Introduction

• through its influence over the money supply, the Federal Reserve has more influence over aggregate demand than any other institution

• shifts in aggregate demand can greatly influence the economy in the short run

What is the Federal Reserve System?

• federal reserve has the power to create money

  • doesn’t have to literally print money, it can add reserves to bank accounts held at the Federal Reserve

  • this new money can be given away or lent out in a way that increases aggregate demand

• Federal Reserve’s most important job is to regulate the US money supply

• Federal Reserve is the government’s bank

  • maintains the US Treasury account

  • manages government borrowing through US Treasury bonds, bills, and notes

• Federal Reserve is also the banker’s bank

  • regulates banks and lends them money

  • manages nations payment system

  • protects financial consumers with disclosure regulations

The US Money Supplies

• money: a widely accepted means of payment

• most important assets that serve as means of payment in the US today:

  • currency (paper bills and coins)

  • total reserves held by banks at the Federal

  • checkable deposits (your checking or debit account)

  • savings deposits, money market mutual funds, and small-time deposits

• liquid asset: an asset that can be used for payments or, quickly and without loss of value, can be converted into an asset that can be used for payments

  • assets differ in their degree of liquidity depending on how quickly they can be converted into an asset that can be used for payment

• currency: coins and paper bills held by people and nonbank firms

• a lot of US cash is used on other countries

  • Panama, Ecuador, El Salvador, and others use the US dollar as their official currency

• dollars are often used unofficially in unstable countries as a means of preserving wealth

• total reserves play an important role in the financial system

• all major banks have accounts at the Federal Reserve

  • they use them to trade with other banks and the Federal Reserve itself

  • it’s not currency, but electronic claims that can be converted into currency if the bank wishes

• checkable deposits: deposits that you can write checks on or access with a debit card

  • these are deposits used most often in making daily transactions

  • aka demand deposits

    • you can access this money “on demand”