ECON 101 Study Guide - Midterm Guide: Fixed Exchange-Rate System, Barter, Deficit Spending
26 May 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Exam 3 Complete Material
• History
o First money developed before 2000, evolved in mesopotamian region and spread to mediterranean
through trade routes
o Initial money was metal ring (like spiral)
▪ Size of ring = value
o Around 1000BC - Chinese introduced Fiat money
▪ Money in industrialized currency
▪ Need to control, regulate and institutional structure
o Changed to coinage: stamp and authenticated
o Effect of money
▪ Increase in specialization of labor
▪ Move from personal subsistence production - start trading for food
▪ Enabled concentration of people in urban centers
o Development of money led to development of complex mathematics
▪ Compound interest...etc financial assets
o Characteristics of good currency
▪ Standardized
▪ Portable
▪ Easily recognizable and uniformity in appearance
▪ Authenticated
• Money
o Defined by function, not form
▪ Medium of exchange - money can buy and sell goods and services (transact)
• Eliminates need to barter (exchange goods/services for goods/services) and
lower transaction costs
o Barter requires double coincidence of wants (each person wants what
the other has) - wastes lot of time searching for trade partners
▪ Store of value - enables you to hold wealth, accumulate assets, enable society to alter
consumption stream overtime
• Can save money, don’t have to spend all of it immediately... or spend a lot at
once (you can borrow money)
• Makes savings possible, which allows for business investment
▪ Standard of value - enables society to compare relative worth of different goods based
on price - compare relative scarcity, desirability - information inherent in price - anything
that allows comparison of worth can be considered money
• Lower transaction costs, less information have to search for
• Monetary regimes
o Commodity money - money has intrinsic value (has alternative use)
▪ Examples include gold, silver, shells, cigarettes & stamps (in concentration camps)
▪ Pro
• Pick right commodity, money supply is controlled by availability of money
o Hard to get, cannot make itself, limitation of supply
• Don’t need a central bank or regulation
▪ Cons
• Large opportunity supply (the resources aren’t actually being used)
o The budweiser is not being consumed
• Can be destabilized easily - gotta be able to monitor and control money
o Gold rush example, lead to inflation
o Commodity backed money - dollar on gold standard example
▪ Certificate is circulated and is backed by a commodity (or other currency of a currency
board)
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▪ Money can be redeemed for the commodity (government has to be able to redeem the
certificate)
▪ Decrease in opportunity costs
▪ Controls money supply by commodity backing
▪ Don’t need regulator (no institutional structures)
▪ Value based on commodity content (ex. gold)
• Fixed exchange rate based on gold
▪ Have to have enough gold to back the dollar
• Can experience gold drain (country prints money but doesn’t have enough gold
to back it)
▪ Modern version of commodity backed money - currency board
▪ Current type of fixed currency
▪ What circulates is local currency, which is backed by foreign currency (instead by
commodity)
• Ex. argentina backed on U.S. dollar
• Cannot create money supply, only if they get more U.S. dollars
• Backed on global currencies: U.S., Euro, Yen
o Fiat money - modern currencies (U.S., Euro, Yen)
▪ No intrinsic value or backing, only value is credibility (ability to have faith and trust in it)
▪ Do not use commodities (want to use all resources for productive activity, maximize
output/GDP, not waste resources like Budweiser)
▪ Have legitimate institutional structure like Central bank (regulatory authority)
▪ Has to control supply in order to maintain value (cannot just print money and devalue
currency)
▪ Decrease opportunity costs of money supply
o Virtual money - blockchain, crypto
▪ Examples: ether, bitcoin...
▪ Virtual credit with no physical form or backing or intrinsic value
▪ Faith and confidence in the worth/value
• Very volatile and changes constantly
• Nobody can arbitrarily create money, also no central authority
o Has to mine - verify all transactions on the blockchain
o Finite limit on currency
▪ Issues
• Divorces money from geography (crypto does not belong to any country)
o Makes taxes difficult, can undermine currency
• Harder to control money supply
• Alters role of banks and central banks
o Alter monetary policy
• Removes middlemen (direct transaction)
• Entities other depository facilities (virtual wallet) in money supply
• May increase inequality (lower income less access to virtual assets)
• Eliminates seigniorage (money made by government by printing money that
helps spending and revenue for CB and gov.)
• Change relationship between money and income
• Increase transparency
• Increase convergence to global economy - globalization
• Controlling money supply for Fiat money
o Federal reserve is Central bank
▪ System of banks (pyramid form)
• Top : ruling and policy making entities (board of gov. & OM committee)
• Mid: regional fed. Reserve banks
• Low: private banks (members of federal reserve - only large national banks)
o Bank of america, wells fargo
▪ Ruling and policy making entities
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find more resources at oneclass.com
• Board of Governors - 7 members appointed (not elected, nominated by
president and vetted by Senate) - determine policy
o 14 year term - one term expires every two years (only one term)
▪ Staggered expiration
• More continuous policies
o President can appoint 2 members per presidential term (4 years)
▪ 2 terms - 8 years - 4 members - majority
▪ Removes fed from political influences**
o Chairman appointed 2nd year of presidential term - 4 years term (of the
7 members)
▪ Spans presidential terms - smooth transition between
presidencies; more continuity; long term focused (less short
term and political)
o Federal reserve does not go to congress or senate for funding - does not
need appropriations from exec. Legist. branch
▪ Monetary policy is depoliticized and focused on long term -
target inflation w/ eye to unemployment and growth
▪ Open market committee - implements policy - decides how to engage in OMO*
• Composed of the board of governors and the 4 regional federal reserve bank
presidents and chairman of federal reserve bank of NY (very powerful position)
- 12 positions total
o All policies start in NY bank (financial center)*
o Regional presidents rotate between states within regions
• Implements policy
o Decides how to engage/conduct in open market operations
o Federal reserve buying and selling bonds
▪ This actually affects interest rate changes, money supply
changes... etc
▪ Constantly selling - people cant tell if fed is net buyer or
seller... cant take advantage
• OMO -> Interest rate changes, money supply changes
• 2 advisory councils
o Bankers advisory council - private sector banks
o Thrifts advisory council - advisory & honorary
▪ Provide feedback and input on private sector sentiment
▪ The fed taps pulse of private sector
• Updates and info/advice
o Both depository institutions - accept deposits and grant loans
▪ Banks mostly served business community (corporate lending)
- depository + investment
▪ Thrifts mostly served consumer market (personal, housing
market...etc) - home mortgage loans, consumer credit -
savings, loans, credit unions, mutual savings
▪ Much similar now (DRMCA 1980)
▪ Regional banks -
• 12 spread across US, mostly on east coast (historically financial center, set up in
1913, very few west coast fed banks as east coast was very active)
• Functions
o Implement policy in their regional market
o Serve as banks for bankers
▪ Hold private bank deposits and grant them loans
o Clear interstate checks (checks drawn between diff states)
o Transfer remittances - sending money to others diff places
o Police their regional banks - policy
find more resources at oneclass.com
find more resources at oneclass.com
