Ch 11 - Ch11 PDF

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CHAPTER 11: The Monetary System Barter: the exchange of one good or service for another Double coincidence of wants: the unlikely occurrence that two people each have a good or service that the other wants 11-1 The Meaning of Money  Money: the set of assets in an economy that people regularly use to buy goods and services from other people  Functions of money o Medium of exchange: an item that buyers give to sellers when they want to purchase goods and services o Unit of account: the yardstick people use to post prices and record debts o Store of value: an item that people can use to transfer purchasing power from the present to the future o Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange  Kinds of money o Commodity money: money that takes the form of a commodity with intrinsic value o Fiat money: money without intrinsic value that is used as money by govt decree  Money in US Economy o Currency: the paper bills and coins in the hands of the public o Demand deposits: balances in bank accounts that depositors can access on demand by writing a check o

11-2 The Federal Reserve System  Fed: the central bank of the US  Central bank: an instn designed to oversee the banking system and regulate the quantity of money in the economy  Chair of the Fed directs the Fed staff, presides over board mtgs, testifies regularly about Fed policy in front of congressional committees  2 jobs of the Fed

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o regulate banks and ensure the health of the banking system o control the quantity of money that is made available in the economy (money supply)  monetary policy: the setting of the money supply by policymakers in the central bank Federal Open Market Committee: discusses the condition of the economy and considers changes in monetary policy Open market operation: the purchase and sale of US govt bonds

11-3 Banks and the Money Supply  Reserves: deposits that banks have received but have not loaned out

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T- account: If banks hold all deposits in reserve banks do not influence the supply of money Fractional reserve banking: a banking system in which banks hold only a fraction of deposits as reserves Reserve ratio: the fraction of deposits that banks hold as reserves When banks hold only a fraction of deposits in reserve, the banking system creates money Money multiplier: the amount of money the banking system generates with each dollar of reserves, it is the reciprocal of the reserve ratio o The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier Bank capital: the resources a bank’s owners have put into the instn Leverage: the use of borrowed money to supplement existing funds for purposes of investment Leverage ratio: the ratio of assets to bank capital Capital requirement: a govt regulation specifying a minimum amount of bank capital

11-4 The Fed’s Tools of Monetary Control  Open market operations (above)  Fed lending to banks o Discount rate: the interest rate on the loans that the fed makes to banks  Reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits  Paying interest on reserves  Federal funds rate: the interest rate at which banks make overnight loans to one another...