Money, Banking, Money, Banking, & the Fed& the Fed

AP Macroeconomics

Chapter 29 & 30 Notes

MoneyMoney

• Definition: anything that can be used as a medium of exchange, measure of value, and a store of value

Why not BARTER?Why not BARTER?• barter = trade

• barter economy –

an economy based

on trade

• Not most efficient

system because it

requires a “mutual coincidence of wants”(each person must have exactly what the other

wants—also called “double coincidence of wants”)

Three Types of MoneyThree Types of Money• 1) Commodity money – money

that has an alternative use as an economic good

• 2) Representative money – money that is backed by a commodity

• 3) Fiat money – money that has value because of government decree

• What phrase is printed on the top left corner of U.S. currency?

Three Types of MoneyThree Types of Money

“This note is legal tender for all debts, public and private”

• legal tender – fiat money that must be accepted as payment for purchases/debts

Characteristics of MoneyCharacteristics of Money• Portable

• Durable

• Divisible

• Stable

• Scarce (limited in supply)

• Accepted

Three Functions of MoneyThree Functions of Money• Medium of exchange – something

accepted by all parties as payment for goods and services

Three Functions of MoneyThree Functions of Money• Measure of value – common measuring

stick to express the worth or value of a good

Three Functions of MoneyThree Functions of Money• Store of value – quality that allows

purchasing power to be saved until needed

MoneyMoney• U.S. currency is printed by the U.S. Dept.

of the Treasury’s Bureau of Printing and Engraving.

• U.S. coins are created by the U.S. Mint.• This money is distributed to banks by the

Federal Reserve Bank (also known as “the Fed”).

• Our currency is known as “Federal Reserve Notes.”

• There are currently about $829 billion in circulation. (most outside the U.S.)

Money TermsMoney Terms• Demand deposit accounts (DDAs) –

funds deposited in a bank that can be accessed by writing a check and without having to secure prior approval from the bank (Ex.: checking accts)

Categories of MoneyCategories of Money• M1 – coins, currency, checks,

checking accounts / DDAs [relates to money’s function as a medium of exchange]

Types of MoneyTypes of Money• M2 – M1 + savings accounts, money

market accounts, CDs (time deposits)[relates to money’s

function as a store of

value]

Types of MoneyTypes of Money• M3 – M2 + Institutional money market

& long-term savings accounts (large time deposits) [relates to money’s

function as a store of value & unit of accounting]

Equation of Exchange

(M)(V)=(P)(Q)• M=money supply (M1)• V=velocity (# of times the avg. $ changes

hands in a year)

• P=price levels (current)

• Q (or Y)=real GDP/output

[PQ=nominal GDP]

Equation of Exchange

(M)(V)=(P)(Q)• What will happen if the money supply

increases, but velocity remains constant?

• What will happen if velocity increases, but M remains constant?

The Federal Reserve Bank

ECONOMICS

Chapter 14

The Federal Reserve (the Fed)The Federal Reserve (the Fed)

• The privately-owned (owned by the people—stockholders of private

banks), publicly-controlled (the President selects the Fed Chairman and appoints the Board of

Governors) central bank of the United States

The Federal Reserve (the Fed)The Federal Reserve (the Fed)• Has the power to lend to banks to prevent

bank runs

FDICFDIC• In 1933, the U.S. government created the

Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $250,000 per customer per bank.

Fractional Reserve SystemFractional Reserve System• Why couldn’t George give his customers

their money? Where was it?

Fractional Reserve SystemFractional Reserve System• Banks make money when they make loans

to their customers and charge them interest.

• Banks are only required to keep a portion of all deposits.

• The Fed decides what percentage of all deposits banks must hold (reserve requirement / reserve rate). [Current=10%]

• Banks can take the remaining money and lend it to customers.

Structure of the FedStructure of the Fed• Directed by a 7-member Board of Governors

– Each app’ted by President to 14-yr. term

• Country is divided into 12 districts, each served by a district bank– New York -Chicago– Boston -Cleveland– Richmond -Atlanta– Dallas -St. Louis– Kansas City -Philadelphia– Minneapolis -San Francisco

Structure of the FedStructure of the Fed• Federal Open Market Committee (FOMC)

– 12 members – 7 governors, pres of NY Fed, and 4 other Fed district presidents

– Evaluates state of economy and determines interest rates

Fed ChairmanFed Chairman

• The head of the Federal Reserve is known as the Chairman. The current Chairman of the Fed is Ben Bernanke.

Fed ResponsibilitiesFed Responsibilities• Main responsibility: controlling the rate of

growth of the money supply

• Acting as the government’s bank• Maintaining the payments system [Ex.: you

swipe debit card @ Zaxby’s, Fed makes sure your $ gets from your bank to Zaxby’s bank]

• Regulating & supervising banks• Preparing consumer legislation [Ex.: making sure

that businesses treat consumers fairly and disclose all information in credit transactions]

MONETARY POLICYMONETARY POLICY

AP Macroeconomics

Chapter 29 & 30 Notes

MacroeconomicsMacroeconomics• macroeconomics—analysis of the

overall national economy

• We can measure the health of the national economy by assessing THREE factors:– GDP – Unemployment– Inflation

A HEALTHY EconomyA HEALTHY Economy• The economy is considered healthy if:

–There is a sustained increase in real GDP (economic growth)

–Unemployment is low–Prices are stable (or there is

minimal inflation)[On business cycle =

Expansion/Recovery]

An UNHEALTHY EconomyAn UNHEALTHY Economy• The economy is considered unhealthy if:

–There is a sustained decrease in real GDP

–Unemployment is high

–Excessive inflation (or deflation) exists

[On business cycle = Contraction/Recession]

Ensuring Economic StabilityEnsuring Economic Stability• *In order to make sure our economy is stable

(economic stability – reduction of extreme ups & downs in the business cycle & standard of living), the federal government steps in with…

• Macroeconomic stabilization policies – attempts by the federal government to keep the economy healthy and to make the future more predictable

Economic Stabilization PoliciesEconomic Stabilization Policies• **The two types of stabilization

policies are fiscal & monetary policy. Monetary policy attempts to either INCREASE or DECREASE

the money supply.

• **Policy can be expansionary or contractionary.

• Expansionary increases the money supply, which spurs economic growth, because it increases demand. (loose $)

• Contractionary decreases the money supply, which can curb inflation and slow down spending and can slow down economic growth. (tight $)

Economic Stabilization PoliciesEconomic Stabilization Policies

• monetary policy – changing the rate of growth of the supply of money in circulation (specifically, to curb inflation or deflation)

• *Implemented

by the FED

Economic Stabilization PoliciesEconomic Stabilization Policies

Three Tools of Monetary PolicyThree Tools of Monetary Policy• open market operations – when

the Fed buys and sells securities (government bonds) on the open market

• contractionary:– selling securities / bonds

• expansionary:– buying securities / bonds

• reserve rate – the amount of deposits the bank must keep “on reserve”

(i.e., stored in their vault or deposited in their local Federal Reserve branch bank)

• contractionary: raising the reserve rate

• expansionary: lowering the reserve rate

Three Tools of Monetary PolicyThree Tools of Monetary Policy

• discount rate – the interest rate on loans made by the Federal Reserve to banks

• contractionary: raising the discount rate

• expansionary: lowering the discount rate

Three Tools of Monetary PolicyThree Tools of Monetary Policy

Effects of Monetary Policy• Federal funds rate – interest rate

banks charge each other **The Fed “targets” this interest rate to**

change the amount of $ in the money supply!

Effects of Monetary Policy• prime rate – interest rate banks

charge their best customers(affected by the discount & fed funds rate)