The Monetary System and the Federal Reserve

The study of the monetary system involves a multi-faceted breakdown of money, its functions, the institutional role of the Federal Reserve, and the practical mechanics of the banking sector.
The monetary system is characterized by how money is defined, how it is categorized into different types, and how it is managed within the broader economy.
A significant portion of economic application involves understanding how the banking sector has the capacity to create money through its operational processes.

Money is defined as a specific set of assets that people in the economy regularly use to purchase goods and services from one another.
It is critical to distinguish between "assets" and "money": - Assets: Broadly defined as anything of value (e.g., real estate, antique stamps, artwork, baseball cards). - Money: A subset of assets that must fulfill three specific criteria or functions to be classified as such.

Medium of Exchange: - This refers to an item that buyers give to sellers when they want to purchase goods and services. - It serves as a standard mechanism for transactions.
Unit of Account: - This is the yardstick people use to post prices and record debts. - Example: In the United States, prices are posted in dollars and cents (e.g., $9.99$ ). People do not post prices in terms of other assets like "two antique stamps."
Store of Value: - This is an item that people can use to transfer purchasing power from the present to the future. - While many assets (like paintings or old baseball cards) act as a store of value because they hold worth over time, they are not "money" because they fail to meet the first two criteria (they are not standard mediums of exchange or units of account).

Liquidity: This term describes the ease and speed with which an asset can be converted into the economy's medium of exchange (dollars and cents). - Cash: The most liquid asset available because it is already the medium of exchange and can be spent immediately. - Real Estate/Other Assets: These are considered illiquid because they cannot be turned into spendable money quickly, regardless of the owner's total wealth.
Credit Cards vs. Debit Cards: - Credit Cards: These are not a form of money. They represent a deferral of payment. When you use a credit card, you are essentially taking a loan that you must later pay back using money. - Debit Cards: While the plastic card itself is not money, the funds linked to the card (the demand deposits) act like writing a check and are considered money.

Commodity Money: - Money that takes the form of a commodity with intrinsic value. - Intrinsic Value: The item would have value even if it were not used as money. - Examples: Gold and silver. Historically, the U.S. monetary system was based on gold.
Fiat Money: - Money without intrinsic value that is used as money because of government decree. - The paper used for currency is virtually worthless on its own. - Government Decree: The U.S. currency states: "This note is legal tender for all debts, public and private." We accept it because the government mandates its use for debt settlement and tax payments.

Money in the U.S. economy is categorized based on its location and accessibility.
Currency: The paper bills and coins in the hands of the public. - "In the hands of the public" refers to money held outside of the banking sector.
Demand Deposits (Checkable Deposits): Balances in bank accounts that depositors can access on demand by writing a check or using a debit card.

M1: The narrowest definition of the money supply. It includes: - Currency. - Demand deposits. - Traveler's checks.
M2: A broader definition of the money supply. It includes everything in M1 plus: - Savings accounts. - Certificates of Deposit (CDs). - Other miscellaneous liquid assets.

The Federal Reserve, often called "the Fed," serves as the central bank of the United States.
It is an independent entity, though its leaders are appointed by political figures. It funds itself independently of the government to remain nonpartisan and focused on the economy's best interests.

Overseeing the Banking System: Ensuring that banks follow safe and sound practices to maintain the stability of the financial system.
Lender of Last Resort: Acting as a source of loans for banks that cannot borrow from anywhere else, providing liquidity during financial stress.
Controlling the Money Supply: Setting monetary policy to influence the amount of money available in the economy.

Located in Washington, D.C., this board consists of $7$ members at full capacity.
Terms: Members serve staggered $7$ -year terms to prevent a single U.S. President from appointing the entire board.
The Chair: The most important member, appointed for a $4$ -year renewable term. - Current Chair: Jerome Powell. - Previous notable Chairs: Janet Yellen (first female chair) and Alan Greenspan (served under multiple presidents).

Located in major cities across the country, though heavily weighted toward the East Coast.
The cities are: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, Kansas City, St. Louis, Dallas, San Francisco, and Minneapolis.
Function: They distribute currency to banks in their respective regions. They do not print money, but they act as the hub for its distribution.
Bank Identification on Currency: - Each bill has a circle with a letter and corresponding numbers (all four numbers on the bill are identical) indicating its origin. - Example: A bill with the letter "K" and the number $11$ comes from the Federal Reserve Bank of Dallas (K is the $11 ext{th}$ letter of the alphabet). - Example: A bill with the letter "L" comes from San Francisco (this bank covers a massive area including California, Hawaii, Alaska, Washington, Oregon, Idaho, and Montana).

The main policymaking organ of the Federal Reserve.
Responsibility: Conducting monetary policy (setting the money supply).
Membership and Voting: - $19$ total people attend the meetings, but only $12$ have voting power. - The $7$ members of the Board of Governors (always vote). - The President of the New York Federal Reserve Bank (always votes due to the city's financial importance). - $4$ Presidents of the remaining ` $11$ regional banks (vote on a yearly rotating basis).

Monetary Policy: The setting of the money supply by policymakers in the central bank.
Money Supply: The quantity of money available in the economy (specifically in the hands of the public).
The Fed currently uses its power to influence interest rates (e.g., cutting rates toward $0$ ) to manage economic cycles and attempt to prevent or minimize recessions.