An Overview of the Monetary SystemChapter 29

The Three Functions of Money Medium of exchange: an item buyers give

to sellers when they want to purchase goods and services

Unit of account: goods/services are valued or measured in dollars

Store of value: an item people can use to transfer purchasing power from the present to the future

The Two Kinds of MoneyCommodity money: Takes the form of a commodity with intrinsic value

Examples: gold coins, cigarettes

Fiat money: Money without intrinsic value, used as money because of government decree

Example: the U.S. dollar

Does it matter which type of money we use?

The Money Supply The money supply (or money stock) is

the quantity of money available in the economy

What assets should be considered part of the money supply? 1. Currency: the paper bills and coins in the

hands of the public

2. Demand deposits: balances in bank accounts that depositors can access on demand by writing a check

Money Definition M1M1CurrencyCheckable deposits

Institutions offering checkable depositsCommercial banksSavings and loan associationsCredit unions

LO1 31-5

Money Definition M2

M2M1 plus “near-monies”Savings deposits including money market deposit accounts (MMDA)

Small-denominated time deposits (CD’s)

Money market mutual funds (MMMF)

LO1 31-6

Money Definitions

January 2010

Source: Federal Reserve System

LO1 31-7

What “Backs” the Money Supply?Guaranteed by government’s ability to

keep value stableWhy is money valuable?1. Acceptability2. Legal tender3. Relative scarcity

Prices affect purchasing power of money, hyperinflation renders money unacceptable. For this reason, the government “needs” to stabilize the purchasing power of money with intelligent monetary and appropriate fiscal policy.

LO2 31-8

Central Banks & Monetary Policy A central bank is an institution that oversees the banking

system and regulates the money supply. The central bank established monetary policy through its policymakers.

In the United States the Federal Reserve Bank (established in1913) is the central bank.

The Federal Reserve Bank is a quasi-public bank.

The Federal Reserve System consists of: Board of Governors (7 members), located in

Washington, DC Regional Fed banks (12), located around the U.S. Federal Open Market Committee (FOMC) which

includes the Board of Governors and 5 presidents from the regional Fed banks (1 year rotation- NY president is always seated). The FOMC decides monetary policy.

“The Fed Today”

Is the Fed unconstitutional?

Federal Reserve Banking System

LO3

The 12 Federal Reserve Banks

31-10

Federal Reserve Banking System

Commercial BanksThrift Institutions

(Savings and Loan Associations,Mutual Savings Banks,

Credit Unions)

The Public(Households and

Businesses)

12 Federal Reserve Banks

Board of Governors

Federal Open Market Committee

LO3 31-11

Who is the chairman of the Fed?

Ben S. BernankeChair of FOMC

Feb 2006 – present

Broad functions of the Federal Reserve

1. Issue currency2. Set reserve requirements3. Lend money to banks 4. Supervise banks5. Control the money supply

LO4 31-13

The Federal Reserve Toolkit

Open Market OperationsReserve RequirementDiscount Rate

LO3 31-14