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MONEY AND BANKING

MONEY AND BANKING. WHAT IS IT?. Forms it takes: money in the U. S. Basic definition: that which is generally acceptable in exchange for goods and services. Functions Means of exchange Store of value Standard of value Why have money at all? Barter, and the transactions cost problem

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MONEY AND BANKING

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  1. MONEY AND BANKING

  2. WHAT IS IT? • Forms it takes: money in the U. S. • Basic definition: that which is generally acceptable in exchange for goods and services

  3. Functions • Means of exchange • Store of value • Standard of value • Why have money at all? • Barter, and the transactions cost problem • Non-money solutions; money as lower cost

  4. FINANCIAL INTERMEDIARIES • The intermediation function: linking ultimate borrowers, lenders (savers) • Problem: existence of • Transactions costs • Asymmetric information

  5. Intermediaries as • Reducing transactions costs • Reducing risk • Increasing saving, investment, economic growth

  6. Commercial banks as a financial intermediary • Banks as firms • Acquire funds by issuing claims against themselves • Earn income by acquiring claims against others: primarily by making loans

  7. Importance of reserves • Held as currency; or as deposit at central bank (the Fed, in the U. S.) • Need reserves to be able to make loans • Consider specie deposit • Incentive to lend • Key: Not everyone is likely to want specie at the same time

  8. CENTRAL BANKS • A bank for bankers • Functions: • Safety and soundness of the banking system-not necessarily the survival of individual banks • “Lender of last resort”: ultimate source of liquidity (reserves) to banks • Control money supply to affect prices; real output; and employment

  9. MONEY IN U. S. HISTORY • The colonial experience • A variety of items served as money • Full-bodied commodity money • Controversy over paper money • Was there an over-issue problem? • Who’s in control? The role of politics in money • Money and colonial economic development

  10. Early national period (1790-1860) • A period of trial and error • Growth of commercial banks • Financial demands of industrialization

  11. Early central banking • First Bank of the U. S.(1791-1811) • Private and public elements • Acted to control note over-issue by private banks: threat of specie redemption • Charter not renewed • Constitutional issue • Easy-money bias on frontier • Fear of favorable treatment for private owners, some of whom were British

  12. Second Bank of the U. S. (1816-1836) • Response to banking problems after 1811-especially war finance • Strict control over note issue of private banks • Helped create national credit market: branches in major cities • Demise • Political feud, Jackson, vs. Biddle • East-west tension • Constitutional issues

  13. Money creation • Coin, issued by the federal government • Currency (bank notes), issued as part of the lending process of commercial banks • Such currency often circulated at a discount from its face value • Limitations on money creation? Availability of reserves, generally in form of specie

  14. 1860-1914 • Civil War finance • Both sides did much financing by issuing currency, generating inflation • National Banking System: 1863 • Uniform currency • Safer currency: backed by Treasury bonds

  15. A series of financial panics • Reserve “pyramiding”: no central source of reserves • Difficult to provide more currency on demand

  16. The Federal Reserve System and after • Why exist? • Lender of last resort • Safety, soundness of banking system • Structure? Mixture of centralized, decentralized features. Why?

  17. Responsibilities? • Supervise, regulate banking system • Lender of last resort • Control money supply, to influence prices, real output; via open market operations • Buying and selling U. S. government securities • Purchase: increases money supply • Sale: decreases money supply • Point: affects bank reserves

  18. System collapse and reform: the 1930s • Events • Political response • Deposit insurance: to help prevent bank runs • Closer regulation of bank activities • Pricing • Products • Entry

  19. The 1980s: Confusion and change • Deregulation • Crisis in banking, savings and loan industries • “Moral hazard” and deposit insurance • Re-regulation • The end of the savings and loan industry?

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