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Chapter 16

ECON 201 Chapter Notes - Chapter 16: United States


Department
Economics
Course Code
ECON 201
Professor
Sarna
Chapter
16

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Chapter16:TheMonetarySystem
16.1TheMeaningofMoney
○ Moneythesetofassetsinaneconomythatpeopleregularlyusetobuygoodsand
servicesfromotherpeople
○ (A)TheFunctionsofMoney
■ Mediumofexchangeanitemthatbuyersgivetosellerswhentheywantto
purchasegoodsandservices
■ Unitofaccounttheyardstickpeopleusetopostpricesandrecorddebts
■ Storeofvalueanitemthatpeoplecanusetotransferpurchasingpowerfromthe
presenttothefuture
■ Liquiditytheeasewithwhichanassetcanbeconvertedintotheeconomy’s
mediumofexchange
● Moneyisthemostliquidassetavailable
● Mostbondsandstocksarerelativelyliquidassets
○ (B)TheKindsofMoney
■ Commoditymoneythemoneythattakestheformofacommoditywithintrinsic
value
● Intrinsicvaluetheitemwouldhavevalueevenifitwerenotusedas
money
● Ex.Gold
● Goldstandardwhenaneconomyusesgoldasmoney
■ Fiatmoneymoneywithoutintrinsicvaluethatisusedasmoneybecauseof
governmentdecree
○ (C)MoneyintheU.SEconomy
Moneystockquantityofmoneycirculatingintheeconomy
● Includesnotjustcurrencybutalsodepositsinbanksandotherfinancial
institutionsthatcanbereadilyaccessedandusedtobuygoodsand
services
Currencythepaperbillsandcoinsinthehandsofthepublic
■ Demanddepositsbalancesinbankaccountsthatdepositorscanaccesson
demandbywritingacheck
■ M1demanddeposits,traveler’schecks,othercheckabledeposits,currency
■ M2M1+savingsdeposits,smalltimedeposits,moneymarketmutualfunds,and
afewminorcategories
16.2TheFederalReserveSystem
○ Centralbankaninstitutiondesignedtooverseethebankingsystemandregulatethe
quantityofmoneyintheeconomy
■ FederalReserve(Fed)thecentralbankoftheUnitedStates
○ (A)TheFed’sOrganization
■ FederalReserveSystemismadeupoftheFederalreserveBoardinD.Cand
twelveregionalFederalReserveBankslocatedinmajorcitiesaroundthecountries
■ Fedregulatebanksandensuresthehealthofthebankingsystem
● TasklargelytheresponsibilityoftheregionalFederalReserveBanks
● Fedmonitorseachbank’sfinancialconditionandfacilitatesbank
transactionsbyclearingchecks
● “Bank’sbank”
○ Fedmakesloanstobankswhenbankswanttoborrow

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● Lenderoflastresortalendertothosewhocannotborrowanywhereelse
○ FinanciallytroubledbankscanborrowfromFedtomaintain
stabilityintheoverallbankingsystem
■ Fedcontrolsthemoneysupply
● Moneysupplythequantityofmoneyavailableintheeconomy
● Monetarypolicythesettingofthemoneysupplybypolicymakersinthe
centralbank
○ (B)TheFederalOpenMarketCommittee
■ Madeupofthesevenmembersoftheboardofgovernorsandfiveofthetwelve
regionalbankpresidents
■ ThroughthedecisionsoftheFOMC,theFedhasthepowertoincreaseor
decreasethenumberofdollarsintheeconomy
■ OpenmarketoperationpurchaseandsaleofU.Sgovernmentbonds
● IftheFOMCdecidestoincreasethemoneysupply,theFedcreatesdollars
andusesthemtobuygovernmentbondsfromthepublicinthenation’s
bondsmarkets
● Iftheywanttodecreasethemoneysupply,theFedsellsgovernment
bondstothepublic
■ Fed’spolicydecisionsarekeydeterminantsoftheeconomy’srateofinflationinthe
longrunandtheeconomy’semploymentandproductionintheshortrun
■ ThechairmanoftheFedhasbeencalledthesecondmostpowerfulpersoninthe
UnitedStates
16.3BanksandtheMoneySupply
○ (A)TheSimplificationModel/Exampleof100PercentReserveBanking
■ Supposecurrencyistheonlyformofmoney,andthesupplyofmoneyis$100
■ TheFirstNationalBankopensandonlyacceptsdepositsanddoesnotmakeloans
● Reservesdepositsthatbankshavereceivedbuthavenotloanedout
● Inthisimaginaryeconomy,alldepositsareheldasreservesandiscalled
100percentreservebanking
Taccountasimplifiedaccountingstatementthatshowschangesinabank’s
assetsandliabilities
Assets
Liabilities
Reserves$100.00
Deposits$100.00
● Becausetheassetsandliabilitiesexactlybalance,thisaccounting
statementissometimescalledabalancesheet
■ Ifbanksholdalldepositsinreserve,banksdonotinfluencethesupplyofmoney
● Themoneysupplyisthe$100ofdemanddeposits
● Eachdepositinthebankreducescurrencyandraisesdemanddepositsby
theexactsameamount,leavingthemoneysupplyunchanged
○ (B)MoneyCreationwithFractionalReserveBanking
■ SupposetheFirstNationalBankdecidestonowlendoutmoneyandearnaprofit
bycharginginterestontheloans
■ TheFirstNationalBankneedstokeepsomereservessothatcurrencyisavailable
ifdepositorswanttomakewithdrawals
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