The Monetary System

Chapter Title: The Monetary System
Key Learnings:
- Definition, functions, and types of money.
- How banks create money.
- Understanding the role of central banks and their control over the money supply.

Medium of Exchange:
- Used to buy goods and services.
Store of Value:
- Transfers purchasing power from the present to the future.
Unit of Account:
- Common unit by which everyone measures prices and values.

Barter Economy:
- Goods are exchanged directly for goods.
- Requirement: Double coincidence of wants.
- E.g., If person A has a pen and wants an eraser, they must find person B, who has an eraser and wants a pen.
- Drawback: Low likelihood of successful exchanges due to dependence on mutual desire for goods.
Monetary Economy:
- Money acts as a medium of exchange and a unit of account.
- E.g., If person A wants an eraser, they can offer money to any seller willing to accept it.
- Benefit: High likelihood of successful transactions due to reduced need for a match in wants.

Barter Economy:
- Limited to simple transactions; costly to find trade partners.
Monetary Economy:
- Allows for more complex transactions; lower costs of transacting.

Fiat Money:
- Has no intrinsic value.
- Examples: Paper currency (e.g., U.S. dollars).
Commodity Money:
- Has intrinsic value.
- Examples: Gold coins, cigarettes in POW camps.

Discussion Question: Which of these are money?
- a. Currency (Yes)
- b. Checks (Not money itself, but funds in account are money)
- c. Deposits in checking accounts (Yes)
- d. Credit Cards (No, they are deferred payment)
- e. Certificates of Deposit (No, not a unit of account or medium of exchange)
- f. Bitcoin (Broadly considered no; accepted by few people as a medium of exchange).

Money Supply:
- Quantity of money available in the economy.
Monetary Policy:
- Control over the money supply; can be complex to measure in modern economies.

Sources of Money:
- Cash
- Demand deposits (checking accounts, debit cards, savings accounts)
Liquid Assets:
- Money used for transactions is considered liquid; excludes illiquid assets.
Measures of Money:
- C: Currency in circulation.
- M1: C + demand deposits + traveler's checks + other checkable deposits.
- M2: M1 + money market mutual fund balances + savings deposits (small time deposits).

Central Bank Definition:
- Responsible for conducting monetary policy; in the U.S., this is the Federal Reserve (the Fed).
Historical Context:
- Established by an act of Congress in 1913.
Role as Lender of Last Resort:
- Provides liquidity to banking institutions when needed.

Function:
- Determines monetary policy.
- Meets approximately every six weeks.
- Composed of seven members of the Federal Reserve Board of Governors and 12 presidents of regional Fed banks.

Chairperson:
- Appointed by the President for a four-year term; has significant influence over the economy and financial markets.
- Current Chair: Jerome Powell.

Stable Prices:
- Aim to manage inflation and maintain price stability.
Maximum Sustainable Employment:
- Focus on creating jobs and reducing unemployment rates.
Independence:
- The Fed operates with a high degree of independence in setting monetary policy.

Bank Regulation:
- Ensures a healthy banking system.
Open-Market Operations:
- Definition: Purchase and sale of government bonds to regulate money supply.
- Increasing Money Supply: The Fed buys bonds from the public.
- Decreasing Money Supply: The Fed sells bonds to the public.
Direct Lending to Banks:
- The Fed can lend directly to banks to influence money supply.
Discount Rate Adjustment:
- Changing the interest rate the Fed charges banks on loans to influence monetary base.

Definition of Money: Stock of assets used for transactions.
Functions of Money: Medium of exchange, store of value, unit of account.
Types of Money: Commodity money (intrinsic value), fiat money (no intrinsic value).
Measuring Money: Complex due to varied forms; Fed controls supply through open-market operations and other tools.