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The Money Supply and the Banking System

The Money Supply and the Banking System. Outline: What counts as money? Measuring the money stock Financial intermediaries The typical bank balance sheet The fractional reserve system. Liquidity. An asset is considered liquid if it can be converted to cash quickly and with little cost.

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The Money Supply and the Banking System

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  1. The Money Supply and theBanking System • Outline: • What counts as money? • Measuring the money stock • Financial intermediaries • The typical bank balance sheet • The fractional reserve system

  2. Liquidity An asset is considered liquid if it can be converted to cash quickly and with little cost

  3. The liquidity scale Oriental Rugs, Jewelry Home Equity LeastLiquid MostLiquid Farm Land SpecializedEquipment Money Bonds,Equities

  4. What counts as money? Monetary AssetsJanuary 31, 2000 Savingsaccounts($1,737 billion) Small TimeDeposits($963 billion) Large TimeDeposits($716 billion) Money MarketMutualFunds ($873 billion) Checkable deposits($587 billion)+TravelersChecks($8 billion) Cash in circulation($521 billion) Most Liquid Least Liquid

  5. M1includes • Currency in circulation • Traveler’s checks • Checkable deposits at commercial banks • Other checkable deposits (OCDs)1 1Includes NOW, ATS, credit union share draft accounts, and demand deposits

  6. Components of M1, July 17, 2000 (in billions) OCDs means “other checkable deposits.” Source: Federal Reserve Bulletin

  7. M2includes • M1 • Savings deposits • Small time deposits • Money market mutual funds (MMMFs)

  8. Components of M2, July 17, 2000 (in billions of dollars)

  9. Financial Intermediaries • We use this to term to describe businesses that specialize in brokering between depositors (savers) and borrowers. • Institutions that are permitted by law to hold checkable deposits include: • Savings and loan associations (S & L’s) • Mutual savings banks • Credit unions • Commercial banks

  10. Typical Bank Balance Sheet

  11. Fractional Reserve System Depository institutions are required by law to hold a minimum fraction of their deposit liabilities in a non-interest bearing account at the Federal Reserve Bank • Legislation • Federal Reserve Act of 1913 • DIDMCA of 1982

  12. What are reserves? • Total reserves:Vault cash plus reserves on account at the Federal Reserve Bank (the “Fed”). • Required reserves: The minimum amount a reserves a bank must hold to comply with the legal reserve requirement. • Required reserve ratio:The minimum fraction of checking account balances (or deposit liabilities) that bank must hold as reserves.

  13. Reserve Requirements in the U.S. Source: Federal Reserve Board

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