,10 MONEY AND PRICES IN THE LONG RUN,29,The Monetary System,THE MEANING OF MONEY,Money is the set of assets in an economy that people regularly use to buy goods and services from other people.,The Functions of Money,Money has three functions in the economy: Medium of exchange Unit of account Store of value,The 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.,The 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.,The Functions of Money,Liquidity Liquidity is the ease with which an asset can be converted into the economys medium of exchange.,The 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.,Money 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. Economy,Copyright2003 Southwestern/Thomson Learning,Billions,of Dollars,0,CASE 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 entities,THE 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.,THE 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.,THE 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 Committee,The 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.,The 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.,The Feds Organization,The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C., and twelve regional Federal Reserve Banks.,The 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 System,Copyright2003 Southwestern/Thomson Learning,The Feds Organization,The Federal Reserve Banks The New York Fed implements some of the Feds most important policy decisions.,The 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.,The 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 a yearly rotating basis).,The Feds Organization,Monetary policy is conducted by the Federal Open Market Committee. Monetary policy is the setting of the money supply by policymakers in the central bank The money supply refers to the quantity of money available in the economy.,The Federal Open Market Committee,Three Primary Functions of the Fed Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices. Acts as a bankers bank, making loans to banks and as a lender of last resort. Conducts monetary policy by controlling the money supply.,The Federal Open Market Committee,Open-Market Operations The money supply is the quantity of money available in the economy. The primary way in which the Fed changes the money supply is through open-market operations. The Fed purchases and sells U.S. government bonds.,The Federal Open Market Committee,Open-Market Operations To increase the money supply, the Fed buy