Money & Banking Chapter 13

Functions Medium of Exchange – Used in the buying and selling of goods Medium of Exchange – Used in the buying and selling of goods Unit of account – Prices quoted in dollars and cents Unit of account – Prices quoted in dollars and cents Store of Value – Easily transferable, convenient way to store wealth Store of Value – Easily transferable, convenient way to store wealth

Money Supply Narrow definition – Currency & check deposits (M1) Narrow definition – Currency & check deposits (M1) Paper currency consists of Federal Reserve Notes issued by the Fed Paper currency consists of Federal Reserve Notes issued by the Fed Currency & checkable deposits held by the Federal government are not included in M1 Currency & checkable deposits held by the Federal government are not included in M1

Money Supply Savings deposits, money market accounts, certificates of deposits (CDs), as well as money market mutual fund accounts all make up the M2 money definition. Savings deposits, money market accounts, certificates of deposits (CDs), as well as money market mutual fund accounts all make up the M2 money definition. Accessibility is the key feature to all these types of accounts Accessibility is the key feature to all these types of accounts M3 includes CDs (time accounts) over 100K M3 includes CDs (time accounts) over 100K

Measuring Money M1 is the most closely watched by the Federal Reserve although managing or monitoring M2 & M3 is very important as these can often easily be transferred into M1 and further complicates controlling the spendable money supply. M1 is the most closely watched by the Federal Reserve although managing or monitoring M2 & M3 is very important as these can often easily be transferred into M1 and further complicates controlling the spendable money supply. Credit cards assist in keeping M1 balances lower Credit cards assist in keeping M1 balances lower

Stabilizing Money Governments ability to keep value stable provides backing. Governments ability to keep value stable provides backing. Money is debt, paper money is debt of the Fed, and check deposits are liabilities of banks. Money is debt, paper money is debt of the Fed, and check deposits are liabilities of banks. Relative scarcity of money allows for it to retain its purchasing power Relative scarcity of money allows for it to retain its purchasing power

Maintaining Value Government attempts to keep stable with appropriate fiscal policy Government attempts to keep stable with appropriate fiscal policy Difficult balance however in limiting inflation while at the same time encouraging economic expansion Difficult balance however in limiting inflation while at the same time encouraging economic expansion

Purchasing Power Higher prices = Less purchasing power Higher prices = Less purchasing power Excessive inflation makes money worthless & unacceptable. Excessive inflation makes money worthless & unacceptable. Worthless currencies leads to use of other currencies and may actually lead to a barter system in certain cases Worthless currencies leads to use of other currencies and may actually lead to a barter system in certain cases

The Demand for Money Transaction Demand – Money kept for purchases, direct relationship with GDP Transaction Demand – Money kept for purchases, direct relationship with GDP Asset Demand – Money kept as a store of value for later use Asset Demand – Money kept as a store of value for later use Total Value = Transactions + Assets Total Value = Transactions + Assets

The Money Market If demand exceeds supply then people will sell assets (bonds, stocks) in order to obtain money. If demand exceeds supply then people will sell assets (bonds, stocks) in order to obtain money. The result is bonds are more readily available, their price then drops, and their yield increases as well as market interest rates. The inverse is true as well. The result is bonds are more readily available, their price then drops, and their yield increases as well as market interest rates. The inverse is true as well. We know how important interest rates are to investment and consumption. It should then be rational to understand how the FED can maniuplate the economy (i.e. buying and selling bonds We know how important interest rates are to investment and consumption. It should then be rational to understand how the FED can maniuplate the economy (i.e. buying and selling bonds

The Federal Reserve Est Est Board of Governors (7) including Chairman Bernanke Board of Governors (7) including Chairman Bernanke FOMC – Federal Open Market Committee (Governors + (5) Reserve Bank Presidents), control T-bond policy. FOMC – Federal Open Market Committee (Governors + (5) Reserve Bank Presidents), control T-bond policy. 12 districts in the United States, each with a Federal Reserve Bank 12 districts in the United States, each with a Federal Reserve Bank

Federal Reserve Branches NYC, NY NYC, NY St. Louis, MO St. Louis, MO Cleveland, OH Cleveland, OH Philadelphia, PA Philadelphia, PA San Fransisco, CA San Fransisco, CA Denver, CO Denver, CO Dallas, TX Washington D.C. Atlanta, GA Chicago, IL Minneapolis, MN Kansas City, MO

Actions of the FED The Federal Reserve sets the lending requirements of commercial banks. The Federal Reserve sets the lending requirements of commercial banks. It also serves as a clearing house for checks It also serves as a clearing house for checks Also lends money to banks Also lends money to banks Controlling monetary policy however is the major function Controlling monetary policy however is the major function

Questions Complete and turn in. Complete and turn in. What backs the money supply in the U.S.? What backs the money supply in the U.S.? What controls or determines the demand (both transaction and asset) for money? What controls or determines the demand (both transaction and asset) for money? How is the money supply categorized? What makes up each component? How is the money supply categorized? What makes up each component?