Money and Banks. The Book

¶ … money and banks. The book gets to the point and states that money is the framework and "currency" of a market economy and how it works. For example, money has to be present for the author of this chapter view in the form of paying home bills, paying for take-out food, and so forth. The chapter than segues to the larger types of money and the disparate forms that money takes on including physical and account/investment-based forms. For example, the balance of a 401(k) account the author of this report may have is just much money as a five dollar bill in a wallet. The difference is the liquidity of the money.

The forms of payment have changed in recent years. However, checks are still very prominent but debit and credit cards comprise exactly half of all payments with checks being a third and preauthorized payments being the rest. The book expands on the fact that the money supply is comprised of cash as well as transaction accounts. Savings accounts are also a form of money and are commonly referred to as "near money."

The book then mentions the money supply as it pertains to aggregate demand and how those two variables press against and away from each other to influence the money supply and where it sits. For example, the recent "Great Recession" caused a major shift (including with the author of this response) from a spend-first ideology to one much more oriented to paring down fixed variable expenses as well as putting huge curbs on discretionary purchases such as keeping with a car that might not be in the best shape or buying a used car instead of a new one.

The book then talks about creation of money which includes deposit creation and the art of giving out a loan which itself creates money. The book then talks about monopoly banks and reserve requirements with the latter being the required reserves that a bank must keep on hand to comply with regulatory requirements. The requirements often require only a fraction of the deposits on the hand be coverable immediately by the bank but this is mostly because unless there is a major run on the bank, that is almost always more than enough to cover the demand from check cashing and withdrawals.

The book then discusses the macroeconomic impact that banks have and the limitations to the same including the bank deposits on hand, the willingness of people to borrow or lend, and so forth. For example, just because a bank is willing to lend out money does not mean that there will be a lot of people that want to borrow it. An example of this would be the people above who pare down or eliminate purchases due to broader economic conditions like a recession. However, during the same recession, one can see banks be much less willing to lend out money because of the increased risks of late payments or even defaults on the loan.

The final limitation mentioned is government regulations on loans and banks in general. A great example of this would be the recent changes to the FHA home loan process whereby the minimum down payment shifted from 3% of the loan/home price to 3.5%. Not a huge jump but it was done on purpose. The banks themselves were doing no money down loans a lot but that practice ebbed a ton once the housing crash happened in 2007-2008 and the market is just now coming back, albeit very slowly.

Chapter 14 Review

The fourteenth chapter of the class text covers monetary policy and starts off up front with the Fed and its current chairman Ben Bernanke. Figure 14.1 shows how internal market forces, external shocks and policy levers like monetary policy and fiscal policy in general affect output, jobs, prices, growth and international balances, each in their own way. The book then talks about the federal reserve system and the federal reserve banks, whose functions include clearing checks between private banks, holding bank reserves, providing currency and providing loans. The Fed is led by a Board of Governors and that is shown in figure form in figure 14.2 of the book.

The monetary tools that can be used are discussed starting halfway down page 291 with the reserve requirements (which were also mentioned in chapter 13) being the first thing up for discussion. The reserve requirements can be altered at any given time based on the discretion and decision of the Fed and this immediately changes the lending capacity of a member bank. For example, if the author's bank is subject to a reserve requirement change, they will either have more or less to lend to customers like the author depending on what the decision is. This change could preclude the author from getting a loan or from getting the desired amount or it would have no effect. It really depends on who and who is not credit-worthy based on the amounts available to lend by the bank. This tit for tat with increases or decreases in reserve requirements is continued well into page 292.

Page 293 talks about a situation where China actually raised reserve requirements to intentionally slow down economic growth and activity as a means to keep it more controlled and stable and not chaotic and unorganized. The book then describes that more in detail on page 294 but then mentions tools like securities sales, discounting and federal funds market management on page 295. Open market operations are described on the bottom of 295 and then talks about portfolio decisions on the next page. Bonds are discussed on page 296 and 297 with the tit for tat being mentioned as to whether one should get bonds or hold onto money. Of course, the author of this report understands depends on the individual situation of the author's money liquidity and amounts as well as the prevailing economic and monetary conditions including interest rates, bond rates and so forth.

