Macroeconomics Chapter 16 Notes
What Money Is and Why It’s Important
• Without money, trade would require barter, the exchange of one good or
service for another.
• Most people would have to spend time searching for others to trade with – a
huge waste of resources.
• This searching is unnecessary with money, the set of assets that people
regularly use to buy goods and service from other people.
The 3 Functions of Money
• Medium of exchange: an item buyers give to sellers when they want to
purchase goods and services.
• Unit of account: the yardstick people use to post prices and record debt.
How prices and debt are quoted.
• Store of value: an item people can use to transfer purchasing power form
the present to the future.
The 2 Kinds of Money
• Commodity money: takes the form of a commodity with intrinsic value.
➢ Examples: gold coins, cigarettes in POW camps
• Fiat money: money without intrinsic value, use as money because of
➢ Example: the US dollar
The Money Supply
• The money supply (or money stock): the quantity of money available in the
• What assets should be considered part of the money supply? Two candidates:
➢ Currency: he paper bills and coins in the hands of the (non-bank) public.
➢ Demand deposits: balances in bank accounts that depositors can access on
demand by writing a check.
Measures of the US Money Supply
• M1: currency, demand deposits, traveler’s checks, and other checkable
• M2: everything in M1 plus savings deposits, small time deposits, money
market funds, and a few minor categories.
• M3: M1 and M2 plus large time deposits, purchase agreements, and other
• **only need to know about M1 & M2**
Where is all the currency?
• 2013: $1.1 trillion currency outstanding ➢ Average adult: holds about $4,490 of currency
➢ Much of the currency is held abroad
➢ Much of the currency is held by drug dealers, tax evaders, and other
• Currency is not a particularly good way to hold health
➢ Can be lost or stolen
➢ Doesn’t earn interest
Central Banks & Monetary Policy
• Central bank: an institution that oversees the banking system and regulates
the money supply.
• Monetary policy: the setting of the money supply by policymakers in the
• Federal Reserve (Fed): the central bank of the U.S.
➢ **Need to know everything about the Fed – HISTORY, STRUCTURE,
The Fed’s Organization
• The Federal Reserve
➢ Created in 1913 from the Federal Reserve Act
➢ After a series of bank failures in 1907
➢ “Panic of 1907” also called “Knickerbocker Crisis” - the failure of the
Knickerbocker Trust Company
➢ Purpose: to ensure the health of the nation’s banking system
• Board of governors
➢ 7 members, 14 year terms
o Appointed by the president & confirmed by the Senate
➢ The chairman
o Directs the Fed staff
o Presides over board meetings
o Testifies regularly about Fed policy in front of congressional committees.
o Appointed by the president (4 year term)
o Janet Yellen (Current Chairwoman)
• The Federal Reserve System
➢ Federal Reserve Board in Washington, D.C.
➢ 12 regional Federal Reserve Banks
o Major cities around the country
o The presidents – chosen by each bank’s board of directors
• The Fed’s jobs
➢ Regulate banks & ensure the health of the banking system
o Regional Federal Reserve Banks
o Monitors each bank’s financial condition
o Facilitates bank transactions – clearing checks
o Acts as a bank’s bank
o The Fed – lender of last resort ➢ Control the money supply
o Quantity of money available in the economy
o Monetary policy – by Federal Open Market Committee (FOMC)
➢ Money Supply
o Quantity of money available in economy
➢ Monetary Policy
o Setting of the money supply
Federal Open Market Committee
➢ 7 members of the board of governors
➢ 5 of the 12 regional bank presidents
o All twelve regional presidents attend each FOMC meeting, but only five get to
o NY regional president always votes
➢ Meets about every six weeks in Washington D.C.
➢ Discuss the condition of the economy
➢ Consider changes in monetary policy
The Structure of The Fed
• The Federal Reserve System consists of:
➢ Board of Governors: 7 members, located in Washington, D.C.
➢ 12 Regional Fed Banks: located around the US
➢ Federal Open Market Committee (FOMC): includes 7 board of governors
and 5 presidents of regional Fed banks, one of whom is always the president
of the NYC regional bank. The FOMC decides monetary policy.
• In a fractional reserve banking system, banks keep a fraction of deposits
as reserves and use the rest to make loans.
• The Fed establishes reserve requirements, regulations on the minimum
amount of reserves that banks must hold against deposits. Banks can hold
the reserves as vault cash or deposits at Fed.
• Banks may hold more than this minimum amount if they choose. This is
called excess reserve.
• The reserve ratio, R
➢ = a fraction of deposits that banks hold as reserves.
➢ = total reserves as a percentage of total deposits
➢ R = reserves
• T-account: a simplified accounting