Economics BASIS 8 Unit 9 : Monetary Policy

Unit 9A : Money & the Money Market

Commodity Money—a physical good that has “intrinsic value” (a use outside of its use as money

Commodity Backed Money—(or representative money) a type of currency guaranteed by a physical commodity, such as gold or silver. the money itself has no intrinsic value

Fiat Currency—currency issued by a government that is not backed by a physical commodity like gold or silver, but rather by the government’s authority and the trust in it’s stability

Functions of Money

• Medium of Exchange—it is something accepted by all parties as payment for goods and services

• Unit of Account—it can be used as a common measuring stick to express worth in terms that most individuals understand. think price tags

• Store of Value—allows purchasing power to be saved until needed, i.e., it’s not something that can expire

Characteristics of Money

• Portability—lightweight and easy to carry with you

• Durability—able to suffer to some wear and tear w/o losing value

• Divisibility—can be broken into smaller denominations, or combined into larger

• Uniformity—easily recognizable

• Limited Supply—scarcity is important to maintaining value. money that is not regulated or is over-produced risks losing its value

• Acceptability—money should be widely taken in exchange for goods and services. in fact, in the U.S., the government mandates this

The money supply is the total amount of money—cash, coins, and balances in bank accounts—available for use in an economy

• M1 Money is the most liquid forms of money (e.g. cash, checking accounts)

  • The money supply in the economy is considered M1 Money

The money supply curve is typically depicted as a vertical line.

• this is because the central bank (like the Fed) uses tools to control the quantity of money in the economy, and this quantity is assumed to be fixed regardless of the interest rates.

Unit 9B : Banking

Under a fractional reserve system, banks are required to keep only a portion of total deposits in the form of legal reserves.

• the size of the required reserves is determined by a required reserve ratio (%), the percentage of every deposit that must be set aside as legal reserves.

New checkable deposits become new money when loans are made; i.e., the money supply is increased.

• checkable deposits or demand deposits, are bank accounts where funds can be withdrawn on demand, such as through checks or debit cards, without prior notice

The central bank of the United States is the Federal Reserve System (often called “The Fed”)

• controls and influences the money supply

• regulates commercial banks

• conducts monetary policy

Commercial Banks are financial institutions that accept deposits form individuals and businesses and provide loans and credit.

Unit 9C : Monetary Policy

One of the most important functions of the Federal Reserve System is to conduct monetary policy—changes in the money supply in order to affect the availability and cost of credit.

The Fed can use 3 major tools to conduct monetary policy in an economy with limited reserves.

• Open Market Operations

• Reserve Requirements

• Discount Policy

Excess Reserves—the amount of money a bank can lend to others

Open Market Operations—the buying and selling of bonds

Reserve Requirement—the amount of funds that a bank holds in reserve to ensure that it is able to meet liabilities in case of sudden withdrawals

Discount Rate—the interest the Fed charges on loans to financial institutions

The Fed can also use tools to conduct monetary policy in an economy with ample reserves primarily by setting the interest on reserve balance (IORB) rate

• the IORB rate is the interest rate banks earn on reserves they have deposited with the Federal Reserve

The IORB rate also helps steer the federal funds rate