© 2009 South-Western, a part of Cengage Learning, all rights reserved C H A P T E R The Monetary System E conomics P R I N C I P L E S O F N. Gregory Mankiw.

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1 © 2009 South-Western, a part of Cengage Learning, all rights reserved C H A P T E R The Monetary System E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 29

2 In this chapter, look for the answers to these questions:  What assets are considered “money”? What are the functions of money? The types of money? 화폐란 ? 화폐의 기능은 ? 화폐의 유형은 ?  What is the Federal Reserve? 중앙은행은 ?  What role do banks play in the monetary system? How do banks “create money”? 통화제도에서 은행의 역할은 ? 어떻게 은행은 통화를 창출하는가 ?  How does the Federal Reserve control the money supply? 중앙은행은 어떻게 화폐공급을 통제하는가 ? 1

3 THE MONETARY SYSTEM 2 What Money Is and Why It’s Important  Without money, trade would require barter, the exchange of one good or service for another. 화폐가 없다면 교역을 위해 물물교환이 필요  Every transaction would require a double coincidence of wants – the unlikely occurrence that two people each have a good the other wants. 모든 거래는 욕망의 이중적 일치를 필요로 함 - 두 사람이 각자가 원하는 재화를 가지고 있기란 쉽지 않다.  Most people would have to spend time searching for others to trade with – a huge waste of resources. 대부분의 사람들은 물건을 바꿀 사람을 찾아 헤매야 할 것이며 이는 엄청난 자원의 낭비를 가져올 것  This searching is unnecessary with money, the set of assets that people regularly use to buy g&s from other people. 화폐가 있으면 이러한 탐색은 필요 없다.

4 THE MONETARY SYSTEM 3 The 3 Functions of Money 화폐의 3 가지 기능  Medium of exchange( 교환의 매개 ): an item buyers give to sellers when they want to purchase g&s 구매자가 재화나 서비스를 구매하고자 할 때 판매자에게 주는 아이템  Unit of account( 회계 단위 ): the yardstick people use to post prices and record debts 사람들이 가격을 매기고 빚을 기록하는 척도  Store of value( 가치저장수단 ): an item people can use to transfer purchasing power from the present to the future 사람들이 구매력을 현재에서 미래로 이전하고자 할 때 사용할 수 있는 수단

5 THE MONETARY SYSTEM 4 The 2 Kinds of Money Commodity money: takes the form of a commodity with intrinsic value Examples: gold coins, cigarettes in POW camps Fiat money: ( 법화 ) money without intrinsic value, used as money because of govt decree Example: the U.S. dollar

6 THE MONETARY SYSTEM 5 The Money Supply 화폐 공급  The money supply (or money stock) 화폐공급 또는 통화량 : the quantity of money available in the economy 경제 내에서 사용 가능한 화폐의 양  What assets should be considered part of the money supply? 어떤 자산이 화폐공급의 부분으로 간주되어야 하는가 ? Two candidates 두 가지 후보 :  Currency( 현금통화 ): the paper bills and coins in the hands of the (non-bank) public  Demand deposits( 요구불 예금 ): balances in bank accounts that depositors can access on demand by writing a check

7 THE MONETARY SYSTEM 6 Measures of the U.S. Money Supply  M1: currency, demand deposits, traveler’s checks, and other checkable deposits. M1 = $1.4 trillion (June 2008)  M2: everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few minor categories. M2 = $7.7 trillion (June 2008) The distinction between M1 and M2 will usually not matter when we talk about “the money supply” in this course.

8 THE MONETARY SYSTEM 7 Central Banks & Monetary Policy  Central bank: an institution that oversees the banking system and regulates the money supply  Monetary policy: the setting of the money supply by policymakers in the central bank  Federal Reserve (Fed): the central bank of the U.S.

