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1、10 MONEY AND PRICES IN THE LONG RUN29The Monetary SystemQuestions What is money? Whatre the functions of money? Where does money come from? Who creates money? How is money created? Is any problem in the course of money creation? Content The meaning of the money -the definition of money -the function
2、s of money The federal reserve system -Fed and the money supply -banks and the money supply Problems in controlling the money supplyTHE MEANING OF MONEY Money is the set of assets in an economy that people regularly use to buy goods and services from other people. Money has three functions in the ec
3、onomy: Medium of exchange Unit of account Store of valueThe Functions of Money Medium of Exchange A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services. A medium of exchange is anything that is readily acceptable as payment. Unit of Account A unit
4、of account is the yardstick people use to post prices and record debts. Store of Value A store of value is an item that people can use to transfer purchasing power from the present to the future. Liquidity Liquidity is the ease with which an asset can be converted into the economys medium of exchang
5、e.Discussion Which of the following are money in the U.S economy? Which are not? Explain your answers by discussing each of the three functions of money. A U.S. penny A Mexican peso A Picasso painting A plastic credit cardThe Kinds of Money Commodity money takes the form of a commodity with intrinsi
6、c value. Examples: Gold, silver, cigarettes. Fiat money is used as money because of government decree. It does not have intrinsic value. Examples: Coins, currency, check deposits.Money in the U.S. Economy Currency is the paper bills and coins in the hands of the public. Demand deposits are balances
7、in bank accounts that depositors can access on demand by writing a check.Figure 1 Money in the U.S. EconomyCopyright2003 Southwestern/Thomson LearningBillionsof Dollars Currency($580 billion) Demand deposits Travelers checks Other checkable deposits ($599 billion) Everything in M1($1,179 billion) Sa
8、vings deposits Small time deposits Money market mutual funds A few minor categories ($4,276 billion)0M1$1,179M2$5,455CASE STUDY: Where Is All The Currency? In 2001 there was about $580 billion of U.S. currency outstanding. That is $2,734 in currency per adult. Who is holding all this currency? Curre
9、ncy held abroad Currency held by illegal entitiesTHE FEDERAL RESERVE SYSTEM The Federal Reserve (Fed) serves as the nations central bank. It is designed to oversee the banking system. It regulates the quantity of money in the economy. The Fed was created in 1914 after a series of bank failures convi
10、nced Congress that the United States needed a central bank to ensure the health of the nations banking system.THE FEDERAL RESERVE SYSTEM The Structure of the Federal Reserve System: The primary elements in the Federal Reserve System are: 1) The Board of Governors 2) The Regional Federal Reserve Bank
11、s 3) The Federal Open Market CommitteeThe Federal Reserve SystemCopyright2003 Southwestern/Thomson LearningThe Feds Organization The Federal Reserve Banks The New York Fed implements some of the Feds most important policy decisions. The Federal Open Market Committee (FOMC) Serves as the main policy-
12、making organ of the Federal Reserve System. Meets approximately every six weeks to review the economy.The Feds Organization Monetary policy is conducted by the Federal Open Market Committee. Monetary policy is the setting of the money supply by policymakers in the central bank The money supply refer
13、s to the quantity of money available in the economy.The Federal Open Market Committee Three Primary Functions of the Fed Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices. Acts as a bankers bank, making loans to banks and as a lender of last reso
14、rt. Conducts monetary policy by controlling the money supply. Open-Market Operations The money supply is the quantity of money available in the economy. The primary way in which the Fed changes the money supply is through open-market operations. The Fed purchases and sells U.S. government bonds.BANK
15、S AND THE MONEY SUPPLY Banks can influence the quantity of demand deposits in the economy and the money supply.BANKS AND THE MONEY SUPPLY Reserves are deposits that banks have received but have not loaned out. In a fractional-reserve banking system, banks hold a fraction of the money deposited as re
16、serves and lend out the rest. Reserve Ratio The reserve ratio is the fraction of deposits that banks hold as reserves. When a bank makes a loan from its reserves, the money supply increases. The money supply is affected by the amount deposited in banks and the amount that banks loan. Deposits into a
17、 bank are recorded as both assets and liabilities. The fraction of total deposits that a bank has to keep as reserves is called the reserve ratio. Loans become an asset to the bank.Money Creation with Fractional-Reserve Banking This T-Account shows a bank that accepts deposits, keeps a portion as re
18、serves, and lends out the rest. It assumes a reserve ratio of 10%.AssetsLiabilitiesFirst National BankReserves$10.00Loans$90.00Deposits$100.00Total Assets$100.00Total Liabilities$100.00 When one bank loans money, that money is generally deposited into another bank. This creates more deposits and mor
19、e reserves to be lent out. When a bank makes a loan from its reserves, the money supply increases. How much money is eventually created in this economy?The Money Multiplier The money multiplier is the amount of money the banking system generates with each dollar of reserves.The Money Multiplier Asse
20、tsLiabilitiesFirst National BankReserves$10.00Loans$90.00Deposits$100.00Total Assets$100.00Total Liabilities$100.00AssetsLiabilitiesSecond National BankReserves$9.00Loans$81.00Deposits$90.00Total Assets$90.00Total Liabilities$90.00Money Supply = $190.00!The Money Multiplier The money multiplier is t
21、he reciprocal of the reserve ratio: M = 1/R With a reserve requirement, R = 20% or 1/5, The multiplier is 5.The Feds Tools of Monetary Control The Fed has three tools in its monetary toolbox: Open-market operations Changing the reserve requirement Changing the discount rate Open-Market Operations Th
22、e Fed conducts open-market operations when it buys government bonds from or sells government bonds to the public: When the Fed buys government bonds, the money supply increases. The money supply decreases when the Fed sells government bonds. Reserve Requirements The Fed also influences the money sup
23、ply with reserve requirements. Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits. The reserve requirement is the amount (%) of a banks total reserves that may not be loaned out. Increasing the reserve requirement decreases the money supply.
24、Decreasing the reserve requirement increases the money supply. Changing the Discount Rate The discount rate is the interest rate the Fed charges banks for loans. Increasing the discount rate decreases the money supply. Decreasing the discount rate increases the money supply.Problems in Controlling t
25、he Money Supply The Feds control of the money supply is not precise. The Fed must wrestle with two problems that arise due to fractional-reserve banking. The Fed does not control the amount of money that households choose to hold as deposits in banks. The Fed does not control the amount of money tha
26、t bankers choose to lend.Application The economy contains 2000 $1 bills.If people hold all money as currency, what is the quantity of money?If people hold all money as demand deposits and banks maintain 100 percent reserves, what is the quantity of money?If people hold equal amounts of currency and demand deposits and banks maintain 100 percent reserves, what is the quantity of money?Application If people hold all money as demand deposits and banks maintain a reserve ratio of 10 percent, what is the quantity of money? If people hold equal amou
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