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THE MONETARY SYSTEM
Mankiw CH. 11
FUNCTIONS OF MONEY
1. Medium of Exchange: An item exchanged when buyers want to purchase goods and services
• Money (Dollars) is the commonly accepted medium of exchange in the U.S.
2. Unit of Account: The measure used to quantify and record economic value.
• You don’t take a loan out for one car, you take a loan out for $30,000 3. Store of Value: Used to store purchasing power over time
• An item used to transfer purchasing power from the present to the future
• i.e. holding currency, holding stocks and bonds
THE KINDS OF MONEY
• Commodity Money: Has intrinsic value. (It would have value even if it was not used as currency) • i.e. Gold, Granola Bars, Cigarettes etc.
• Fiat Money: Money without intrinsic value that is used as currency because of government decree. • i.e. US Dollars, Euros, Yen • “This note is legal tender for all debts, public and private”
MEASURING MONEY IN THE U.S. ECONOMY
• Money Stock: Money circulating in the economy How much money is in the U.S. Economy? 1. Currency- Paper bills and coins in hands of the public (Most widely accepted
currency) 2. Demand Deposits- Balances in bank accounts that depositors can access on
demand - You can access your checking account fairly easy by making withdrawals,
writing checks, using debit cards etc.
THE FEDERAL RESERVE
• The Federal Reserve is the central bank of the United States • Made up of 7 Members (Including one Chairman) • The Federal Reserves 2 main functions: 1. Regulate banks and the overall health of our banking system 2. Control the quantity of money that is made available in the economy.
(The Money Supply) • Policy is made by the Federal Open Market Committee (FOMC) • Money supply is increased or contracted by open-market operations. (Buying or
Selling government bonds)
BANKS AND THE MONEY SUPPLY
• We have accounted for the amount of money held as currency, now we need to discuss demand deposits (the balance in your checking account).
Some Preliminary Need to Know Information.. • Reserves: the portion of deposits that banks have not, and will not lend out. • A bank’s liabilities include deposits, assets include reserves and outstanding loans. • 100-percent-reserve banking: a system in which banks hold all deposits as
reserves. • Fractional-reserve banking: a system in which banks hold only a fraction of their
deposits as reserves.
• T-Account: Simplified accounting statement showing a banks assets and liabilities • 100% Reserve Banking: Gives depositors safe place to store money • Fractional Reserve Banking: Only holds a fraction of money as reserves • Reserve Ratio: The fraction of deposits that a bank holds as reserves
• (This can be determined by government regulation and bank policy) • Reserve Requirement: The minimum amount of reserves banks must hold (Set
by the FED) • Excess Reserves: Reserves held that are above the legal minimum
• (So banks can be more confident they will not run short of cash)
THE MONEY MULTIPLIER
• The Money Multiplier: The amount of money the banking system generates with each dollar of reserves • If $100 of reserves generates $1000 of money, the money multiplier
is 10 • The money multiplier is the reciprocal of the reserve ratio!
• Reserve Ratio= 10% 10/100 or 1/10 Money multiplier is 10! • The higher the reserve ratio, the less of each deposit banks loan out,
thus a smaller money multiplier