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1. What are the functions of money, and how is the money supply measured?

 Medium of Exchange: Any object that is generally accepted in exchange for
goods and services
 Unit of Account: Agreed measure for stating the price of goods and services.
Price goods in terms of the money
 Stored Value: Money can be held and exchanged later for goods and services.
Money can be exchanged at a later date without any problems. 100 dollars
that is saved now can be spent 6 months later with no issues.

Money Supply Measured
 The Fed can measure money in different categories (M1 and M2). In these
amounts, they can calculate all the checking accounts and determine the
supply of money
o M1: Money Supply 1: Currency (Bills) + Checking Deposits (Demand
deposits) + Travellers checks
o M2: M1 + Savings accounts + Time Deposits

2. Explain what a financial intermediary is, with examples, and explain how these
institutions are regulated.

Financial intermediary takes deposits and makes loans. Examples:
 Commercial banks: Makes loans
 Thrifts Institutions: Saving banks, Saving and Loans, and Credit Unions
o Deals with mortgages and personal loans to special groups
 Money Market Mutual Funds: Sell shares in the fund and holds assets, such as
treasury bills and short-term commercial bills.

 Insurance: Deposit insurance, such as the FDIC
 Balance Sheet Regulations
o Capital Requirements: Owners need to invest personal money into the
bank to prevent bankruptcy
o Reserve Requirement: Banks are expected to keep a certain
percentage within the bank to have cash available
o Lending Rules: If organized as a savings bank, they must make a
certain percentage of mortgages or loans to maintain their status
o Deposit Rules

3. What are the functions of the Federal Reserve Bank, and how is it organized

 Control of quantity of money
 Issue paper currency
 Act as Bankers’ bank
 Supervise/inspect commercial banks with treasury, FDIC, state banking
authority, etc
 Federal Government’s bank: Keeps deposits, sells bonds, exchanges foreign
currency to be used by the government

 Board of Governors
o Washington D.C.
o 7 Members (appointed by the president)
o SETS reserve ratios
o Accept/Reject discount rates changes proposed by 12 regional banks
o Serve on Open Market Committee
 12 Regional Federal Reserve Banks
o Propose discount rate changes
o Handles everyday operations of system (clearing checks, replacing
old paper currency)
o 5 Presidents are members of Open Market Committee
 Open Market Committee
o 7 Governors + 5 Regional Presidents
o Determines open market policy, with operations carried out by
NEW YORK’s federal reserve

4. Using a graph, explain the demand and supply for money.

Supply and Demand for Money
 Institutions
o Private Banking System: Supplies money
o Individuals and Businesses: Demand money
o Central Bank: Referee between the two sides

 As the supply of the money INCREASES, the interest rate also INCREASE
o Direct relationship
o More loans that you make, the more money you can make
 As the demand of the money DECREAES, the interest rate INCREASES
o Indirect relationship
o Low interest rate means more people are willing and wanting to get
loans because the price is low

5. What are the three tools used by the Federal Reserve Bank to control the money
supply? For each tool, explain what action the Fed would take to increase the money

Three tools
 Reserve Requirement
o Forces banks to have more money kept in reserve in the bank. If you
DECREASE the reserve requirement, you INCREASE the supply of
money—because you are not needed to keep as much money in the
 Discount Rate
o This is the rate from which banks can borrow from the Fed
o If the Fed DECREASE/LOWER this price/rate, the banks WILL want
to borrow money, thus INCREASING the money supply.
 Open Market Operations
o This is the purchase and selling of bonds by the Fed to and from the
o If the Fed BUYS bonds FROM the banks, they can INCREASE the
money supply. The Fed is giving money to the banks in exchange for
their bonds.

6. If an economy is in recession and the Federal Reserve Bank lowers interest rates,
what happens to aggregate demand, GDP, and the price level?

You can manipulate the aggregate demand by changing the supply of money

Lowering the interest rate will
 INCREASE Business Investments (I)
 INCREASE Consumer Durable Spending (C): Easier to borrow money to make
large purchases
 INCREASE Hosing Purchases: Mortgages are cheaper

This will combine to:
 INCREASE Aggregate Demand
 INCREASE Price Level

Graph of the Price Level: