13.1 What is Money?

Money: Any items that are regularly used in economic transactions or exchanges and accepted by buyers and sellers.
Economic exchange: One party hands over currency and the other party hands over goods and services.
Currency is money and checks also function as money because they are used to pay suppliers.

Three Properties of Money

Medium of Exchange: Any item that buyers give to sellers when they purchase goods and services.
Barter: The exchange of one good or service for another.
Double Coincidence of Wants: The problem in a system of barter is that one person may not have what the other desires.
Principle of Voluntary Exchange: A voluntary exchange between two people makes both people better off.
Without money, we would be left with a barter system, and most transactions that make both people better off would not be possible.
Unit of Account: a standard unit in which we can state prices and compare the value of foods and services.
In our economy, money is the unit of account because we quote all prices in terms of money.
Store of value: the property of money that holds that money preserves value until it is used in an exchange.
Money is actually a somewhat imperfect store of value because of inflation.
Commodity Money: A monetary system in which the actual money is a commodity, such as gold or silver.
Gold standard: A monetary system in which gold backs up paper money.
Fiat money: A monetary system in which money has no intrinsic value but is backed by the government.

Measuring Money in the U.S. Economy

M1: The sum of currency in the hands of the public, demand deposits, other checkable deposits, and traveler’s checks.
The first part of M1 is currency held by the public, that is, all currency held outside bank vaults.
The second component is deposited in checking accounts, called demand deposits.
The third component, other checkable deposits, was introduced in the early 1980s and did pay interest.
M2: M1 plus other assets, including deposits in savings and loans accounts and money market mutual funds.

13.2 How Banks Create Money

A Bank’s Balance Sheet: Where the Money Comes From and Where It Goes

Balance sheet: An account statement for a bank that shows the sources of its funds (liabilities), as well as the uses of its funds (assets).
Liabilities: The sources of funds for a bank, including deposits and owners’ equity.
Assets: The uses of the funds of a bank, including loans and reserves.
Owners’ equity: The funds provided to a bank by its owners.
Reserves: The portion of banks’ deposits set aside in either vault cash or as deposits at the Federal Reserve.
Required reserves: The specific fraction of their deposits that banks are required by law to hold as reserves.
Excess reserves: Any additional reserves that a bank holds above-required reserves.

How Banks Create Money

Reserve ratio: The ratio of reserves to deposits.

How the Money Multiplier Works

The total increase in checking account balance throughout all banks = (initial cash deposit) x 1/(reserve ratio)
Money Multiplier: The ratio of the increase in total checking account deposits to an initial cash deposit.

How the Money Multiplier Works in Reverse

The expansions and contractions offset each other when private citizens and firms write checks to one another.

13.3 A Banker’s Bank: The Federal Reserve

Central bank: A banker’s bank-an an official bank that controls the supply of money in a country.
Lender of last resort: A central bank is the lender of last resort, the last place, all others have failed, from which banks in emergency situations can obtain loans.

Functions of the Federal Reserve

The Fed supplies currency to the economy
The Fed provides a system of check collection and clearing
The Fed holds reserves from banks and other depository institutions and regulates banks.
The Fed conducts monetary policy
Monetary Policy: The range of actions taken by the Federal Reserve to influence the level of GDP or inflation.

The Structure of the Federal Reserve

Federal Reserve Bank: One of 12 regional banks that are an official part of the Federal Reserve System.
Board of Governors of the Federal Reserve: The seven-person governing body of the Federal Reserve System in Washington, D.C.
Federal Open Market Committee (FOMC): The group that decides on monetary policy. It consists of the seven members of the Board of Governors plus five of 12 regional bank presidents on a rotating basis.

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Our nation’s central bank, the Federal Reserve, is responsible for controlling the money supply.

13.1 What is Money?

Money: Any items that are regularly used in economic transactions or exchanges and accepted by buyers and sellers.
Economic exchange: One party hands over currency and the other party hands over goods and services.
Currency is money and checks also function as money because they are used to pay suppliers.

Three Properties of Money

Medium of Exchange: Any item that buyers give to sellers when they purchase goods and services.
Barter: The exchange of one good or service for another.
Double Coincidence of Wants: The problem in a system of barter is that one person may not have what the other desires.
Principle of Voluntary Exchange: A voluntary exchange between two people makes both people better off.
Without money, we would be left with a barter system, and most transactions that make both people better off would not be possible.
Unit of Account: a standard unit in which we can state prices and compare the value of foods and services.
In our economy, money is the unit of account because we quote all prices in terms of money.
Store of value: the property of money that holds that money preserves value until it is used in an exchange.
Money is actually a somewhat imperfect store of value because of inflation.
Commodity Money: A monetary system in which the actual money is a commodity, such as gold or silver.
Gold standard: A monetary system in which gold backs up paper money.
Fiat money: A monetary system in which money has no intrinsic value but is backed by the government.

Measuring Money in the U.S. Economy

M1: The sum of currency in the hands of the public, demand deposits, other checkable deposits, and traveler’s checks.
The first part of M1 is currency held by the public, that is, all currency held outside bank vaults.
The second component is deposited in checking accounts, called demand deposits.
The third component, other checkable deposits, was introduced in the early 1980s and did pay interest.
M2: M1 plus other assets, including deposits in savings and loans accounts and money market mutual funds.

13.2 How Banks Create Money

A Bank’s Balance Sheet: Where the Money Comes From and Where It Goes

Balance sheet: An account statement for a bank that shows the sources of its funds (liabilities), as well as the uses of its funds (assets).
Liabilities: The sources of funds for a bank, including deposits and owners’ equity.
Assets: The uses of the funds of a bank, including loans and reserves.
Owners’ equity: The funds provided to a bank by its owners.
Reserves: The portion of banks’ deposits set aside in either vault cash or as deposits at the Federal Reserve.
Required reserves: The specific fraction of their deposits that banks are required by law to hold as reserves.
Excess reserves: Any additional reserves that a bank holds above-required reserves.

How Banks Create Money

Reserve ratio: The ratio of reserves to deposits.

How the Money Multiplier Works

The total increase in checking account balance throughout all banks = (initial cash deposit) x 1/(reserve ratio)
Money Multiplier: The ratio of the increase in total checking account deposits to an initial cash deposit.

How the Money Multiplier Works in Reverse

The expansions and contractions offset each other when private citizens and firms write checks to one another.

13.3 A Banker’s Bank: The Federal Reserve

Central bank: A banker’s bank-an an official bank that controls the supply of money in a country.
Lender of last resort: A central bank is the lender of last resort, the last place, all others have failed, from which banks in emergency situations can obtain loans.

Functions of the Federal Reserve

The Fed supplies currency to the economy
The Fed provides a system of check collection and clearing
The Fed holds reserves from banks and other depository institutions and regulates banks.
The Fed conducts monetary policy
Monetary Policy: The range of actions taken by the Federal Reserve to influence the level of GDP or inflation.

The Structure of the Federal Reserve

Federal Reserve Bank: One of 12 regional banks that are an official part of the Federal Reserve System.
Board of Governors of the Federal Reserve: The seven-person governing body of the Federal Reserve System in Washington, D.C.
Federal Open Market Committee (FOMC): The group that decides on monetary policy. It consists of the seven members of the Board of Governors plus five of 12 regional bank presidents on a rotating basis.