class 7: banks, money, housing and financial assets

Finance through time and space:

• Finance 6 dimensions → past, present and future.

• borrowing: take from future

• Saving: giving to the future

how do we measure the price of money?

• intertest rate

  • set in markets but influenced by state institutions especially central banks.

what are the 3 functions of money:

• medium of exchange

• unit of account (=network good)

• store value

Are crypto assets money or a currency?

• unit of account - yes

• medium of exchange- if others accept it yes

• store value- absolutely not

• too volatile to be a currency.

What is money based on today?

• IOU based or liability based.

  • if you own national currency/ bank money → central bank or commercial bank owes you that much.

Money generating system is…

… decentralized

→ central banks issue physical money (base money)

→ commercial banks create money when they issue loans.

what are stocks and bonds?

• stocks= high risk/ high reward → shares in profits of companies

• bonds= governement IOU (safest form of asset)

What is the central bank?

• supplier of base money

• sets the polivy interest rate → applies to banks borrow from each other and frim central bank, base money.

What are commercial banks?

• firm that creates money (bank money) in the form of deposits in the process of creating supplying creddit.

  • sets the lending rate (nominal interest rate)

What are investment and alternative banks?

• firm that buys and sells financial assets.

• not-for-profit bank to ensure bank services for areas, people and governments where commercial banks underservuce (ex: farmers…)

Why are banks seen as fragile financial intermediaries?

• need to have enough cash on hand to meet daily demand = minimum capital standards

• need to manage their investments to meet cash demand.

• need to be able to borrow from other banks overnight.

• need deposit insurance if goes badly

• might need to be closed (= resolution)

• need to be able to borrow from central bank(= lender of last resort)

What are balance sheets?

• summaries the household or firm’s owns and what it owes to others

• assets, liabilites and net worth(=assets-liabilities)

• 2 sides must balance out be be considered solvent.

what is the trade-off between consuming goods now and later?

• opportunity cost of having more goods now id having fewer later.

  • borrowing lending allow us to rearrange capacity to buy G&S across time

how do we calculate the trade-off between current consumption and future consumption?

• interest rate= r

• 1+r = MRT → trade-off

Real vs. nominal interest rate.

• if you lend someone $100 for 1 year at an interest rate of (%

  • inflation= 0% → 9% interest=$9

  • inflation= 5% → 4% interest= $4

  • inflation= 9% → 0% interest

  • inflation= 10%→ lose money (-1%)

Why were interest rates low pre-covid (2008-2020)?

• central banks kept rates low → boost economy.

• economic growth, employment was flat

• situation worse in Europe

Why were interest rate high post-covid?

• economic shocks: shortages, increase demand.

• central banks raise interest rates to fight inflation.

What are the benefits of debt for individuals and governments?

• make an investment today that will hopefully pay-off in the future.

• to avoid liquidating assets to make payments

Why can borrowing be economically optimal?

• in order to smooth consumption:

  • helps provide stable standard of living in response to longer gaps in revenue and desired spending.

What are the problems with borrowing?

• could be motivated by myopia (impatience)

• actors may reject borrowing when it could help (allergic to debt)

• optimal decision making→ discount rate= interest rate.

how do we solve the conflict of interest between the principal and the agent?

• equity= lender may require sime of the borroweer ti put some wealth into the project

• collateral= borrower has to set aside property that will be transfered to lender if loan is not repaid.

  • these situations= secured credits