MONEY AND BANKING

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?