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An Overview of the Monetary System

Learn about the three functions of money, types of money, money supply, definitions of M1 and M2, central banks, and monetary policy. Explore the Federal Reserve System and its role in stabilizing the economy.

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An Overview of the Monetary System

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  1. An Overview of the Monetary System Chapter 29

  2. 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 0

  3. The Two Kinds of Money Commodity money: Takes the form of a commodity with intrinsic value Examples: gold coins, cigarettes 0 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?

  4. 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? Currency: the paper bills and coins in the hands of the public Demand deposits: balances in bank accounts that depositors can access on demand by writing a check 0

  5. Money Definition M1 • M1 • Currency • Checkable deposits • Institutions offering checkable deposits • Commercial banks • Savings and loan associations • Credit unions 31-5 LO1

  6. Money Definition M2 • M2 • M1 plus “near-monies” • Savings deposits including money market deposit accounts (MMDA) • Small-denominated time deposits (CD’s) • Money market mutual funds (MMMF) 31-6 LO1

  7. Money Definitions January 2010 Source: Federal Reserve System 31-7 LO1

  8. What “Backs” the Money Supply? • Guaranteed by government’s ability to keep value stable • Why is money valuable? • Acceptability • Legal tender • 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. 31-8 LO2

  9. 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” 0 Is the Fed unconstitutional?

  10. Federal Reserve Banking System The 12 Federal Reserve Banks 31-10 LO3

  11. Federal Reserve Banking System Board of Governors Federal Open Market Committee 12 Federal Reserve Banks Commercial Banks Thrift Institutions (Savings and Loan Associations, Mutual Savings Banks, Credit Unions) The Public (Households and Businesses) 31-11 LO3

  12. Who is the chairman of the Fed? 0 Ben S. BernankeChair of FOMCFeb 2006 – present

  13. Broad functions of the Federal Reserve Issue currency Set reserve requirements Lend money to banks Supervise banks Control the money supply 31-13 LO4

  14. The Federal Reserve Toolkit Open Market Operations Reserve Requirement Discount Rate 31-14 LO3

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