9 THE MONETARY SYSTEM 8 The Structure of the Fed The Federal Reserve System consists of:  Board of Governors (7 members), located in Washington, DC  12 regional Fed banks, located around the U.S.  Federal Open Market Committee (FOMC), includes the Bd of Govs and presidents of some of the regional Fed banks The FOMC decides monetary policy. Ben S. Bernanke Chair of FOMC, Feb 2006 – present

10 THE MONETARY SYSTEM 9 Bank Reserves( 은행의 지급준비금 )  In a fractional reserve banking system, banks keep a fraction of deposits as reserves and use the rest to make loans. 부분지금준비 은행제도에서 은행은 예금의 일부를 지급준비로 보유하고 나머지를 대출  The Fed establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits. 중앙은행은 법정 지급준비금 ( 은행이 반드시 보유해야 하는 최소지급준비금 ) 을 정함  Banks may hold more than this minimum amount if they choose.  The reserve ratio, R 예금 중에서 은행이 지급준비금으로 보유하는 금액의 비율

11 THE MONETARY SYSTEM 10 Bank T-account 은행의 T 계정  T-account: a simplified accounting statement that shows a bank’s assets & liabilities.  Example: FIRST NATIONAL BANK AssetsLiabilities Reserves$ 10 Loans $ 90 Deposits$100  Banks’ liabilities include deposits, assets include loans & reserves.  In this example, notice that R = $10/$100 = 10%.

12 THE MONETARY SYSTEM 11 Banks and the Money Supply: An Example Suppose $100 of currency is in circulation. 100 달러의 현금이 유통 중이라고 가정 To determine banks’ impact on money supply, we calculate the money supply in 3 different cases 은행이 화폐공급에 미치는 영향을 알아보기 위해 3 가지 다른 경우의 화폐공급을 계산 : 1.No banking system 2.100% reserve banking system: banks hold 100% of deposits as reserves, make no loans 3.Fractional reserve banking system

13 THE MONETARY SYSTEM 12 Banks and the Money Supply: An Example CASE 1: No banking system Public holds the $100 as currency. Money supply = $100.

14 THE MONETARY SYSTEM 13 Banks and the Money Supply: An Example CASE 2: 100% reserve banking system Public deposits the $100 at First National Bank (FNB). FIRST NATIONAL BANK AssetsLiabilities Reserves$100 Loans $ 0 Deposits$100 FNB holds 100% of deposit as reserves: Money supply = currency + deposits = $0 + $100 = $100 In a 100% reserve banking system, banks do not affect size of money supply.

15 THE MONETARY SYSTEM 14 Banks and the Money Supply: An Example CASE 3: Fractional reserve banking system Money supply = $190 (!!!) Depositors have $100 in deposits, Borrowers have $90 in currency. FIRST NATIONAL BANK AssetsLiabilities Reserves$100 Loans $ 0 Deposits$100 Suppose R = 10%. FNB loans all but 10% of the deposit: 10 90

16 THE MONETARY SYSTEM 15 Banks and the Money Supply: An Example How did the money supply suddenly grow? When banks make loans, they create money. The borrower gets  $90 in currency (an asset counted in the money supply)  $90 in new debt (a liability) CASE 3: Fractional reserve banking system A fractional reserve banking system creates money, but not wealth 부분지급준비제도는 통화를 창출한다. 그러나 부를 창출하는 것은 아니다.

17 THE MONETARY SYSTEM 16 Banks and the Money Supply: An Example CASE 3: Fractional reserve banking system If R = 10% for SNB, it will loan all but 10% of the deposit. SECOND NATIONAL BANK AssetsLiabilities Reserves$ 90 Loans $ 0 Deposits$ 90 Suppose borrower deposits the $90 at Second National Bank (SNB). Initially, SNB’s T-account looks like this: 9 81

18 THE MONETARY SYSTEM 17 Banks and the Money Supply: An Example CASE 3: Fractional reserve banking system If R = 10% for TNB, it will loan all but 10% of the deposit. THIRD NATIONAL BANK AssetsLiabilities Reserves$ 81 Loans $ 0 Deposits$ 81 The borrower deposits the $81 at Third National Bank (TNB). Initially, TNB’s T-account looks like this: $ 8.10 $72.90

19 THE MONETARY SYSTEM 18 Banks and the Money Supply: An Example CASE 3: Fractional reserve banking system The process continues, and money is created with each new loan. Original deposit = FNB lending = SNB lending = TNB lending =... $100.00 $90.00 $81.00 $72.90... Total money supply =$1000.00 In this example, $100 of reserves generates $1000 of money.

