| 1. |
Money is whatever performs the
three basic functions of money: a medium of exchange
a unit of account
and a store of
value.
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| 2. |
In the U.S. economy
money is whatever is
generally used as a medium of exchange and consists of the debts of the Federal government
and of commercial banks and other financial institutions.
- The narrowly defined money supply is called M1
and has two principal components.
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- The smaller component is currency: coins which
are token money and paper money largely in the form of Federal Reserve Notes.
- The larger and more important component is
checkable deposits in commercial banks and thrift institutions.
- These checkable deposits include demand deposits
(checking accounts)
negotiable order of withdrawal (NOW) accounts
automatic transfer
service (ATS) accounts
and share draft accounts
all of which give the depositor the
ability to write checks.
- Currency and checkable deposits owned by the
Federal government
commercial banks and savings institutions
and the Federal Reserve
Banks are not
however
included in M1 or any of the more broadly defined money supplies.
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- M2 and M3 are the more broadly defined money
supplies and include not only the currency and checkable deposits in M1 but such
near-monies as noncheckable savings deposits and time deposits in commercial banks and
savings institutions.
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- M2 includes M1 plus noncheckable savings deposits
plus small time deposits (less than $100
000) plus money market deposit accounts (MMDA)
plus money market mutual funds (MMMF).
- M3 includes M2 plus large time deposits ($100
000
or more).
- There are advantages to each of the different
measures of money
but since M1 is included in all the definitions and the principles that
apply to it are applicable to the other measures
that narrow definition is used for the
textbook discussion unless noted otherwise.
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- Near-monies held by the public are important
because they affect spending habits
serve as a stabilizing force in economic activity
and provide different definitions of money for the conduct of monetary policy.
- Credit cards are not money but are a device by
which the cardholders obtain a loan (credit) from the issuer of the card.
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| 3. |
In the United States
- Money is the promise of a commercial bank
a
savings (thrift) institution
or a Federal Reserve Bank to pay
but these debts cannot be
redeemed for anything tangible.
- Money has value only because people can exchange
it for desirable goods and services.
- The value of money is inversely related to the
price level.
- Money is backed by the confidence which the
public has that the value of money will remain stable; the Federal government can use
monetary and fiscal policy to keep the value of money relatively stable.
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| 4. |
Business firms and households wish to hold and
therefore
demand money for two reasons.
- Because they use money as a medium of exchange
they have a transactions demand which is directly related to the nominal gross domestic
product of the economy.
- Because they also use money as a store of value
they have an asset demand which is inversely related to the rate of interest.
- Their total demand for money is the sum of the
transactions and asset demands.
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| 5. |
In the money market
the demand for money and
the supply of money determine the interest rate. Graphically
the demand for money is a
downsloping line and the supply of money is a vertical line
and their intersection
determines the interest rate. Disequilibrium in this market is corrected by changes in
bond prices and their inverse relationship with interest rates.
- If there is a shortage of money
bonds will be
sold. The increase in supply of bonds will drive down bond prices
causing interest rates
to rise until the shortage is eliminated.
- If there is a surplus of money
bonds will be
bought. The increased demand for bonds will drive up bond prices
causing interest rates
to fall until the surplus is eliminated.
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| 6. |
The financial sector of the economy is
significantly influenced by the Federal Reserve System (Fed) and the nation’s banks
and thrift institutions.
- The banking system remains centralized and
regulated by government because historical problems led to different kinds of money and
the mismanagement of the money supply.
- The Board of Governors of the Fed exercises
control over the supply of money and the banking system. The U.S. president appoints the
seven members of the Board of Governors.
- Four important bodies help the Board of Governors
establish and conduct policy: the Federal Open Market Committee (FOMC)
which establishes
policy over the buying and selling of government securities; and three Advisory Councils
that provide input from commercial banks
thrift institutions
and consumer-related
organizations.
- The 12 Federal Reserve Banks of the Fed serve as
central banks
quasipublic banks
and bankers’ banks.
- The U.S. banking system contains thousands of
commercial banks and thrift institutions that are directly affected by the Fed’s
decisions.
- The Fed performs seven functions: issuing
currency
setting reserve requirements and holding reserves
lending money to banks and
thrifts
collecting and processing checks
serving as the fiscal agent for the Federal
government
supervising banks
and controlling the money supply. The last function is the
most important.
- There is a continuing controversy about the
independence of the Fed because it limits congressional and presidential control
but most
economists think this is necessary to protect the Fed from strong political pressure and
from making poor economic decisions.
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| 7. |
Three recent developments have affected money
and banking in the United States.
- There has been a relative decline in the number
of banks and thrift institutions since the early 1980s. Three responses to this change
have been the expansion of services by banks and thrifts
an increase in the number of
bank and thrift mergers
and a push for regulatory reform to deregulate banks and thrifts
and permit more competition in the financial services industry.
- Financial markets are now more globalized and
integrated because of advances in computer and communications technology.
- The character of money has changed with the shift
to use of electronic money and other forms of payment.
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