10 MONEY AND PRICES IN THE LONG RUNCopyright 2004 South-Western29The Monetary SystemCopyright 2004 South-WesternTHE MEANING OF MONEY Money is the set of assets in an economy that people regularly use to buy goods and services from other people.Copyright 2004 South-WesternThe Functions of Money Money has three functions in the economy: Medium of exchange Unit of account Store of valueCopyright 2004 South-WesternThe Functions of Money Medium of Exchange A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services. A medium of exchange is anything that is readily acceptable as payment.Copyright 2004 South-WesternThe Functions of Money Unit of Account A unit of account is the yardstick people use to post prices and record debts. Store of Value A store of value is an item that people can use to transfer purchasing power from the present to the future.Copyright 2004 South-WesternThe Functions of Money Liquidity Liquidity is the ease with which an asset can be converted into the economys medium of exchange.Copyright 2004 South-WesternThe Kinds of Money Commodity money takes the form of a commodity with intrinsic value. Examples: Gold, silver, cigarettes. Fiat money is used as money because of government decree. It does not have intrinsic value. Examples: Coins, currency, check deposits.Copyright 2004 South-WesternMoney in the U.S. Economy Currency is the paper bills and coins in the hands of the public. Demand deposits are balances in bank accounts that depositors can access on demand by writing a check.Figure 1 Money in the U.S. EconomyCopyright2003 Southwestern/Thomson LearningBillions of Dollars Currency ($580 billion) Demand deposits Travelers checks Other checkable deposits($599 billion) Everything in M1 ($1,179 billion) Savings deposits Small time deposits Money marketmutual funds A few minor categories($4,276 billion)0M1 $1,179M2$5,455Copyright 2004 South-WesternCASE STUDY: Where Is All The Currency? In 2001 there was about $580 billion of U.S. currency outstanding. That is $2,734 in currency per adult. Who is holding all this currency? Currency held abroad Currency held by illegal entitiesCopyright 2004 South-WesternTHE FEDERAL RESERVE SYSTEM The Federal Reserve (Fed) serves as the nations central bank. It is designed to oversee the banking system. It regulates the quantity of money in the economy.Copyright 2004 South-WesternTHE FEDERAL RESERVE SYSTEM The Fed was created in 1914 after a series of bank failures convinced Congress that the United States needed a central bank to ensure the health of the nations banking system.Copyright 2004 South-WesternTHE FEDERAL RESERVE SYSTEM The Structure of the Federal Reserve System: The primary elements in the Federal Reserve System are: 1) The Board of Governors 2) The Regional Federal Reserve Banks 3) The Federal Open Market CommitteeCopyright 2004 South-WesternThe Feds Organization The Fed is run by a Board of Governors, which has seven members appointed by the president and confirmed by the Senate. Among the seven members, the most important is the chairman. The chairman directs the Fed staff, presides over board meetings, and testifies about Fed policy in front of Congressional Committees.Copyright 2004 South-WesternThe Feds Organization The Board of Governors Seven members Appointed by the president Confirmed by the Senate Serve staggered 14-year terms so that one comes vacant every two years. President appoints a member as chairman to serve a four-year term.Copyright 2004 South-WesternThe Feds Organization The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C., and twelve regional Federal Reserve Banks.Copyright 2004 South-WesternThe Feds Organization The Federal Reserve Banks Twelve district banks Nine directors Three appointed by the Board of Governors. Six are elected by the commercial banks in the district. The directors appoint the district president, which is approved by the Board of Governors.The Federal Reserve SystemCopyright2003 Southwestern/Thomson LearningCopyright 2004 South-WesternThe Feds Organization The Federal Reserve Banks The New York Fed implements some of the Feds most important policy decisions.Copyright 2004 South-WesternThe Feds Organization The Federal Open Market Committee (FOMC) Serves as the main policy-making organ of the Federal Reserve System. Meets approximately every six weeks to review the economy.Copyright 2004 South-WesternThe Feds Organization The Federal Open Market Committee (FOMC) is made up of the following voting members: The chairman and the other six members of the Board of Governors. The president of the Federal Reserve Bank of New York. The presidents of the other regional Federal Reserve banks (four vote on