20 THE MONETARY SYSTEM 19 The Money Multiplier  Money multiplier: the amount of money the banking system generates with each dollar of reserves  The money multiplier equals 1/R.  In our example, R = 10% money multiplier = 1/R = 10 $100 of reserves creates $1000 of money (Notice : 본원통화를 A, 지급준비율을 R 이라하면 통화량 = A + A(1-R) + A(1-R)^2 + ….. = A(1/1-(1-R) = A/R)

21 A C T I V E L E A R N I N G 1 Banks and the money supply 20 While cleaning your apartment, you look under the sofa cushion find a $50 bill (and a half-eaten taco). You deposit the bill in your checking account. 청소하다 50 달러 발견하여 요구불 계좌에 저축 The Fed’s reserve requirement is 20% of deposits. R=20% A.What is the maximum amount that the money supply could increase? B.What is the minimum amount that the money supply could increase?

22 A C T I V E L E A R N I N G 1 Answers 21 If banks hold no excess reserves, then money multiplier = 1/R = 1/0.2 = 5 The maximum possible increase in deposits is 5 x $50 = $250 But money supply also includes currency, which falls by $50. Hence, max increase in money supply = $200. You deposit $50 in your checking account. A. What is the maximum amount that the money supply could increase?

23 A C T I V E L E A R N I N G 1 Answers 22 Answer: $0 If your bank makes no loans from your deposit, currency falls by $50, deposits increase by $50, money supply does not change. You deposit $50 in your checking account. A. What is the maximum amount that the money supply could increase? Answer: $200 B. What is the minimum amount that the money supply could increase?

24 THE MONETARY SYSTEM 23 The Fed’s 3 Tools of Monetary Control 1. Open-Market Operations ( 공개시장조작 ): the purchase and sale of U.S. government bonds by the Fed.  To increase money supply, Fed buys govt bonds, paying with new dollars. …which are deposited in banks, increasing reserves …which banks use to make loans, causing the money supply to expand.  To reduce money supply, Fed sells govt bonds, taking dollars out of circulation, and the process works in reverse.

25 THE MONETARY SYSTEM 24 The Fed’s 3 Tools of Monetary Control 1. Open-Market Operations (OMOs): the purchase and sale of U.S. government bonds by the Fed.  OMOs are easy to conduct, and are the Fed’s monetary policy tool of choice.

26 THE MONETARY SYSTEM 25 The Fed’s 3 Tools of Monetary Control 2. Reserve Requirements (RR): affect how much money banks can create by making loans.  To increase money supply, Fed reduces RR. Banks make more loans from each dollar of reserves, which increases money multiplier and money supply.  To reduce money supply, Fed raises RR, and the process works in reverse.  Fed rarely uses reserve requirements to control money supply: Frequent changes would disrupt banking.

27 THE MONETARY SYSTEM 26 The Fed’s 3 Tools of Monetary Control 3. The Discount Rate( 재할인율 ): the interest rate on loans the Fed makes to banks  When banks are running low on reserves, they may borrow reserves from the Fed.  To increase money supply, Fed can lower discount rate, which encourages banks to borrow more reserves from Fed.  Banks can then make more loans, which increases the money supply.  To reduce money supply, Fed can raise discount rate.

28 THE MONETARY SYSTEM 27 The Fed’s 3 Tools of Monetary Control 3. The Discount Rate: the interest rate on loans the Fed makes to banks  The Fed uses discount lending to provide extra liquidity when financial institutions are in trouble, e.g. after the Oct. 1987 stock market crash.  If no crisis, Fed rarely uses discount lending – Fed is a “lender of last resort.”

