Money and Banking— Monetary Policy Chapter 13

Functions of Money  1. Medium of exchange—used for buying and selling g & s  2. Unit of account—prices are quoted in dollars & cents  3. Store of value: allows purchasing power to be stored until needed (liquid)

Characteristics of Money  1. portability—easily transferred  2. durability—should not deteriorate when being used as a store of value  3. divisibility—easily broken down into smaller units  4. limited availability--$ decreases in value when there is too much

How is money made?

Supply of Money—M1  Includes currency and checkable deposits  1. currency (coins & paper) held by public  A. Is “token” money “fiat”  Ex: The metal in a dime is worth less then 10 cents.  B. All paper currency consists of Federal Reserve Notes issued by the FED

Supply of Money—M1  2. Checkable deposits are included since they can be spent almost as readily as currency & can be changed into currency  A. Commercial banks are a main source of checkable deposits for households and businesses  B. Thrift institutions also have checkable deposits (savings and loans, credit unions, etc.)

Supply of Money—M1  3. Currency and checkable deposits held by the federal gov’t or FED are not included in M1

M2  M2 = M1 + 1.Savings deposits & money market deposit accounts 2.Certificates of deposit < $100, Mutual Funds

M3  M3 = M2 + large CDs > $100,000

Importance  M2 is watched closely by the FED to determine monetary policy

Credit Cards  Are they money?  No, they are short term loans  Allow the owner to keep M1 levels low since they need less for daily purchases

What “backs” the money supply?  1. consumer confidence in the gov’t ability to keep its value stable  2. the value of money is the exchange of g & s  Is a medium of exchange  Legal tender  Relatively scarce so maintains purchasing power

 3. Money’s purchasing power determines its value. Higher prices means less purchasing power  4. Excessive inflation may make money worthless.  5. Maintaining the value of money  Congress through fiscal policy (G &T)  FED through monetary policy (interest rates)

Study Questions  Page 262  Numbers 1, 2, 3 (pick any 3 statements to explain) and 4 (first 3 questions only)

In Plain English Video  Take notes  Focus on the  Board of Governors (BoG)  Federal Reserve Banks  Federal Open Market Committee (FOMC)

The Money Market: Interaction of Money Supply and Demand  Key Graph # 10 illustrates the money market. If combines demand with supply of money.

 If the quantity demanded exceeds the quantity supplied, people sell assets like bonds to get money. This causes bond supply to rise, bond prices to fall and a higher market rate of interest.  If the quantity of supplied exceeds the quantity demanded, people reduce money holdings by buying other assets like bonds. Bond prices rise and lower market rates of interest result.

 Monetary authorities can shift supply to affect interest rate, which in turn affect Ig and C and AD and ultimately output, employment and prices.  Key Graphs 11 and 12