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Lecture 16

LGS 200 Lecture 16: Macroeconomics Chapter 16 Notes

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University of Alabama
Legal Studies
LGS 200

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 government decree. ➢ Example: the US dollar The Money Supply • The money supply (or money stock): the quantity of money available in the economy • 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 deposits. • 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 categories. • **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 criminals. • 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 central bank. • Federal Reserve (Fed): the central bank of the U.S. ➢ **Need to know everything about the Fed – HISTORY, STRUCTURE, RESPONSIBILIES** 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 • FOMC ➢ 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 vote 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. Bank Reserves • 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 Deposits Bank T-account • T-account: a simplified accounting
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