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Topic 1/ pp.

1 of 3 ECN3141 Money & Banking


- items used to make payment
- also known as money supply
- includes currency in circulation outside FI and Govt coffers, and checkable deposit in
Depository Institution
- determined by Central Bank (Fed)
- during recession, Fed increase Money Supply
- During rising inflation, Fed decrease Money Supply

Money & Inflation

- inflation occurs due to excessive expenditures on goods and services
- rapid growth in MS leads to rapid growth in expenditure
- inflation occurs if expenditure rises faster than nation’s capacity to produce

- accept deposit and grant loan
- serves as financial intermediaries between those who have excess funds and
those who need money.
- Financial intermediation promotes economic efficiency.

Interest rate
- cost of borrowing
- influence households’ decision to purchase durable goods
- affect construction of new business plant and commercial building
- real interest rate – rate adjusted for inflation
- affect exchange rate through demand and supply for currency

Federal Budget Deficit

- govt expenditure exceed revenue
- most believe that deficit raise interest rate
- higher interest rate discourage new investment thus reducing standard of living
- higher rate attract foreign fund thus driving up value of domestic currency which
eventually make it difficult for domestic firm to compete in international market.

Stock Market
- claim of ownership in individual corporation
- stock index reflect overall prospect of corporations
- constitute important portion of people’s wealth
- influence investment spending

Bond Market
- Bond is a debt instrument
- Contractual agreement by issuer to pay lender
- Interest rate determined by supply and demand for bond
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Foreign Exchange Market

- market for foreign currencies
- price of currency id foreign exchange rate
- fixed exchange rate system – held constant through govt intervention
- floating exchange rate system – based on supply and demand
- currency appreciation – increase in value thus encourage import
- currency depreciation – decrease in value thus encourage export


Full-Bodied or Commodity Money

- commodity such as gold, iron copper used as money
- value as money (used in exchange) and value as commodity (nonmoney) must
be the same

Representative Full-Bodied Money

- as society became more affluent, use of full bodied money became inconvenient
- paper money backed 100% by valuable metals
- first issued in 16th century in England

Fiat or Credit Money

- does not backed by commodity
- derives value by fiat or government decree
- started 400 years ago in England

Checking Account
- payment via transfer of balances at depository institution
- lead to economic efficiency – transaction without carrying money and no
transportation cost
- Drawback – take time

Electronic Money
- Electronic funds transfer system (EFTS) in progress
- Fedwire – electronic transfer of fund between Fed and banks
- Clearing House Interbank System (CHIPS) – allow banks to transfer funds
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Modern Measure of Money

- Currency
- Demand Deposits
- Other Checkable Deposits
- Traveller’s Check

- M1
- Overnight Repo issued by commercial Bank and Overnight
Eurodollar Deposits
- Money Market Mutual Funds
- Savings deposit money market Deposit account
- Small time deposit (more than 100,000)

- M2
- Large time deposit (more than 100,000)
- Term repo and term Eurodollar deposit
- Money Market Mutual Funds Shares (Institutions)

Weighted Measure of Money – Divisia Aggregates

- taking into account the different impact of financial assets on economic activity
- M = DDO + C + 0.5(MMMF) + 0.25(SD + TD)