ch. 14 - money, banks, and the federal reserve system

  • functions of money…

    1. medium of exchange

    2. store of value = saving and building up money)

    3. unit of account = use the value of the dollar to account for the goods and services that they sell

    4. standard of deferred payment = making payments every month to pay off a loan plus interest

  • forms of money

    • cash: cash printed by the federal reserve, coins are minted by the mint

    • checking balances = usually doesn’t give any interest

      • savings balances = may give you some interest

    • cashiers checks/money orders/travelers checks: guaranteed by the issuing institution, gets tread like straight up money

    • these 3 are all the narrow definition of money = M1 (currency + checking balances + money orders/cashier checks)

    • money market neutral funds (money in an investment account for stocks)

    • time deposits: less liquid

    • all of these combined = the BROAD DEFINITION OF MONEY M2

  • currency printed by the federal reserve being circulated and supplied to the economy = M0 = monetary base

    • feb 2023: around 5.32 trillion dollars

  • the federal reserve only prints a certain amount, but the checking balance is usually a lot more — lending money created new money

  • commercial banks can increase the total amount of money in the economy through lending

  • required reserve ration (RRR) = for every dollar of deposit that a bank receives, they have to save 10c to its account with the federal reserve

  • CDR: currency drain ratio = expected daily withdraw

  • practical money multiplier = 1 + CDR/CDR + RRR

  • federal reserve system:

    1. board of goverrners: they get appointed by the president, serving 14-yr terms, one of the members serves as the chairperson with a 4yr renewal term

    2. 12 regional banks - responsible for assessing the state of the economy in their respected district

    3. federal open market committee - buy and sell the treasury debt

      • then goes to commercial banks to see if they want to purchase

      • quantitative easing = fed reserve is printing the dollar that is being put into the economy

  • monetary policy tools:

    1. interest rate

    2. reserve requirement

    3. money supply

  • objectives of the fed reserve

    1. objectives - public:

      1. low inflation rate

      2. high employment

      3. high economic growth

      4. financial stability of the commercial banks

  • quantity of money needed in the economy: quantity theory of money

    • need x price level = supply of money x speed of circulation

  • high inflation → need contractionary monetary policy (consumption goes down, business investments go down)

    • the overall GDP goes down, demand for products and services goes down, prices go down = lower inflation

      • increased interest rate

      • tighten the reserve ratio so that banks cannot lend as much

        • ex: increase reserve ration from 10% to 11%

      • reduce money supply

  • high unemployment + slow economic growth → expansionary policy (consumption goes up, businesses investments go up)

    • the overall GDP goes up, demand goes up, and prices go up = high inflation

      • reduce interest rate - cost of borrowing is lower

      • relax the RRR

      • increase money supply - print more money and buy treasury debt so that the treasury has money to use