Chapter 31 Money and Banking

Functions of Money Medium of Exchange – Money can be used to buy goods and services; it is readily acceptable as payment Unit of Account – Money measures the relative worth of goods and services Store of Value – Because money is liquid (immediately spendable) it is a convenient way to store wealth

Measuring the Money Supply M1 = Currency + Checkable Deposits (currency = coins + paper money) M1 includes items that are immediately usable as money M2 = M1 + near monies (items that can be quickly converted to money) Near monies include non-checkable savings accounts, money market accounts, and small time deposits (CDs)

Excluded From the Money Supply Currency held by the government, Federal Reserve Banks, or commercial banks Treasury Bonds and Bills US Savings Bonds Credit Cards

What “Backs” the Money Supply Faith – The money supply is no longer backed by gold. Essentially, people have faith in the ability of monetary authorities to manage the value of money Three factors promote the value of money 1. Acceptability – currency and checkable deposits are acceptable as a medium of exchange 2. Legal Tender – read your paper money 3. Relative Scarcity – the Federal Reserve manages the supply of money

Money and Prices The purchasing power of money varies inversely with price level. Rapid inflation deteriorates the value of money. It may result in money ceasing to function as a medium of exchange (see Germany, 1923)

The Federal Reserve The Federal Reserve Act of 1913 created the modern Federal Reserve System. Board of Governors – There are seven members appointed by the president and confirmed by the Senate to 14 year terms. From this group the president selects the chairperson (Ben Bernanke) and vice chairperson who each serve 4 year terms.

12 Federal Reserve Banks Bankers’ banks – Fed banks accept deposits from commercial banks and make loans to these institutions when necessary The Federal Reserve banks are responsible for issuing currency The New York Fed is generally regarded as the most powerful of the Fed banks.

Federal Open Market Committee The FOMC meets regularly (about 10 times a year) and is responsible for establishing monetary policy (more on this later) The FOMC is led by the chairperson of the board of governors.

Fed Functions Issuing currency Setting reserve requirements and holding reserves Lending money to banks and thrifts Providing for check collection Acting as a fiscal agent for the US government Supervising banks Controlling the money supply