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Personal Finance Scott Wentland [email protected] 434-395-2160 Longwood University 201 High Street Farmville, VA 23901 Longwood University Finally, money… • The government also plays another important role: it is in charge of money • Money is anything that is widely accepted as a means of payment. • • • • Currency: Paper bills and coins. Bank reserves held by banks at the Fed. Checkable deposits: your checking or debit account. Savings deposits, money market mutual funds, and small-time deposits. Longwood University The 2 Kinds of Money Commodity money: takes the form of a commodity with intrinsic value Examples: gold coins, cigarettes in POW camps Fiat money: money without intrinsic value, used as money because of govt decree Example: the U.S. dollar Longwood University THE MONETARY SYSTEM 3 The U.S. Money Supplies Longwood University Federal Reserve • Who is in charge of money in the US? • The Federal Reserve – Central Bank of the United States, also called “the Fed” – Can issue and create money. • Influence interest rates and engages in monetary policy Longwood University Federal Reserve • Is a bank with two customers. – It is the government’s bank. • Maintains the bank account of the U.S. Treasury. • It manages government borrowing. – Issuing, transferring, and redeeming of U.S. Treasury bonds, bill, and notes. – It is the banker’s bank. • • Banks keep their own accounts at the Fed. Banks can borrow from the Fed. • The Fed Also… – Regulates other banks. – Manages the nation’s payment system. – Protects financial consumers with disclosure regulations. • Most important function: Regulating the U.S. money supply. Longwood University Monetary Policy • Three Major Tools the Fed Uses to Control the Money Supply 1. Open market operations: buying and selling of U.S. government bonds on the open market. • Influences interest rates 2. Discount rate lending and the term auction facility: Federal Reserve lending to banks and other financial institutions. 3. Required reserves and payment of interest on reserves: Changing the minimum RR; paying interest on any reserves held by banks at the Fed. Longwood University Monetary Policy • Its tools determine how much money is floating in the economy – Raise the money supply • Generally associated with lower interest rates – Lower the money supply • Generally associated with higher interest rates • Controlling the money supply and influencing interest rates is the key policy tool it uses to help stabilize the economy – More about this in Principles of Macroeconomics Longwood University Monetary Policy • Monetary policy is the primary controller of inflation – Inflation is an ↑ in the average level of prices. – Usually measured by the CPI (Consumer Price Index) and other indices Longwood University Longwood University Longwood University Monetary Policy • The Fed has an extraordinarily important job – Oversee how much money is in the economy – Stabilize the economy – Control interest rates and inflation – Regulates and oversees financial markets and the entire banking system • This is why you see it in the newspaper so much – When the Fed speaks, markets listen – The world listens… Longwood University Monetary Policy vs. Fiscal Policy • Monetary policy – Federal Reserve stabilizing the business cycle • Mostly through money creation, interest rates, NGDP • Fiscal policy – Federal budget (Congress & the President) stabilizing the business cycle • Mostly through taxes & spending • Both address issues with AD • Pro’s and con’s Longwood University Monetary Policy vs. Fiscal Policy • Final thoughts: – Macroeconomic policy is very difficult because the economy is so complex – Economists have just scratched the surface in understanding the complexities of the economy and market – A little economics can go a long way • But even economic experts must be humble about the limits of our knowledge Longwood University Thank You Longwood University