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What is Money?

What is Money?. Set of assets in the economy that people regularly use to buy goods & services from each other Prevents need for bartering. Functions of Money. Medium of Exchange: as item that buyers give to sellers when they purchase goods & services

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What is Money?

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  1. What is Money? Set of assets in the economy that people regularly use to buy goods & services from each other Prevents need for bartering

  2. Functions of Money Medium of Exchange: as item that buyers give to sellers when they purchase goods & services Unit of Account: What people use to post prices and record debts Store of Value: Item that people can use to transfer purchasing power from present to the future

  3. Liquidity • Ease with which an asset can be converted into the economy’s medium of exchange • What’s liquid? What’s not?

  4. Kinds of Money 1. Commodity Money: Money that takes the form of a commodity with intrinsic value (would have value even if it wasn’t money) • Examples? 2. Fiat Money: Money without intrinsic value that’s used as money by gov’t decree • Examples?

  5. Money in the U.S. Economy • Money Stock: Quantity of money circulating in the economy • M1: Currency (paper bills & coins), Demand Deposits (balance of bank accounts that’s easily accessible), Traveler’s Checks • M2: Savings accounts, Money Market Mutual Funds, Small Time Deposits, all M1

  6. Are Credit Cards Money? • Why or Why Not?

  7. The Federal Reserve System • Fed is central bank of the U.S., designed to oversee the banking system and regulate the quantity of money in the economy

  8. Federal Reserve and Monetary Policy • Amount of money in economy determines amount of spending • Too much = inflation • Too little = recession

  9. Fed manages money supply by….. • Influence lending among banks and other financial institutions

  10. 2. Monetary Policy • Expansionary = expand credit, MS, growth (easy money) • Contractionary = restrict credit, MS, growth (tight)

  11. Three Tools • Open Market Operations (Federal Funds Rate) • Discount Rate • Reserve Requirement

  12. 4. OMO • Most used • Fed buys and sells US government securities -US Bonds • Expansionary- buy bonds • Fed buys $1000 bond from Joe • Joe now has $1000 = increase in MS c) Contractionary – sell bonds • Fed sells $1000 bond to Joe • Joe now has a bond but $1000 less in cash = decrease in MS

  13. (pg 1 ; last two paragraphs) Fed’s effect on INTEREST RATES Intro to Money Market Graphs (text 736,738,741) • Expansionary ; buy bonds ; increase MS ; decrease IR MS 1 MS 2 Int Rate MD Q of Money

  14. b) Contractionary ; sell bonds ; decrease MS ; increase IR MS 2 MS 1 MD

  15. (1st page ; last paragraph and 2nd page ; first paragraph) Federal Funds Rate (What is it?) • Federal Funds – reserve balances of financial institutions held at 12 Regional Fed Banks • If a bank can not meet its “reserve requirement” – it can borrow reserve funds from other banks • FFR – the interest rate banks pay when they borrow from each other

  16. 5. FOMC sets “TARGET” rate for FFR • Uses OMO to adjust MS to adjust FFR “at or near target” • How does this affect you, me, and the rest of the economy? Use of OMO and FFR……. “sets off a chain of events…..”

  17. 5 (bottom left column) • Expansionary Monetary Policy • FOMC buys securities • Increase MS • Decrease FFR…….which leads to • Increase banks lending and borrowing….leads to.. • Increase willingness of banks to let you borrow at lower rates ….which leads to • Decrease in other interest rates throughout the economy • Increase in MS • Increase Consumption, Investment…AD and LRAS

  18. 6. Discount Rate • Banks borrow directly from Fed • Least powerful of 3 tools – but a change in DR does signal a change and can create a desired reaction • Lower DR…….. • Lower other IR….increase MS

  19. ` 7. Reserve Requirement • Most powerful ; least used • Expansionary = lower RR

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