Functions of Money  Medium of Exchange – accepted for goods/services  Measure of Value – single standard used to compare value  Store of Value – provides a way to retain or accumulate wealth

Supply of Money  Demand deposit – amount on deposit in a checking account  Time deposit – amount on deposit in an interest- bearing savings account.  Near monies – accounts that can be converted to cash in a short amount of time  Liquidity – the ability to turn an asset into cash. (More liquid assets can be converted to cash in a shorter amount of time.)

Measures of the Money Supply  M1 = currency and demand deposits  M2 = M1 + certain securities and small time deposits  M3 = M1 + M2 + large time deposits

The Federal Reserve (the Fed)  Central bank of the U.S. responsible for regulating the banking industry and controlling the money supply.  President (with approval of Senate) appoints the governors of the Fed for 14 year terms.  The long terms “insulate” the governors from political pressure.

Tools of the Fed for controlling $ supply  Discount rate  Reserve requirements  Open Market operations  (note that all of these “tools” work two ways. See table 19-1 p.576

Discount Rate  Interest rate the Fed charges for loans to member banks. (inter-bank lending rate)  Decrease in the discount rate increases the amount of loanable funds and increases the amount of $ money supply.  Since the discount rate is the wholesale rate for money all interest rates should decrease thus stimulating business and individual to borrow. Econ. activity increases.

Reserve Requirement  % of deposits a bank must retain, either in its vault or on deposit with the Fed.  Increase in the r.r. decreases the amount of loanable funds, increasing the interest rate and slowing down econ activity as businesses and consumers are less likely to borrow.

Open market operations  Most used tool  Buying and selling of government securities (Treasury Notes, Bonds and Bills)  When the Fed sells securities (assuming people buy them) $ is taken out of circulation thus decreasing econ activity.  Even today the Fed has always been able to easily sell Treasury instruments.

Other Fed functions  Serving as the government bank  Clearing checks and electronic transfers  Inspection of currency  Regulating and inspecting banks

What doesn’t the Fed control?  Insurance companies  Brokerage firms  Pension funds  Investment banking firms  Finance companies  Mutual funds  These and others perform limited banking functions but operate outside the sphere of regulation. (trouble-makers! )