Understanding the Monetary System: Money, Functions, and Federal Reserve Policies

1. Monetary System

2. Money • Set of assets in an economy that people regularly use to buy goods and services from other people

3. Functions of Money • Medium of exchange- an item that buyers give sellers when they want to purchase goods and services • Unit of account- yardstick people use to post prices and record debts • Store of value- an item that people can use to transfer purchasing power from the present to the future

4. Liquidity • Ease with which an asset can be converted into the economy’s medium of exchange • Money is the medium of exchange- therefore it is the most liquid asset • Stocks and bonds can be sold fairly easily= relatively liquid assets • Real estate, art work, etc require more time and effort to sell- less liquid

5. Federal Reserve System • Federal Reserve (the Fed) is the central bank of the US • Central bank- institution designed to oversee the banking system and regulate the quantity of money in the economy • Fed was created in 1914 after a series of bank failures • The primary customers of the Federal Reserve are private banks • Controls the money supply in the US

6. Running of the Federal Reserve • Fed is run by Board of Governors- has 7 members who are apptd by the pres and confirmed by the Senate • Serve 14 year terms- gives them independence from short term political pressures

7. Running of the Federal Reserve • Most impt of the 7 is the Chairman- directs staff, presides over board mtgs, and testifies regularly in front of Congress • Pres appts chairman to 4 year terms- currently Ben Bernancke • Fed Reserve is made up of the Fed Reserve Board in DC and 12 regional Fed Reserve Banks- closest to us is SF

8. 2 Jobs of the Fed • Regulate banks and ensure health of the banking system- regional banks mostly take care of this, monitors ea bank’s financial condition and facilitates bank transactions- acts as a bank’s bank • Controls quantity of $ that is made available in the econ (money supply)

9. Monetary Policy • setting of money supply by policymakers in the central bank • Overall level of prices in an economy adjusts to bring money supply and demand into balance

10. Monetary Policy • When central bank increases the supply of $, it causes the price level to rise • Persistent growth in the quantity of $ supplied leads to inflation • Gov’t can pay for some of its spending simply by printing $ but can cause hyperinflation

11. Inflation • An increase in the overall level of prices in the economy • Keeping inflation at a low level is goal of economic policymakers • Currently 1.1% • Main cause of inflation- growth in quantity of money- if gov’t prints more $ the value of it falls • During periods of rapidly increasing inflation rates, a person’s salary will buy fewer goods than before