Unit 5: Lesson 1: Managing the Money Supply

MoneyIts Uses and Characteristics

Uses of Money Explained

Money, as defined by dictionary.com, is:◦any circulating medium of exchange, including

coins, paper money, and demand deposits. However, for the purposes of economics, money

actually has three distinct uses, some of which are not adequately covered in the above definition.

These uses are:◦a Medium of Exchange◦a Unit of Account◦a Store of Value

…a Medium of Exchange By definition, a Medium of

Exchange is anything that is used to determine value during the exchange of goods and services.

Money allows us to use systems of trade beyond the Barter System. ◦ Bartering is directly

trading one good or service for another.

Your money acts as a common ground for determining value.

…a Unit of Account Money can be used as a

means to compare the values of goods and services.

You can use the monetary value assigned to a specific good or service to compare it to one offered by a different provider.

Money allows us to compare similar offers for goods and services to determine the best value.

…a Store of Value Money is used to

maintain the value of a transaction over time.

If you receive monetary compensation for a good or service, the actual amount that your received does not change if you do not use it immediately.◦ You can spend, or

exchange, your money at a later time without penalty.

However, the functional value of the stored money may change over time due to other factors.Video Review

What then is Money?

An item must have six key characteristics to be considered as “Money”.

These Characteristics are:◦Durability◦Portability◦Divisibility◦Uniformity◦Limited Supply◦Acceptability

DurabilityDurability means

that the item must be able to withstand being used repeatedly.

Items that are considered Currency, coins and paper bills used as money meet this requirement.

PortabilityPortability means

that individuals are able to carry money with them and transfer it easily to other individuals.

This is why coins and paper money have historically proved popular.

DivisibilityDivisibility means

that the money can easily be divided into smaller units of value.

Today, different coins and notes convey these fractional values.

UniformityUniformity means

that all versions of the same denomination of currency must have the purchasing power.

As an example, a 1928 $2 bill will still buy $2 worth of goods or services today.

Limited SupplyLimited Supply

means that restrictions on the amount of money in circulation ensure that values remain relatively constant for the currency.

The responsibility for maintaining an adequate money supply falls on the Federal Reserve System.

AcceptabilityAcceptability means that everyone must be

able to use the money for transactions.In the United States this is indicated on our

paper bills by the notation: “This note is legal tender for all debts, public and private”.

Value of Money (#3)

Commodity Money – Objects have value for other objects (bartering)

Fiat Money – Money only has value because other people want your money. (Current value of money)

Representative Money – Money has value because it represents something else. (Gold standard)

Video Review

Monetary Policy

The actions the Federal Reserve takes to influence the GDP and the rate of inflation in the economy.

It is necessary to prevent inflation and the devaluing of the American dollar.

Money Supply (#14)

M1 – checking accounts and cashM2 – checking accounts, cash, savings

accounts and investments.

Tools of Monetary Policy

1. Federal Open Market Committee (FOMC)

Open market operations – the buying and selling of bonds, bills and notes in order to alter the supply of money.

Net worth = total assets minus total liabilities

If the FOMC wants to decrease the money supply, they will sell stocks, bonds and notes in order to take the money from those they bought it from. (#18)

2. Required Reserve Ratio

The fraction of deposits banks are required to keep in reserve The Board of Governor’s decides the ratio.

If the RRR decreases, then the banks can loan out more money.(#16)

3. The Discount Rate

The interest rate that the Federal Reserve charges commercial banks for loans.

Commercial banks borrow from the Federal Reserve as a last resort because the discount rate is higher than the federal funds rate. (#11) (#17)

*Federal funds rate = the interest rate banks charge each other for loans.

Video Review

Structure of the Federal Reserve

History of The Federal Reserve 1st Central Bank

◦ Began in 1790◦ Roles: issued a single currency, reviewed banking practices, helped federal

government carry out duties and powers◦ Problems: Congress debated over the federal governments power to run

banks◦ Ended in 1811

2nd Central Bank◦ Began in 1816◦ Roles: Same as 1st Bank; restore order◦ Problem: Same as 1st Bank; too much federal power over banks◦ Ended in 1836

Federal Reserve Act of 1913◦ Began in 1913◦ Roles: provide a source of emergency cash, set interest rates, divide central

banks into regions◦ Problem: Regional banks did not work together. They wanted different

interest rates, etc. ◦ Reformed in 1935

Present-Day Federal Reserve System◦ Began in 1935◦ Roles: provide a source of emergency cash, set interest rates , more

centralized power with a board, but district banks still brought ideas to the table.

Federal Reserve Districts

Structure of the Federal Reserve

Presidents of The Federal Reserve

Janet Yellen Ben Bernanke

Currently in office since 2014

Held office from 2006 - 2014

Both presidents are economists from the business world, the academic world or government. They have a keen sensitivity toward public opinion and the ability to use the media to affect public opinion.

Roles of Titles

Board of Governors◦Set reserve requirements◦Determine the discount rate policy◦Develop and administer regulations for:

Truth in Lending Act Equal Credit Opportunity Act Home Mortgage Disclosure Act Truth in Savings Act

◦Approve or disapprove proposed bank mergers◦  regulatory and supervisory responsibilities over: 

banks that are members of the System, bank holding companies, international banking facilities in the United States Edge Act and agreement corporations foreign activities of member banks U.S. activities of foreign-owned banks

Roles of Titles Continued

Member Banks◦Manage the Treasury Department’s checking account

that processes Social Security checks, income tax refunds, and other government payments. = They are the banker for the U.S. government (#7).

◦Sell, transfer and redeem bonds, bills and notes◦Hold auctions for bonds, bills and notes◦Replace paper currency as it becomes worn out◦Clear checks◦Supervise lending practices of banks◦Lend money as a last resort at the discount rate◦Research and publish economic activities◦Holds reserves for commercial banks◦Conduct bank examinations◦Manage the money supply

Quick Review of the Fed Video

Who issues money?

Federal Reserve Notes – or paper currency, is issued by the U.S. Treasury Department.

Coins are issued by the U.S. Mint.

Check Clearing Process

1. Check is deposited, customer receives money.2. Check information is electronically sent to the

clearing house (Federal Reserve) to check for accuracy and identity.

3. Check information is sent to the writer’s bank to verify that the money is in the account.

4. If the money is in the account, it is transferred to the customer’s bank.

5. If the money is not in the account, a no pay message is sent to the customer’s bank and the customer will have to return the money and pay a fee.

Video 2Video 1

Money Creation

Process by which money enters circulationMoney multiplier formula

Video

Why not print money?

The government cannot print more money than needed because it could cause inflation.

Homework

Unit 5: Lesson 2 Key QuestionsStudy for the Lesson 1 Quiz