Money and Banking

Banks as financial intermediaries

• Bring borrowers and lenders together

Bank profits & interest rates

• Banks lend at higher interest rates than they pay for money deposited
• The more a bank lends, the more profit it can make

Bank reserves

• Banks keep a portion of deposited funds on hand to meet day to day needs

Fractional reserve banking & consumer confidence

• The banking system depends on consumers believing they can get their money when they ask

Bank runs

• If everyone wants their money at once, they won't be able to get it
• Bank runs occurred frequently during the great depression

Beginnings of Central Banking

• Need for Government Involvement in banking--a sound economy requires a sound banking system
• 1st Bank of U.S. (1791)
• 20 year charter
  • Responsibilities--print money and lend to government
  • Controversy over whether bank was constitutional
    • McCulloch vs. Maryland (1819)
      • Supreme Court decision supported bank
      • Said "Constitutional end justifies any means"
• 2nd Bank of U.S. (1816-1836)

Federal Reserve System

• Organization
  • 12 geographic districts
  • Led by a 7 member Board of Governors
    • Chair: Alan Greenspan--may be 2nd most influential person in the U.S.

Independence of FED

• Funding from banks, not from Congress
• 14 year terms for Board of Governors, removal difficult

Functions

• Provide currency to banks
• Act as a clearing house for checks
• Specify reserve requirements--minimum % that banks cannot loan out
• Supervise banks--assure that good practices are followed
• Make loans to banks--to meet short term needs
• Regulate money supply--increase or decrease the amount of money in the economy as a means of keeping the economy healthy

The Fed and Interest Rates

The interest rate is the price of money

Supply and demand interact to determine the market interest rate (when D = S)

If the FED decreases the supply of money, there will be excess demand for money (D>S)

Excess demand increases prices. Since the interest rate is a price, interest rates will go up.

Interest Rates and the Economy

• Money earned by savers
  • Bonds
• Money market accounts
• Certificates of deposit
• Business investment
  • New facilities
• Modernization of existing facilities
• "Large Ticket" consumer purchases
  • Homes
• Automobiles