Chapter 29: Monetary System §

Dollarization: the world’s attempt to align their currency with the US Dollar

• Bretton Wood System: a monetary system after WWII as US has the gold reserve

Nationalized Currency: controlling own currency could help country with economic control

• Fiscal Policy: Government spending…
• Monetary Policy

I. What is Money? §

• Money is the set of assets that is used to buy goods and services from each other.
• Wealth is large amount of money or valuable possessions that someone own.

1. Three Functions of Money §

to be considered money it needs

1. Medium of Exchange: an accepted form of asset of money
   • Credit Card: the amount of money you owe and need to pay by a given period
   • Debit Card: exchanging money for a card representing money you own
   • Cryptocurrency: purely digital currency
2. Unit of Account: measurement for value or price of goods and services
   • Price Tag: to inform of value of products
   • Coupon: …
3. Store of Value: how the medium will maintain its value
   • Through inflation, deflation, and time it won’t lose its value or purchasing power

2. Types of Money §

• Commodity Money: a form of money that is naturally valuable. Gold, Silver…
• Fiat Money: money without natural value, but given value by the government. Currency, coins…
• Why Gold picked as Safe Haven Asset?
  • Stable state (not gas, not liquid, solid)
  • Durable (doesn’t burn, or tear, can withstand weather)

3. Liquidity §

the ease with which an asset can be converted into the economy medium of exchange

M1: very easy to exchange for goods and services (more liquid)

M2: harder and/or slower to exchange for goods and services (less liquid)

M3: …

II. Bank and Money Supply §

Banking System §

• Central Bank: an institution that oversees the banking system and regulate the money supply.

  • Functions
    • Regulate Private Banks
      • Issue license for commercial banks to open
        1. Minimum Capital Requirement
        2. Reserve Requirement fraction of deposits are kept from loans and kept in a bank vault or the central bank, to give withdrawal for households.
           • Is not counted as circulating money
    • Regulate Money Supply: minimum reserve to avoid bank system failure
      • Print currency
      • Monetary policy: method to inject and retract money in the economy (maintain currency value)

  ⇒ Commercial Bank: get’s its money supply from Central Bank

  ⇒ Households: get money deposit and loans from commercial bank

Money Supply §

• Money Supply: currency that is not in Central or Commercial Banks and are circulating in the economy.

  $MoneySupply=Cash+CheckableDeposit$

• Money deposited in banks can multiply itself by lending out deposits and keeping a fraction as a reserve each time.

  • Measured by the $MoneyMultiplier=\frac{1}{reserveratio}$
  • Reserve Ratio: Percentage of deposit to be put in vaults or central bank

Terms §

• Leverage:

  Borrowed money to supplement existing money to invest

  • Liability: profits might not be enough to repay borrowed money
  • Equity: potential profile
  • Asset: existing money

  $LeverageRatio=\frac{Asset}{Equity}$

• Credit Crunch: Shortage of capital making banks to lower loans

III. Tools of Monetary Control §

Increase or Decrease of Money Supply

1. Conventional Monetary Tools §

Open-Market Operations (OMOs) §

• Buy Bond to increase Money Supply
• Sell Bond to decrease Money Supply

Reserve Requirement §

• Discount Rate: interest rates for banks to borrow from the central bank

  • Make Lower: more money supply

    Encourage Private banks to borrow more and loan to more people

  • Make Higher: less money supply

• Federal Fund Rate: interest rates for banks borrowing from one another

Reserve Ratio §

• Lower to increase money supply
  • Less money in vaults & central banks
  • More money to loan to public
  • More money multiplier
• Higher to decrease money supply
  • More money in vaults & central banks
  • Less money to loan to people
  • Less money multiplier

2. Unconventional Monetary Tools §

Quantitative Easing §

After financial crisis to economic recovery

• Inject Money: Buy vast amount of government bonds and commercial bonds

  Put lots of money in the market, so economy would recover

• Subtract Money: sell bonds

  • Lowering bond interest rates to encourage money use in the economy

Discount Rate §

To stop Deflation Spiral (Negative Interest Rate)

• Give interest to people for borrowing money
• Charge people to put money in banks

Encourage people to spend money