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Money & Banking
Chapter 13
Functions
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Medium of Exchange – Used in the buying and
selling of goods
Unit of account – Prices quoted in dollars and
cents
Store of Value – Easily transferable, convenient
way to store wealth
Money Supply
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Narrow definition – Currency & check deposits
(M1)
Paper currency consists of Federal Reserve
Notes issued by the Fed
Currency & checkable deposits held by the
Federal government are not included in M1
Money Supply
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Savings deposits, money market accounts,
certificates of deposits (CD’s), as well as money
market mutual fund accounts all make up the
M2 money definition.
Accessibility is the key feature to all these types
of accounts
M3 includes CD’s (time accounts) over 100K
Measuring Money
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M1 is the most closely watched by the Federal
Reserve although managing or monitoring M2 &
M3 is very important as these can often easily be
transferred into M1 and further complicates
controlling the spendable money supply.
Credit cards assist in keeping M1 balances lower
Stabilizing Money
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Government’s ability to keep value stable
provides backing.
Money is debt, paper money is debt of the Fed,
and check deposits are liabilities of banks.
Relative scarcity of money allows for it to retain
its purchasing power
Maintaining Value
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Government attempts to keep stable with
appropriate fiscal policy
Difficult balance however in limiting inflation
while at the same time encouraging economic
expansion
Purchasing Power
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Higher prices = Less purchasing power
Excessive inflation makes money worthless &
unacceptable.
Worthless currencies leads to use of other
currencies and may actually lead to a barter
system in certain cases
The Demand for Money
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Transaction Demand – Money kept for
purchases, direct relationship with GDP
Asset Demand – Money kept as a store of value
for later use
Total Value = Transactions + Assets
The Money Market
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If demand exceeds supply then people will sell assets
(bonds, stocks) in order to obtain money.
The result is bonds are more readily available, their
price then drops, and their yield increases as well as
market interest rates. The inverse is true as well.
We know how important interest rates are to
investment and consumption. It should then be rational
to understand how the FED can maniuplate the
economy (i.e. buying and selling bonds
The Federal Reserve
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Est. 1913
Board of Governors (7) including Chairman
Bernanke
FOMC – Federal Open Market Committee
(Governors + (5) Reserve Bank Presidents),
control T-bond policy.
12 districts in the United States, each with a
Federal Reserve Bank
Federal Reserve Branches
NYC, NY
 St. Louis, MO
 Cleveland, OH
 Philadelphia, PA
 San Fransisco, CA
 Denver, CO
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Dallas, TX
 Washington D.C.
 Atlanta, GA
 Chicago, IL
 Minneapolis, MN
 Kansas City, MO
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Actions of the FED
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The Federal Reserve sets the lending
requirements of commercial banks.
It also serves as a “clearing house for checks”
Also lends money to banks
Controlling monetary policy however is the
major function
Questions
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Complete and turn in.
What backs the money supply in the U.S.?
What controls or determines the demand (both
transaction and asset) for money?
How is the money supply categorized? What
makes up each component?