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Lecture Economics (9/e): Chapter 29 - David C. Colander

Chapter 29 - The financial sector and the economy. After reading this chapter, you should be able to: Discuss the functions and measures of money, define banks and explain how they create money, explain why the financial sector is so important to macroeconomic debates, explain the role of interest rates in an economy. | The peculiar essence of our banking system is an unprecedented trust between man and man; and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it. — Walter Bagehot The Financial Sector and the Economy Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Goals Discuss the functions and measures of money Define banks and explain how they create money Explain why the financial sector is so important to macroeconomic debates Explain the role of interest rates in an economy 2 The Financial Sector and the Economy The financial sector is central to almost all macroeconomic debates The real sector is the market for the production and exchange of goods and services The financial sector is the market for the creation and exchange of financial assets Financial assets include money, stocks, and bonds Plays a central role in organizing and coordinating our economy 3 The Definition and Functions of Money Money is a highly liquid financial asset that serves as a: Medium of exchange Unit of account Store of wealth Liquid means to be easily changeable into another asset or good Money is a financial asset that makes the real economy function smoothly 4 The U.S. Central Bank: The Fed The Federal Reserve Bank (the Fed) is the U.S. central bank Federal Reserve notes are liabilities of the Fed that serve as cash in the U.S. A bank is a financial institution whose primary function is accepting deposits for, and lending money to, individuals and firms Individuals’ deposits in savings and checking accounts serve the same purpose as does currency and are also considered money 5 Alternative Measures of Money Economists have developed different measures of money Two are M1 and M2 M1 is a measure of the money supply; it consists of currency in the hands of the public plus checking accounts and traveler’s checks M2 is a measure of the money supply; it . | The peculiar essence of our banking system is an unprecedented trust between man and man; and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it. — Walter Bagehot The Financial Sector and the Economy Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Goals Discuss the functions and measures of money Define banks and explain how they create money Explain why the financial sector is so important to macroeconomic debates Explain the role of interest rates in an economy 2 The Financial Sector and the Economy The financial sector is central to almost all macroeconomic debates The real sector is the market for the production and exchange of goods and services The financial sector is the market for the creation and exchange of financial assets Financial assets include money, stocks, and bonds Plays a central role in organizing and coordinating our .