FUNDAMENTALS OF BUSINESS ECONOMICS

II.  Real Loanable Funds Market

A.  Financial Intermediaries and Money Creation

1.  Financial intermediaries

• Link savers with borrowers

a.  Direct vs. indirect financing

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b.  Money market vs. capital market

• Money market instruments - maturities one year or less

• Capital market instruments - maturities greater than one year

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c.  Primary vs. secondary markets

• Primary market - market when securities are first issued

• Secondary market - securities traded after they are issued

d.  Financial disintermediation

• Mass withdrawals from financial intermediaries

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2.  Bank balance sheet

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a.  Assets

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(1) Reserves

• Cash, deposits at the central bank (Federal Reserve in the U.S.)

• Reserves needed to meet reserve requirements, satisfy demands for cash, and facilitate check clearing

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(2)  Loans

• Short-, medium-, and long-term

• To individuals and businesses

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(3)  Securities

• Debt instruments - earn interest, some price fluctuations

• Equities - earn dividends, greater price fluctuations (capital gains)

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(4)  Deposits at other banks

• Interbank deposit market - place to invest short-term funds

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(5)  Other assets

• Buildings, land, furniture, equipment, etc.

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b.  Liabilities

(1)  Deposits

 

(2)  Borrowings from other banks

• Done when short of funds

• Federal funds rate - interest rate banks charge one another

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(3)  Borrowings from the central bank

• Same as above

• Discount rate - interest rate charged by Federal Reserve to member banks

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c.  Stockholders equity

• Claim by owners of a bank on the bank's assets

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3.  Money creation

• Money created by lending and / or by purchasing securities

• Fractional reserve banking system - only a fraction of total deposits need to be kept on hand as reserves, rest can be loaned out

• Required reserve ratio (reserve requirement) - portion of bank's deposit liabilities that must be held as reserve assets

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a.  First bank

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b.  Banking system

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c.  Checking deposit multiplier

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d.  Other factors affecting the checking deposit multiplier

(1)  Currency in circulation

• People hold some cash instead of depositing all money

• Preferred asset ratio for currency in circulation = C_C / D

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(2)  Customary reserves

• Reserves held in excess of required reserves

• Preferred asset ratio for customary reserves = U / D

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(3)  Near-money deposits

• Some money deposited in near money (savings, time deposits)

• Preferred asset ratio for near money = N / D

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e.  M2 money multiplier

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