Learning Goal Define the fundamental functions of money
Did You Know That … Money ◦ Any medium that is universally accepted in an economy both by sellers of goods and services as payment for those goods and services and by creditors as payment for debts
The Functions of Money The functions of money ◦ Medium of exchange ◦ Unit of accounting ◦ Store of value (purchasing power) ◦ Standard of deferred payment
The Functions of Money(contd) Medium of Exchange ◦ Any item that sellers will accept as payment ◦ Money facilitates exchange by reducing transaction costs associated with means-of-payment uncertainty Permits specialization, facilitates efficiencies Avoids need for Barter! Keeps Fenick from teaching to trade for Donuts!
The Functions of Money(contd) Barter ◦ The direct exchange of goods and services for other goods and services without the use of money ◦ Simply a direct exchange requires a double coincidence of wants ◦ I want a sandwich, I need to find someone that wants to learn Economics!
The Functions of Money(contd) Unit of Accounting ◦ A measure by which prices are expressed ◦ The common denominator of the price system ◦ A central property of money
The Functions of Money(contd) Store of Value ◦ The ability to hold value over time ◦ A necessary property of money ◦ Money allows you to transfer value (wealth) into the future
The Functions of Money(contd) Standard of Deferred Payment ◦ A property of an item that makes it desirable for use as a means of settling debts maturing in the future ◦ An essential property of money
Properties of Money Liquidity ◦ The degree to which an asset can be acquired or disposed of without much danger of any intervening loss in nominal value and with small transaction costs ◦ Money is the most liquid asset
Properties of Money (cont’d) Question ◦ What is the cost of holding money (its opportunity cost)? Answer ◦ It is the alternative interest yield obtainable by holding some other asset
Properties of Money (cont’d) Questions ◦ What backs money? ◦ Is it gold, silver, or the federal government? Answer ◦ Your confidence
Properties of Money (cont’d) Transactions Deposits ◦ Checkable and debitable account balances in commercial banks and other types of financial institutions, such as credit unions and mutual savings banks ◦ Any accounts in financial institutions on which you can easily transmit debit-card and check payments without many restrictions
Properties of Money (cont’d) Fiduciary Monetary System ◦ A system in which currency is issued by the government and its value rests on the public’s confidence that it can be exchanged for goods and services ◦ The Latin fiducia means “trust” or “confidence”
Properties of Money (cont’d) Currency and transactions deposits are money because of their ◦ Acceptability ◦ Predictability of value
Defining Money Money is important ◦ Changes in the rate at which the money supply increases or decreases affect important economic variables (at least in the short run) such as inflation, interest rates, employment, and the level of real GDP Money Supply ◦ The amount of money in circulation
Financial Intermediation andBanks Most nations have a banking system that encompasses two types of institutions 1. One type consists of private banking institutions 2. The other type of institution is a central bank
Chapter 15 Sections 1 and 2The Fed and Money Supply
Learning Goal Describe the basic structure and functions of the Federal Reserve System
The Federal Reserve (AKA – The Fed) The central bank of the United States of America. ◦ Created by Congress in 1913
Mission Statement & The DualMandate The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Written into the Federal Reserve Act, is the mission “To create a healthy growing economy with high employment and price stability.”
The Fed The “Fed” is a system/network of banks. Responsible for Monetary Policy.
Cont. Monetary Policy – Changing the growth of money supply in circulation.
Federal Open Market Committee Board of Governors, head of NY Fed Bank, and 4 rotating heads of the other 11 district banks. ◦ Meet 8 times a year to set MONETARY POLICY ◦ Extremely important decision making body.
Banking System 12 District Banks – 25 branch banks underneath it. ◦ All national banks must become members of the Federal Reserve System.
Loose Money Policy “Expansionary” Credit is abundant and inexpensive to obtain. ◦ Encourages economic growth
Tight Money Policy “Contractionary” Credit is in short supply and expensive to obtain. ◦ Used to control inflation ◦ Think money when money is “tight” it is harder to get, not as much available.
Fractional Reserve Banking Only a fraction of bank deposits must be kept on hand or in reserves the rest can be lent out.
Reserve Requirements A requirement by the Fed – % of Money that banks must keep on reserve from deposits. ◦ Example – Jack deposits $1000 into a checking account. The reserve requirement is 10%. The bank must therefore hold $100 and may loan out the remaining $900.
Chapter 15 Section 3Regulating the Money Supply
Learning Goal Describe what tools the Federal Reserve uses to run a smooth economy.
The Federal Reserve The main goal of the Federal Reserve is to keep the money supply growing steadily and the economy running smoothly
Tool #1 – Changing ReserveRequirements Reserve Requirements – The % of money that banks must hold from a deposit. ◦ Increase Requirements – Less money available to lend out ◦ Decrease Requirements – More money available to lend out
#2 – Discount Rate Banks can borrow money from the Fed (to meet reserve requirements). ◦ The interest charged by The Fed on these loans is the Discount Rate
Cont. Prime Rate – Interest rate banks charge its best business customers. Banks pass on discount rate changes to customers.
Cont. Decrease Interest Rate = Loans become cheaper to obtain = Loans INCREASE in Quantity Demanded Increase interest rates – Loans become more expensive – discourages borrowing
#3 – Open Market Operations Buying and selling government securities (Most common tool Fed uses to control money supply ◦ Fed buys securities it is increasing money supply ◦ Fed sells securities it is decreasing money supply
Federal Funds Rate Interest rate that banks charge each other for short-term loans. Banks that cannot meet reserve requirements must borrow or pay a penalty.
Cont. Fed tries to indirectly change this rate through open market operations.
Delays in Effects of MonetarySupply Full effects can take months, sometimes up to a year
Criticisms of Fed Policies Fed has increased money supply during times of inflation (creating worse inflation) Fed has decreased money supply during recessions (thereby making the recession worse)
Cont. Some Recommend – Money supply increased at same rate each year (no monetary policy) Gov’t (spending and taxation) also has a dramatic affect on the economy.