1、Chapter 12 Economical Policy,THE MEANING OF MONEY,Money is the set of assets in an economy that people regularly use to buy goods and services from other people.,The Functions of Money,Money has three functions in the economy: Medium of exchange Unit of account Store of value,The Functions of Money,

2、Medium of Exchange A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services. A medium of exchange is anything that is readily acceptable as payment.,The Functions of Money,Unit of Account A unit of account is the yardstick people use to post prices an

3、d record debts. Store of Value A store of value is an item that people can use to transfer purchasing power from the present to the future.,The Functions of Money,Liquidity is the ease with which an asset can be converted into the economys medium of exchange.,The Kinds of Money,Commodity money takes

4、 the form of a commodity with intrinsic value. Examples: Gold, silver, cigarettes. Fiat money is used as money because of government decree. It does not have intrinsic value. Examples: Coins, currency, check deposits.,Money in the U.S. Economy,Currency is the paper bills and coins in the hands of th

5、e public. Demand deposits are balances in bank accounts that depositors can access on demand by writing a check.,Figure 1 Two Measures of the Money Stock for the U.S. Economy,Billions,of Dollars,0,CASE STUDY: Where Is All The Currency?,In 2004 there was $699 billion of U.S. currency outstanding. Tha

6、t is $3,134 in currency per adult. Who is holding all this currency? Currency held abroad Currency held by illegal entities,THE FEDERAL RESERVE SYSTEM,The Federal Reserve (Fed) serves as the nations central bank. It is designed to oversee the banking system. It regulates the quantity of money in the

7、 economy.,THE FEDERAL RESERVE SYSTEM,The Fed was created in 1913 after a series of bank failures convinced Congress that the United States needed a central bank to ensure the health of the nations banking system.,THE FEDERAL RESERVE SYSTEM,The primary elements in the Federal Reserve System are: The

8、Board of Governors The Regional Federal Reserve Banks The Federal Open Market Committee,The Feds Organization,The Fed is run by a Board of Governors, which has seven members appointed by the president and confirmed by the Senate. Among the seven members, the most important is the chairman. The chair

9、man directs the Fed staff, presides over board meetings, and testifies about Fed policy in front of Congressional Committees.,The Feds Organization,The Board of Governors Serve staggered 14-year terms so that one comes vacant every two years. President appoints a member as chairman to serve a four-y

10、ear term.,The Feds Organization,The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C., and twelve regional Federal Reserve Banks.,The Feds Organization,The Federal Reserve Banks Twelve district banks Nine directors Three appointed by the Board of Governors. Six are e

11、lected by the commercial banks in the district. The directors appoint the district president, which is approved by the Board of Governors. The New York Fed implements some of the Feds most important policy decisions.,The Federal Reserve System,The Feds Organization,Three Primary Functions of the Fed

12、 Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices. Acts as a bankers bank, making loans to banks and as a lender of last resort. Conducts monetary policy by controlling the money supply.,The Federal Open Market Committee (FOMC),Serves as the mai

13、n policy-making organ of the Federal Reserve System. Meets approximately every six weeks to review the economy.,The Federal Open Market Committee (FOMC),The Federal Open Market Committee (FOMC) is made up of the following voting members: The chairman and the other six members of the Board of Governo

14、rs. The president of the Federal Reserve Bank of New York. The presidents of the other regional Federal Reserve banks (four vote on a yearly rotating basis).,The Federal Open Market Committee (FOMC),Monetary policy is conducted by the Federal Open Market Committee. The money supply refers to the qua

15、ntity of money available in the economy. Monetary policy is the setting of the money supply by policymakers in the central bank.,The Federal Open Market Committee,Open-Market Operations The money supply is the quantity of money available in the economy. The primary way in which the Fed changes the m

16、oney supply is through open-market operations. The Fed purchases and sells U.S. government bonds.,The Federal Open Market Committee,Open-Market Operations To increase the money supply, the Fed buys government bonds from the public. To decrease the money supply, the Fed sells government bonds to the

17、public.,BANKS AND THE MONEY SUPPLY,Banks can influence the quantity of demand deposits in the economy and the money supply.,BANKS AND THE MONEY SUPPLY,Reserves are deposits that banks have received but have not loaned out. In a fractional-reserve banking system, banks hold a fraction of the money de

18、posited as reserves and lend out the rest.,BANKS AND THE MONEY SUPPLY,The reserve ratio is the fraction of deposits that banks hold as reserves.,Money Creation with Fractional-Reserve Banking,When a bank makes a loan from its reserves, the money supply increases. The money supply is affected by the

19、amount deposited in banks and the amount that banks loan. Deposits into a bank are recorded as both assets and liabilities. The fraction of total deposits that a bank has to keep as reserves is called the reserve ratio. Loans become an asset to the bank.,Banking Money Creation with Fractional-Reserv

20、e,This T-Account shows a bank that accepts deposits, keeps a portion as reserves, and lends out the rest. It assumes a reserve ratio of 10%.,Money Creation with Fractional-Reserve Banking,When one bank loans money, that money is generally deposited into another bank. This creates more deposits and m

21、ore reserves to be lent out. When a bank makes a loan from its reserves, the money supply increases.,The Money Multiplier,How much money is eventually created by the new deposit in this economy?,The Money Multiplier,The money multiplier is the amount of money the banking system generates with each d

22、ollar of reserves.,The Money Multiplier,Increase in the Money Supply = $190.00!,The Money Multiplier,Original deposit = $100.00 1st Natl. Lending = 90.00 (=.9 x $100.00) 2nd Natl. Lending = 81.00 (=.9 x $ 90.00) 3rd Natl. Lending = 72.90 (=.9 x $ 81.00) and on until there are just pennies left to le

23、nd! Total money created by this $100.00 deposit is $1000.00. (= 1/.1 x $100.00),The Money Multiplier,The money multiplier is the reciprocal of the reserve ratio: M = 1/R Example: With a reserve requirement, R = 20% or .2: The money multiplier is 1/.2 = 5.,The Feds Tools of Monetary Control,The Fed h

24、as three tools in its monetary toolbox: Open-market operations Changing the reserve requirement Changing the discount rate,The Feds Tools of Monetary Control,Open-Market Operations The Fed conducts open-market operations when it buys government bonds from or sells government bonds to the public: Whe

25、n the Fed sells government bonds, the money supply decreases. When the Fed buys government bonds, the money supply increases.,The Feds Tools of Monetary Control,Reserve Requirements The Fed also influences the money supply with reserve requirements. Reserve requirements are regulations on the minimu

26、m amount of reserves that banks must hold against deposits.,The Feds Tools of Monetary Control,Changing the Reserve Requirement The reserve requirement is the amount (%) of a banks total reserves that may not be loaned out. Increasing the reserve requirement decreases the money supply. Decreasing th

27、e reserve requirement increases the money supply.,The Feds Tools of Monetary Control,Changing the Discount Rate The discount rate is the interest rate the Fed charges banks for loans. Increasing the discount rate decreases the money supply. Decreasing the discount rate increases the money supply.,Problems in Controlling the Money Supply,The Feds control of the money supply is not precise. The Fed must wrestle with two problems that arise due to fractional-reserve banking. The Fed does