Depending on all that, this would dictate whether to buy bonds, get rid of bonds, hold onto cash, use the cash for a better or wiser purpose and so forth. This decision is affected, in whole or in part, based on the demand of a person like the author of this report and the wider demand of the larger market is what aggregate demand is. The government can engage in expansionary policy as well as restrictive policy depending on the prevailing market conditions and where the optimal position for the above should be relative to what is going on now. Much the same thing is looked at and influenced as it can be as far as aggregate supply goes and for the same reasons. Supply and demand work together and the economy needs to be in a position where the supply and demand are as close to being equal as possible, which is the equilibrium. The chapter closes out with some talk of policy perspectives including discretionary policy, fixed rules, how eclectic the Fed can be and so on.

Chapter 2 Web Exercises

1. At the NOVA Online section of PBS's website, there is an interesting article on the history of money (http://www.pbs.org/wgbh/nova/moolah/history.html).

a. Choose one item that was used as money in the past. Explain how this "money" could be used today to fulfill the purposes of money described in this chapter. Give a real-life example of each.

In the past, there was a heavy reliance on the barter system. Rather than relying only on cash a means to pay for something, many people would trade what they had a glut of (or at least needed less than something else they really needed) as a means of trade. Sometimes the trade would be even but other times it would be much less so. Examples of this in action would trading oxen, wagons, tools, crops wood and so forth.

For example, a farmer with a lot of wheat would trade that wheat to someone who made tools but needed wheat. The farmer would get the tools he/she needs and the blacksmith would get the wheat he needed. The blacksmith would be able to use the wheat to eat while the farmer would get the tools necessary to fix his farm implements and other items. Even though no money traded hands, it was a win-win for everyone involved.

Much the same thing still happens but to a much lesser degree. There is much more reliance on cash as a means to buy something but bartering and other forms of trades occur all of the time. Money and bartering can even be combined in the case that the value of two items being traded are acceptably close enough to be evenly traded.

b. How well would this money fulfill the purposes of money described in this chapter? What are the advantages and drawbacks of using this money as opposed to currency like the U.S. dollar?

Bartering is a good thing in that it can be used as a means to exchange goods and the value that the goods might have vary a lot depending on who is offering what and what that same person needs. For example, the value of some gas to someone that is just trying to mow their lawn is a lot less than with someone who is trying to escape a coming hurricane.

However, a dollar-based system is better in that the value of money is much more stable and definable than with non-cash items because the value of those non-cash items (or any other "currency") is subject to a lot of disagreement and questions. $100 in U.S. dollars is worth much the same to one person as it is another. The gas example above can apply to money as well, but not nearly to the same degrees and lengths that bartering values would be, all else equal.

Also, there is clear regulation for the value of the dollar and the regional differences are going to be a lot less not counting the differences with the cost of living and access issues like terrain and paved roads.

1. Visit the website of the Board of Governors of the Federal Reserve System, at http://www.federalreserve.gov/. Click on "About the Fed," and answer the questions below. (You may need to refer to the FAQ and click around a bit to find all of the answers you need.)

a. Who are the current Governors of the Federal Reserve? Give a very brief biography of each. How much does each of these Governors earn?

The current governors are as follows

Ben Bernanke

Janet Yellen

Elizabeth Duke

Daniel Tarullo

Sara Bloom Raskin

Jeremy Stein

Jerome Powell

Bernanke makes $199,700 as of 2012 (as dictated by Congress) while everyone else (including Yellen, who is the vice chair) makes $179,700.

http://www.richmondfed.org/faqs/bog/

b. How many governors are there, how many are there supposed to be?

Including Bernanke, there is currently seven members and that is what they should be.

c. Have any of the current Governors ever worked in the private banking industry?

It's about half and half, really.

Bernanke was mostly in the government and educational spheres including at several colleges like Princeton and the NBER. He really does not have a history as a private banker.

Yellen, the Vice-Chair has a similar history as Bernanke as she was been in the college and government sphere for much of her career. She has been educated or worked at Brown, Harvard and Yale.