Principles of Macroeconomics

1. Principles of Macroeconomics Money and Banking

2. Money • Money = any item that is generally accepted as a means of payment for goods and services • Common functions of money: • medium of exchange • unit of account • store of value • standard of deferred payment • Money does not always serve in the last three of these functions.

3. Evolution of Money • Commodity money • Token money • Fiat money (legal tender)

4. Monetary aggregates: M1 • M0= A measure of the money supply which combines any liquid or cash assets held within a central bank and the amount of physical currency circulating in the economy. In the United Kingdom, the M0 supply is also referred to as narrow money. • M1 = those items that serve as a medium of exchange • M1 = currency (including coins) + checkable deposits + traveler’s checks • Note that credit does not serve as money

5. M2 and M3 • M2 = M1 + savings deposits + small denomination (< $100,000) time deposits + retail money market mutual fund balances • M3 = M2 + repurchase agreements + Eurodollar deposits

6. Global money • Sales among industrialized countries usually conducted in the currency of the seller • Sales between industrialized and developing countries are usually conducted in the developed country’s currency • Currencies of industrialized countries dominate international transactions • International reserve currency – used to settle debts between governments (dollar, pound, euro, and yen are most commonly used)

7. Composite currencies • ECU – introduced in 1979 – value tied to weighted average of national currencies of EU – (replaced by the euro) • Special drawing rights – average of the values of the dollar, euro, yen, and pound – created in 1970 by the IMF

8. Banking • Commercial banks – traditionally offered only checking accounts • Thrift institutions – traditionally offered only savings accounts • Financial deregulation in the 1980s eliminated the last remaining distinctions between commercial banks and thrift institutions

9. Financial intermediation • Direct finance – loans made directly from lenders to borrowers • Financial intermediation – banks (and other financial intermediaries) accept deposits and make loans • Financial intermediaries receive profits fr5om the difference in interest rates on loans and deposits • Reasons for financial intermediation: • economies of scale • lowers transaction costs • Savers and borrowers have different time horizons

10. Bank failures • High failure rates in the 1930s and 1980s • Federal Deposit Insurance Corporation (FDIC) – created in 1933 – insures deposits up to $100,000

11. International banking • Eurocurrency markets – deposits held in currencies that differ from the currency of the country in which the bank is located • Eurocurrency deposits are not subject to U.S. banking laws and offer higher interest rates (along with higher risk) • International banking facilities – since 1981- bookkeeping systems that allow U.S. banks to participate in offshore banking activities

12. Fractional reserve banking system • Banks create money whenever a loan is issued. • Reserve requirement (set by Federal Reserve Board) = fraction of deposits that must be held as reserves • Reserves = vault cash + deposits at Fed • Banks may loan their excess reserves • Required reserves = reserve requirement x deposits • Excess reserves = total reserves – required reserves

13. T-accounts and deposit multiplier • Initial assumptions: • no currency holdings • no excess reserves • Deposit expansion multiplier = 1/reserve requirement (shown on board)

14. IMF - Overview • The International Monetary Fund (IMF) is an organization of 186 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. • The IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty.

15. Overview • With its global membership of 186 countries, the IMF is uniquely placed to help member governments take advantage of the opportunities—and manage the challenges—posed by globalization • The IMF tracks global economic trends and performance, alerts its member countries when it sees problems on the horizon, provides a forum for policy dialogue, and passes on know-how to governments on how to tackle economic difficulties • The IMF provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty

16. Key IMF Activities The IMF supports its membership by providing: • policy advice to governments and central banks based on analysis of economic trends and cross-country experiences; • research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets; • loans to help countries overcome economic difficulties; • concessional loans to help fight poverty in developing countries; and • technical assistance and training to help countries improve the management of their economies.

17. Objectives of the IMF • To promote international monetary cooperation • To facilitate the expansion and balanced growth of International Trade • To promote exchange rate stability • To make its resources available to its members who are experiencing BOP problems • To establish a multilateral system of payments

18. Conditionality • IMF lends to its member countries, ensuring that, members are pursuing policies that will improve external payment problems. • Commitment to implement corrective measures. • To repay in a timely manner.

19. Membership • The IMF currently has a near-global membership of 186 countries. To become a member, a country must apply and then be accepted by a majority of the existing members. • Upon joining, each member of the IMF is assigned a quota, based broadly on its relative size in the world economy.

20. Organisation • The IMF has a management team and 17 departments that carry out its country, policy, analytical, and technical work. The current management team: • Christine Lagarde, a French national, became the IMF's tenth Managing Director in November 2012. Previously, she was the Finance Minister of France • John Lipsky, an American, has been First Deputy Managing Director since September 2006. Before coming to the IMF, he worked for JPMorgan Investment Bank. • Takatoshi Kato, a Japanese national, became Deputy Managing Director of the IMF in February 2004. Previously, he advised the president of Tokyo-Mitsubishi Bank.