29 THE MONETARY SYSTEM 28 The Federal Funds Rate( 기준금리 )  On any given day, banks with insufficient reserves can borrow from banks with excess reserves. 지급준비금이 부족한 은행이 남는 은행에게 빌릴 수 있으며,  The interest rate on these loans is the federal funds rate. 이 때 적용되는 금리가 기준금리이다.  The FOMC uses OMOs to target the fed funds rate. 공개시장위원회는 기준금리를 타깃으로 공개시장조작을 한다.  Many interest rates are highly correlated, so changes in the fed funds rate cause changes in other rates and have a big impact in the economy. 다양한 금리들은 서로 긴밀히 연관되어 있어서 기준금리의 변화는 다른 금리의 변화를 초래하여 경제에 큰 영향을 미친다.

30 The Fed Funds Rate and Other Rates, 1970-2008 (%) 0 5 10 15 20 19701975198019851990199520002005 Fed funds prime 3-month Tbill mortgage

31 THE MONETARY SYSTEM 30 Monetary Policy and the Fed Funds Rate To raise fed funds rate, Fed sells govt bonds (OMO). This removes reserves from the banking system, reduces supply of federal funds, causes r f to rise. rfrf F D1D1 S2S2 3.75% F2F2 S1S1 F1F1 3.50% The Federal Funds market Federal funds rate Quantity of federal funds

32 THE MONETARY SYSTEM 31 Problems Controlling the Money Supply  If households hold more of their money as currency, banks have fewer reserves, make fewer loans, and money supply falls. 가계가 돈을 현금으로 더 많이 보유할수록 은행의 준비금은 줄어들어 대출이 줄고 화폐공급은 줄어든다.  If banks hold more reserves than required, they make fewer loans, and money supply falls. 은행이 초과 지급준비금을 가지고 있을 경우에도 대출이 줄고 화폐공급이 준다.  Yet, Fed can compensate for household and bank behavior to retain fairly precise control over the money supply. 그러나 중앙은행은 통화공급에 대한 정밀한 통제를 유지하기 위하여 가계와 은행의 행동을 상쇄할 수 있다.

33 32 Bank Runs and the Money Supply  A run on banks: When people suspect their banks are in trouble, they may “run” to the bank to withdraw their funds, holding more currency and less deposits 사람들이 자신의 은행이 문제가 있다고 의심하게 될 때 그들은 은행으로 달려가서 가능한 한 많은 현금을 확보하려 할 것이다.  Under fractional-reserve banking, banks don’t have enough reserves to pay off ALL depositors, hence banks may have to close. 부분지준제도하에서 은행은 모든 예금자에게 돈을 지불할 수 없기 때문에 은행문을 닫아야 한다.  Also, banks may make fewer loans and hold more reserves to satisfy depositors. 물론 은행은 예금자를 안심시키기 위해 대출을 줄여 더 많은 준비금을 보유할 수도 있다.  These events increase R, reverse the process of money creation, cause money supply to fall. 그러면 화폐공금이 감소

34 THE MONETARY SYSTEM 33 Bank Runs and the Money Supply  During 1929-1933, a wave of bank runs and bank closings caused money supply to fall 28%.  Many economists believe this contributed to the severity of the Great Depression.  Since then, federal deposit insurance has helped prevent bank runs in the U.S.  In the U.K., though, Northern Rock bank experienced a classic bank run in 2007 and was eventually taken over by the British government.

35 CHAPTER SUMMARY  Money includes currency and various types of bank deposits.  The Federal Reserve is the central bank of the U.S., is responsible for regulating the monetary system.  The Fed controls the money supply mainly through open-market operations. Purchasing govt bonds increases the money supply, selling govt bonds decreases it. 34

36 CHAPTER SUMMARY  In a fractional reserve banking system, banks create money when they make loans. Bank reserves have a multiplier effect on the money supply. 35