Relationship between money and banking system

relationship between money and banking system

money and banking in the working of any economic system. the workings of an economic system can be reduced to a series of relationships between. The design of the money and banking system is implicated in the largest . the trend to transform nature into commodities and relationships into services. MONEY AND BANKING Unit between parties could be referred to as Barter System in simple. . Money Multiplier = Money Supply / Base Money Relationship between reserve money and money multiplier Money supply.

Lower real interest rates provide incentives for people to save less and to borrow more.

relationship between money and banking system

Real interest rates are positive because people must be compensated for deferring the use of resources from the present into the future. Riskier loans command higher interest rates than safer loans because of the greater chance of default on the repayment of risky loans.

Investment in factories, machinery, new technology, and the health, education, and training of people can raise future standards of living. Investment in physical and human capital can increase productivity, but such investments entail opportunity costs and economic risks.

relationship between money and banking system

Investing in new physical or human capital involves a trade-off of lower current consumption in anticipation of greater future production and consumption. Higher interest rates discourage investment. Monetary policies are decisions by the Federal Reserve System that lead to changes in the supply of money and the availability of credit.

relationship between money and banking system

Changes in the money supply can influence overall levels of spending, employment, and prices in the economy by inducing changes in interest rates charged for credit and by affecting the levels of personal and business investment spending.

The major monetary policy tool that the Federal Reserve System uses is open market purchases or sales of [U.

relationship between money and banking system

Other policy tools used by the Federal Reserve System include increasing or decreasing the discount rate charged on loans it makes to commercial banks and raising or lowering reserve requirements for commercial banks. Identify the differences between commodity-backed money and fiat money. Discuss different methods of valuing currency — government set value; pegging to other currencies; floating exchange rate — and how economic changes, trade policies, and central banks can affect the value of currencies.

Explain currency exchange rates and currency speculation. Briefly review the history and development of fractional reserve banking. Define the money supply and relate changes in the money supply to commercial banking. Explain how the composition of the money supply responds to market forces. Define and demonstrate the money multiplier.

Review the operation of supply, demand, and price in product markets, and develop the example of interest as the price in capital markets.

Discuss the relationship between interest rates and investment, and relate to the business cycle model. Add interest and investment to the previously developed circular flow model. Discuss how deficit spending and other fiscal policies may impact interest rates, investment, and national economic goals growth, stability, security, equity.

Present and explain the Quantity Theory of Money. Money supply measures include currency in circulation and transaction and time demand deposits. Banks and other financial intermediaries perform an important role in the economy by coordinating the actions of savers and lenders on the one hand, and borrowers and investors on the other.

The real interest rate is the price of money. The nominal interest rate is the real interest rate plus the expected rate of inflation. Changes in real interest rates change the levels of saving and borrowing in the economy. The level of investment in the economy, and therefore the rate of economic growth, is directly related to interest rates. Banks provide a place where individuals and businesses can invest their funds to earn interest with a minimum of risk.

Banks, in turn, redeploy these funds by making loans. In this regard, banks are remarkably similar to other financial intermediaries, like finance companies and insurance companies, which also acquire funds from individuals and businesses and pass on these funds to other individuals and businesses.

relationship between money and banking system

Like financial companies and life insurance companies, banks are particularly well-equipped to invest in the most challenging types of financial investments--loans to individuals and small businesses. Why are banks singled out for special treatment?


As it turns out, most of what we call money in the United States is represented by the deposits issued by banks. Consequently, banks serve as the principal caretakers of the payments system because we write checks on our bank accounts to pay for things we buy.

Moreover, because money has linkages to the overall performance of the economy, banks are intimately involved in how the central bank of the Unites States, called the Federal Reserve, influences overall economic activity.

In particular, the Federal Reserve directly influences the lending and deposit creation activities of banks. This, in turn, helps determine how much people are willing to save and how much businesses are willing to invest and whether the prices of stocks and bonds go up, down, or sideways in the financial markets.

How does this work? For the complete answer, you have to read the rest of this book!

How Banks Create Money and the Money Multiplier- Macro 4.8

But here's a preview of what you will find. The remaining chapters in Part I set the stage. We define money and look at its relationship with economic performance. Then we'll provide an overview of financial institutions, instruments, and markets and how they serve as a mechanism for the flow of saving and investment. In Part II we examine the performance and behavior of financial markets where funds move directly from those who have funds to those who need funds.

We pay special attention to how all types of securities are valued, how interest rates are determined, and how complicated markets, such as derivatives and foreign exchange, actually work.

In Part III we look at intermediated markets where funds move between borrowers and lenders via financial intermediaries, such as banks, insurance companies, pension funds, and some institutions you may not have heard of. In Part IV we examine the overall financial system.

Money and the Banking System — The Federal Reserve and Monetary Policy

This will involve looking at the relationship between financial markets and intermediated markets, the regulation of these markets, and an international comparison across different financial systems. Part V begins this process by discussing the art of central banking. We can then address questions about the linkages among money, inflation, growth, and employment in Part VI.

Along the way we'll learn that not everyone agrees on just what these linkages are, so you'll have to make up your own mind about what seems right. Part VI brings us 'round full circle linking monetary policy, prices in the stock and bond market, and the performance of the economy. Why would you want to study money, banking and financial markets?