Macroeconomics- money supply and Federal Reserve System

three functions of money

medium of exchange, unit of account, store of value

medium of exchange

something that you can use to trade for goods and services (universally used)

unit of account

a value in which items are held and can then be compared in order for easier exchange

store of value

an asset set aside for future use (holding on to wealth)

liquidity

the ease with which an item can be converted into the most widely accepted and easily spent form of money with little to no purchasing power (money is perfectly liquid)

Why a house is extremely illiquid

1. hard to sell, takes time and effort

2. loss of purchasing power: paying a real estate agent, taxes, etc.

Money, m0

part of money supply that is just paper currency and coins

Money, m1

m0 + checkable deposits + demand deposits + traveler's checks

commercial banks

primary depository institutions

thrift institutions

a savings and loan association, mutual savings bank, credit union, etc.

near-monies

certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into m1

money, m2

m1 + 3 categories of near-monies: savings deposits (includes money market deposit accounts), small-denominated time deposits (<$100,000), and money market mutual funds held by individuals

savings account

deposit in CB or TI on which interest can be received, used for saving and not daily transactions

money market deposit account (MMDA)

interest bearing account containing a variety of interest-bearing short-term securities

time deposits

interest-earning deposit that a depositor can withdraw without penalty after a certain period of time

money market mutual funds (MMMF)

mutual funds that invest in short-term securities, depositors can write checks in minimum amounts or more against their accounts

legal tender

any form of currency that must be accepted for settlement in financial debt

value of dollar equation

value of dollar = 1 / price level (hundredths)

federal reserve system (the Fed)

our nation's central bank that is not controlled by the federal government

composition of Fed

12 regional federal reserve banks and the board of governors in Washington DC (7 members)

bank reserves

amount of deposits not loaned out by bank (guarantees that there will be money to take out of bank when people need it)

fractional reserve banking system

banks take in deposits and lend most of the money they take in

board of governors

7 members that serve for 14 years, elections are staggered, appointed by President and confirmed by Senate (free of political bias, government wants them to make decisions based on constitutional law)

federal open market committee (FOMC)

makes decisions about growth of money supply (5 presidents of district banks plus 7 BoG members)

3 crucial functions of Fed

establish and implement monetary policy, operate nation's payment system, supervise and regulate banking system

3 tools of monetary supply

discount rate, open market operation, reserve requirement

discount rate

interest rate that Fed charges banks (high rate = less likely banks will borrow from Fed), not used often since banks barely borrow from Fed

open market operation

primary tool of monetary policy, Fed purchases and sells US treasury securities (can buy bonds to increase money supply because money goes to banks and banks pay Fed)

reserve requirement

amount of funds bank holds in reserve to ensure it can meet liabilities in case of a sudden withdrawal

operate nation's payment system

payor --> payee --> depository bank --> Fed --> payor's bank --> payor

supervise and regulate banking system

uses Federal deposit insurance committee (FDIC), which is an insurance company that insures deposits under control of the Fed (makes people less likely to withdraw money quickly--> $250,000 limit)