Unit 5: Lesson 1: Managing the Money Supply

Its Uses and Characteristics Money Its Uses and Characteristics

Uses of Money Explained Money, as defined by dictionary.com, is: any circulating medium of exchange, including coins, paper money, and demand deposits. However, for the purposes of economics, money actually has three distinct uses, some of which are not adequately covered in the above definition. These uses are: a Medium of Exchange a Unit of Account a Store of Value Uses of Money Explained

…a Medium of Exchange By definition, a Medium of Exchange is anything that is used to determine value during the exchange of goods and services. Money allows us to use systems of trade beyond the Barter System. Bartering is directly trading one good or service for another. Your money acts as a common ground for determining value.

…a Unit of Account Money can be used as a means to compare the values of goods and services. You can use the monetary value assigned to a specific good or service to compare it to one offered by a different provider. Money allows us to compare similar offers for goods and services to determine the best value.

…a Store of Value Money is used to maintain the value of a transaction over time. If you receive monetary compensation for a good or service, the actual amount that your received does not change if you do not use it immediately. You can spend, or exchange, your money at a later time without penalty. However, the functional value of the stored money may change over time due to other factors. Video Review

An item must have six key characteristics to be considered as “Money”. These Characteristics are: Durability Portability Divisibility Uniformity Limited Supply Acceptability What then is Money?

Durability Durability means that the item must be able to withstand being used repeatedly. Items that are considered Currency, coins and paper bills used as money meet this requirement.

Portability Portability means that individuals are able to carry money with them and transfer it easily to other individuals. This is why coins and paper money have historically proved popular.

Divisibility Divisibility means that the money can easily be divided into smaller units of value. Today, different coins and notes convey these fractional values.

Uniformity Uniformity means that all versions of the same denomination of currency must have the purchasing power. As an example, a 1928 $2 bill will still buy $2 worth of goods or services today.

Limited Supply Limited Supply means that restrictions on the amount of money in circulation ensure that values remain relatively constant for the currency. The responsibility for maintaining an adequate money supply falls on the Federal Reserve System.

Acceptability Acceptability means that everyone must be able to use the money for transactions. In the United States this is indicated on our paper bills by the notation: “This note is legal tender for all debts, public and private”.

Commodity Money – Objects have value for other objects (bartering) Fiat Money – Money only has value because other people want your money. (Current value of money) Representative Money – Money has value because it represents something else. (Gold standard) Value of Money (#3) Video Review

The actions the Federal Reserve takes to influence the GDP and the rate of inflation in the economy. It is necessary to prevent inflation and the devaluing of the American dollar. Monetary Policy

Money Supply (#14) M1 – checking accounts and cash M2 – checking accounts, cash, savings accounts and investments. Money Supply (#14)

Tools of Monetary Policy

1. Federal Open Market Committee (FOMC) Open market operations – the buying and selling of bonds, bills and notes in order to alter the supply of money. Net worth = total assets minus total liabilities If the FOMC wants to decrease the money supply, they will sell stocks, bonds and notes in order to take the money from those they bought it from. (#18) 1. Federal Open Market Committee (FOMC)

2. Required Reserve Ratio The fraction of deposits banks are required to keep in reserve The Board of Governor’s decides the ratio. If the RRR decreases, then the banks can loan out more money.(#16) 2. Required Reserve Ratio

3. The Discount Rate Video Review The interest rate that the Federal Reserve charges commercial banks for loans. Commercial banks borrow from the Federal Reserve as a last resort because the discount rate is higher than the federal funds rate. (#11) (#17) *Federal funds rate = the interest rate banks charge each other for loans. 3. The Discount Rate Video Review

Structure of the Federal Reserve

History of The Federal Reserve 1st Central Bank Began in 1790 Roles: issued a single currency, reviewed banking practices, helped federal government carry out duties and powers Problems: Congress debated over the federal governments power to run banks Ended in 1811 2nd Central Bank Began in 1816 Roles: Same as 1st Bank; restore order Problem: Same as 1st Bank; too much federal power over banks Ended in 1836 Federal Reserve Act of 1913 Began in 1913 Roles: provide a source of emergency cash, set interest rates, divide central banks into regions Problem: Regional banks did not work together. They wanted different interest rates, etc. Reformed in 1935 Present-Day Federal Reserve System Began in 1935 Roles: provide a source of emergency cash, set interest rates , more centralized power with a board, but district banks still brought ideas to the table.

Federal Reserve Districts

Structure of the Federal Reserve

Presidents of The Federal Reserve Janet Yellen Ben Bernanke Currently in office since 2014 Held office from 2006 - 2014 Both presidents are economists from the business world, the academic world or government. They have a keen sensitivity toward public opinion and the ability to use the media to affect public opinion. Presidents of The Federal Reserve

Roles of Titles Board of Governors Set reserve requirements Determine the discount rate policy Develop and administer regulations for: Truth in Lending Act Equal Credit Opportunity Act Home Mortgage Disclosure Act Truth in Savings Act Approve or disapprove proposed bank mergers  regulatory and supervisory responsibilities over:  banks that are members of the System, bank holding companies, international banking facilities in the United States Edge Act and agreement corporations foreign activities of member banks U.S. activities of foreign-owned banks Roles of Titles

Roles of Titles Continued Member Banks Manage the Treasury Department’s checking account that processes Social Security checks, income tax refunds, and other government payments. = They are the banker for the U.S. government (#7). Sell, transfer and redeem bonds, bills and notes Hold auctions for bonds, bills and notes Replace paper currency as it becomes worn out Clear checks Supervise lending practices of banks Lend money as a last resort at the discount rate Research and publish economic activities Holds reserves for commercial banks Conduct bank examinations Manage the money supply Roles of Titles Continued Quick Review of the Fed Video

Federal Reserve Notes – or paper currency, is issued by the U. S Federal Reserve Notes – or paper currency, is issued by the U.S. Treasury Department. Coins are issued by the U.S. Mint. Who issues money?

Check Clearing Process Check is deposited, customer receives money. Check information is electronically sent to the clearing house (Federal Reserve) to check for accuracy and identity. Check information is sent to the writer’s bank to verify that the money is in the account. If the money is in the account, it is transferred to the customer’s bank. If the money is not in the account, a no pay message is sent to the customer’s bank and the customer will have to return the money and pay a fee. Check Clearing Process Video 1 Video 2

Money Creation Process by which money enters circulation Money multiplier formula 𝑖𝑛𝑖t𝑖𝑎𝑙 𝑐𝑎𝑠ℎ 𝑑𝑒𝑝𝑜𝑠𝑖𝑡 𝑋 1 ÷𝑅𝑅𝑅 Video Money Creation

The government cannot print more money than needed because it could cause inflation. Why not print money?

Unit 5: Lesson 2 Key Questions Study for the Lesson 1 Quiz Homework