy

The two most widely followed measures of the money stock are M1 and M2. This figure shows the size of each measure in 2009.

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The Federal Reserve System

  • Federal Reserve (Fed)
    • The central bank of the United States
  • Central bank
    • Institution designed to
      • Oversee the banking system
      • Control the money supply
        • Quantity of money available in the economy
        • Monetary policy
          • By Federal Open Market Committee (FOMC)

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The banking system

  • Fractional-reserve banking
    • Banks hold only a fraction of deposits as reserves
  • Reserve ratio
    • Fraction of deposits that banks hold as reserves
  • Reserve requirement
    • Minimum amount of reserves that banks must hold; set by the Fed

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  • Leverage ratio
    • Ratio of assets to bank capital
  • Capital requirement
    • Government regulation specifying a minimum amount of bank capital

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Bank runs and the money supply

  • Bank runs
    • Depositors suspect that a bank may go bankrupt
      • “Run” to the bank to withdraw their deposits
    • Problem for banks under fractional-reserve banking
      • Cannot satisfy withdrawal requests from all depositors

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Bank runs and the money supply

  • Bank runs today
    • Not a major problem
  • The government
    • Guarantees the safety of deposits at banks to a limit
    • Banks are regulated and watched more carefully

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CBRT’s Tools of Monetary Control

  • The policy rate
    • Interest rate on the loans that the CBRT makes to banks
    • Higher policy rate
      • Reduce the money supply
    • Smaller policy rate
      • Increase the money supply

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CBRT’s Tools of Monetary Control

  • Open-market operations
    • Purchase and sale of government bonds
    • To increase the money supply
      • CBRT buys Turkish government bonds
    • To reduce the money supply
      • CBRT sells Turkish government bonds
    • Now CBRT is only allowed to do so in the secondary markets; that is, it cannot directly finance government

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CBRT’s Tools of Monetary Control

  • Reserve requirements
    • Regulations on minimum amount of reserves
      • That banks must hold against deposits
    • An increase in reserve requirement
      • Decrease the money supply
    • A decrease in reserve requirement
      • Increase the money supply

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The Market Rate

  • The Market Rate
    • Interest rate at which banks make overnight loans to one another
    • A change in CBRT’s policy rate
      • Changes the market rate as well

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© 2011 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.