Economics Dr.

Sauer

Lecture Chapter 10: Monetary System I. Money The ________________________________ of using money for transactions is extraordinarily useful in a large, complex society. The existence of money makes trade between people ____________. Imagine that there was no item in the economy widely accepted in exchange for goods and services. People would have to rely on _______________the exchange of one good or service for anotherto obtain the things they need. Problems with a Barter System 1. In order for a transaction to take place, there needs to be a ___________________________ of wants. 2. There is no ____________________ measure of value. 5 pigs = ? shoes = ? haircuts = ? insurance Number of unique exchange rates (_____________) in a barter economy:

Ex: An economy with 1000 goods would need

3. Certain goods/services are not ______________. 4. Lack of standards for ____________ payments. 5. Difficulty in ____________ wealth.

Money is the set of assets that people _____________________________ to buy goods and services. In order to be money, the ______________ has to fulfill 3 functions: 1. _________________________________: an item that buyers give to sellers in exchange for goods and services ex: paper bills, coins, shells, cigarettes 2. _________________________________: the yardstick that people use to post prices and record debts ex: your Visa bill is denominated in dollars not chickens 3. _________________________________: the item can be used to transfer purchasing power from the present to the future ex: diamonds are durable, milk is not

There are 2 kinds of money: 1. ___________________ money takes the form of a commodity that has ___________________value. - the material that the money is made of has uses besides money ex: gold, silver, cigarettes

2. __________________ money has no intrinsic value; it is a material used as money by ___________________________. - the general public also has to believe it has value ex: US paper bills Dont be Afraid of Fiat Money Money is simply a ________________________. - it is a way to make transactions easier - it is a way to transfer purchasing power to the future Money itself doesnt matter to you what matters is that you can trade the money for things you want and need, now or in the future. - money is a _________________________ of purchasing power Trading money for ____________ serves no real purpose for you. If you want to trade money for gold so you can trade gold for goods and services, the gold is no different than the paper currency. Money is simply a _______________________________. (but a very important one)

II. The Federal Reserve System The Federal Reserve (the Fed) is the _________________________________ of the United States. federalreserve.gov A Central Bank is an institution which oversees the _______________ system and regulates the ____________________________ in the economy. The Fed was created in ____________ after a series of bank failures. The Federal Reserve System is comprised of -Board of _____________________ headquartered in Washington D.C. -Federal Open Market _________________ -__________ Regional District Banks 1. The Board of Governors (BoG) has 7 members who serve 14 year terms. Their primary responsibility is the formulation of ________________________. - sit on the Federal Open Market Committee It also has regulatory and supervisory responsibilities over banks. 2. The Federal Open Market Committee (FOMC) makes decisions regarding the _____________________ in the economy.

The FOMC is most important monetary policymaking body of the Federal Reserve System. The monetary policy is designed to _______________ economic growth full employment stable prices sustainable pattern of international trade and payments At meetings they discuss ____________________ and decide how to adjust the money supply. 3. 12 Regional District Banks that serve as the ___________________________ of the nation's central banking system. (the banks bank) - move currency in and out of circulation - check clearing - supervise/ examine banks - hold banks cash reserves and make loans to banks

III. The Feds Tools of Monetary Policy When the economy is ______________, the Fed may want to try to ________________ it. When the economy is experiencing __________________ or is heating up too quickly, the Fed may want to try to ____________________. The US has a ___________________ banking system. This means banks do not have to keep all deposits on hand, they can ________________ a portion of them. The fraction of deposits that a bank must keep on hand is called the _____________________________. -aka reserve requirement, reserve ratio, required ratio - For large banks, this ratio is 10%. Monetary Policy Tool #1 The Fed controls the required reserve ratio. - hugely powerful tool - almost never used This affects the amount of money that __________________________ out. - more lending means more economic activity

Suppose a bank has $200 million worth of deposits. That bank has to keep at least on hand at all times. It can lend out the other ______________________ if it wants to. The $20 million is called ___________________ reserves. The $180 million is called __________________ reserves. When the reserve requirement is ________________ - banks are able to lend out less - slows the economy down When the reserve requirement is ________________ - banks are able to lend out more - speeds the economy up

Monetary Policy #2 The Fed controls the discount rate, which is the interest rate that the Fed charges to banks for loans (BoG - every 6 weeks) This is the ________ interest rate the Fed can ____________ control. This interest rate usually just acts as a _____________ from the Fed to banks about what the Fed would like banks to do. A _______________ discount rate: - means that it will be more costly for banks to borrow from the Fed (should they need to) - so banks take this as a signal to lend out less (be less risky) - when banks lend out less, the economy slows down A _______________ discount rate: - means that it will be less costly for banks to borrow from the Fed (should they need to) - so banks take this as a signal to lend out more (okay to be more risky) - when banks lend out more, the economy speeds up

Monetary Policy Tool #3 Open Market Operations are the purchase or sale of US government bonds by the Fed. (FOMC every 6 weeks) The Fed uses Open Market Operations to ____________ the Federal Funds Rate. - _________________ the Fed Funds Rate directly The Federal Funds Rate is the rate that _________________________________ on short term loans. (overnight)

Why would banks borrow from each other overnight? - a bank might not have enough reserves on hand to meet their requirement many loans) - books must balance at close of business - borrow from another bank just overnight

(made too

When the Fed ____________________: - banks receive cash in exchange for the bonds they were holding - banks have more cash reserves on hand so they are willing and able to lend it out to other banks - this decreases the federal funds rate - banks know it is cheap to borrow from a bank overnight so they are willing to make more loans - economy speeds up When the Fed ____________________: - banks receive bond certificates in exchange for their cash - banks have less in cash reserves on hand so they are not as willing and able to lend it out to other banks - this increases the federal funds rate - banks know it is more expensive to borrow from a bank overnight so they want to make fewer loans - economy slows down

Summary of Policy Tools: To ____________________ the economy, the Fed could: - _________ the reserve requirement - _________ the discount rate - _________ the federal funds target and _________ To _____________________the economy, the Fed will increase the quantity of money in the economy. - _________the reserve requirement - _________ the discount rate - _________ the federal funds target and _________ The Feds mandate is to facilitate a sustainable pace of economic growth. This is difficult because 1. 2. 3. Summary: In order for an asset to be money it must be able to fulfill 3 functions. There are 3 branches of the US Federal Reserve System. There are 3 main tools of monetary policy in the US.