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