© 2001 j. douglass klein money. © 2001 j. douglass klein money

© 2001 J. Douglass Klein

MONEY


The Equation of Exchange

M V = P Y

Quantity of Money x Velocity of Money

Price Level x Real Output

=



M V = P Y

What if the money supply grows without any increase in the level of real output?

What if the velocity also increases??????????????


Prices, 1750-1890

50

70

90

110

130

150

170

190

210

230

250

1750 1760 1770 1780 1790 1800 1810 1820 1830 1840 1850 1860 1870 1880 1890

MV = PY


Basic Bank Accounting

In any introductory Economics text, review “T” accounts

Assets Liabilities

Specie (gold & silver; reserves)

IOUs (loans owed to the bank, by govt. or individuals)

Notes of Other banksOther Assets

Deposits (money owed to others)

Notes issued by this bank (promises to pay)


History of Banking

Origins of Paper Money Goldsmiths in 16th C. Italy Issued deposit receipts

Origins of Fractional Reserve Banking What if you make loans by issuing deposit receipts instead of specie?

Why there is a money multiplier? A certain amount of gold supports more money in circulation.



Assets Liabilities

Specie (gold & silver)

Deposit ticket (gold owed to others)

After a while, the deposit tickets circulate instead of goldVoila! Paper money!



Assets Liabilities



One day, someone asks for a loan of some gold.The Goldsmith loans the gold in exchange for an IOU



Assets Liabilities



One day, someone asks for a loan of some gold.The Goldsmith loans the gold in exchange for an IOU

I.O.U.1 brick

Loan

The birth of fractional reserve banking



Assets Liabilities



The goldsmith doesn’t even have to loan out gold.The goldsmith can ISSUE MORE TICKETS!

I.O.U.1 brick

Loans

I.O.U.1 brickI.O.U.1 brick

I.O.U.1 brick



Assets Liabilities



At this point there are 8 deposit tickets supported by four bars of gold. The reserve ratio is .5

I.O.U.1 brick

Loans


I.O.U.1 brick



Assets Liabilities

4 Specie (gold & silver)

8 Deposit ticket (gold owed to others)

4 Loans

Any change on one side must be matched by an equal change on the other

+1 Gold +1 deposit ticket

+1 Loan +1 deposit ticket

What happens if depositors begin withdrawing gold?


Problems with Colonial Banking

States issued own money

Continental Congress tried fiat money Not Worth a Continental

Gresham’s Law


Money - 1775-1779

Value of paper money issued (exchange rate of paper to gold coin)

05101520

2530354045

1775 1776 1777 1778 1779

1775 11776 1.5177717781779 42.2


Hamilton’s Bank

“Without a paper, in general currency, equivalent to gold and silver, a considerable proportion of the specie of the country must always be suspended from circulation…” (277)

“To attach full confidence to an institution of this nature, it appears to be an essential ingredient in its structure, that it shall be under a private, not a public direction…” (278)

The capital of the bank is set at $10 million, with the federal government subscribing in the amount $2 million.


Banking abuses

“Perils of State Banking” (1818)

Describe some of the abuses of state banks. (pages 441-443)

Describe the consequences of those abuses.



Assets Liabilities



I.O.U.1 brick

Loans


I.O.U.1 brick

I.O.U.1 brick

I.O.U.1 brickI.O.U.1 brickI.O.U.1 brick

I.O.U.1 brickI.O.U.1 brickI.O.U.1 brick

I.O.U.1 brick


Wholesale Prices (1910-14 = 100)

Source: Hughes, American EconomicHistory, p. 217.

End of the First BUS (1811)

Veto of the 2nd BUS (1832)

© 2001 j. douglass klein money. © 2001 j. douglass klein money

Documents

douglass klein money

brick slide

douglass klein mv

bars of gold

iou slide

py slide

equation of exchange

assets deposits money