Money and the Banking System

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• Money and the Banking System

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Do you know anyone with a lot of money? What does
that mean? Some people make a great income each
year. So they probably have a lot of money. Some
people are born into families with a lot of
wealth Bill Gates kids are an example. They,
too, probably have a lot of money. Here we want
to focus on those things that we call money. But
we do not focus on the income or wealth aspects.
We want to see how policy dealing with money can
affect the operation of the economy.
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Overview
Here we want to study the monetary system in the
US. Monetary policy is a tool designed to get
the interest rate to a level so that investment
can be at a desired level. Policy makers
ultimately want to have economic growth, price
stability and full employment. Reaching these
goals can be influenced by Federal Reserve
policy. Lets begin our study of this material
by asking what is money?
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What is money?
You might say money is the dollars we have, and
that is right , but more basically anything that
performs the functions of money is money. The
three functions of money are 1) medium of
exchange, 2) Unit of account, and 3) Store of
value. A medium of exchange means money is the
thing that is readily accepted as payment for
goods and services. When money is used we dont
have to barter. Barter can be a drag because of
the double coincidence of wants.
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What is money?
As a unit of account, the monetary unit(what we
call the dollar) is how we state relative value.
Goods and services have prices stated in terms of
the monetary unit. We know the relative worth of
stuff by looking at the dollar amount of the
stuff. Money is a store of value, meaning that
you can use it now, or you can use it later.
Other assets also act as a store of value, but
money has the advantage of immediate use by a
firm or a household in meeting all financial
obligations.
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Commodity money and fiat money section Commodity
money is when money takes the form of something
with intrinsic value. Money would have value for
uses other than just money. Cigarettes in a
prison would be commodity money. I think fiat
money is the money tucked into the glove
compartment on that little car. ? Really, fiat
money has no intrinsic value. Government says
something is money and it is. Our dollars are
fiat money.
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M1 definition of money
In the US, the most basic definition of money
is M1 coins paper checkable deposits
other checkable deposits travelers checks, or
more basically for our purpose currency
checkable deposits. Checks are dollar
denominated accounts at banks and other financial
institutions. They are money because they are
generally accepted as a medium of
exchange. Caution 1) Credit cards are NOT money,
they are loans for our purposes.
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What backs our money?
A gold standard or other metal standard - meaning
there can be only as much money as there is gold,
or some formula amount of money per ounce of gold
- may not be consistent with our desires to make
trades. This is why modern economies have moved
away from metal standards. So, what backs our
money? Our money is backed by our faith that it
can be readily used. We accept money because we
know others will accept it from us!!
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The Federal Reserve
The Federal Reserve, hereafter called the Fed, is
the central bank in the US. The Fed was
established in 1913, has 12 districts, is run by
a seven member Board of Governors appointed by
the president, and is owned by member banks. The
functions of the Fed are to 1) supply the
economy with fiduciary currency 2) provide a
system of check collection and clearing 3) hold
depository institutions reserves 4) act as the
governments fiscal agent 5) supervise member
banks 6) act as the lender of last resort 7)
regulate the money supply. Lets look at each
of these on the following screens.
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Fed functions

1) The paper currency is printed by the Bureau
of Engraving but is controlled by the Fed. The
currency is a Federal Reserve note - check a bill
you have. 2) Check collection and clearing. Say
you buy something from LL Bean and write a check
and send it to Boston. The Boston bank that gets
the check from LL Bean can check with the Fed and
see the bank you wrote the check on. Your
account then is subtracted from and LL Beans
account is added to. 3) The Fed is often called
a bankers bank and as such bankers keep some of
their reserves at the Fed. When you put money in
the bank, the bank has a liability since it is
responsible to you. It also now has an asset
that is called reserves.
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fed functions
4) As the governments fiscal agent the Fed acts
as the bank for the US Treasury. Government
revenues go to the Fed and checks to pay for
stuff comes from the Fed. 5) The Fed supervises
member banks to make sure they are not doing
dumb stuff. The Fed can make unannounced
visits to check the bank out. 6) The Fed is a
lender of last resort. If a financial
institution has troubles the Fed can lend it the
funds it needs to stay in business. This happens
from time to time. 7) The Fed regulates or
controls the money supply through monetary
policy.
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FOMC
FOMC The Federal Open Market Committee (FOMC) is
really the part of the Fed that controls the
money supply. They decide when to buy or sell
bonds in the market to influence the amount of
money in the system.