• Money is the set of assets in the economy that people regularly use to purchase goods and services from other people. Money has three functions in the economy: It is a medium of exchange, a unit of account, and a store of value. These functions distinguish money from other assets such as stocks and bonds, real estate, and the like.

  1. Definition of Commodity Money: money that takes the form of a commodity with intrinsic value.

  2. Definition of Fiat Money: money without intrinsic value that is used as money because of government decree.

• Are credit cards money? Not at all! If you use your credit card to make a purchase, you obtain a short-term loan from the financial institution that issued the card. Credit cards are thus a method of postponing payment for a brief period. In shopping for a credit card, a person should want to consider features such as the credit card’s annual percentage rate, the grace period, whether the issuer may be charged an over-limit fee or a late-payment fee, and the annual cost of the card.

• The basic money supply, M1, consistents of currency and checking. Under federal law, only the US Treasury issues coins and the Federal Reserves issues paper currency. Checking account money is created by the banking system.

• The check collection system in the United States is efficient, but the collection process that a check goes through may be complicated. The checking processing system is conducted by local clearinghouses, corresponding banks, and the Federal Reserve’s check collection network.
• Most of our money comes from checking accounts issued by banks, rather than currency. Through the process of lending reserves, banks create money. The money multiplier is used to calculate the maximum amount of money the banking system generates with each dollar of reserves. The money multiplier is the reciprocal of the reserve requirement ratio.
• The Federal Reserve System, often called the Fed, is the central bank of the United States. It was created through an act signed by President Woodrow Wilson in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system.

• The Fed has a structure designed by Congress to give it a broad perspective on the economy. At the head of the Fed’s formal organization is the Board of Governors. The 12 district Federal Reserve banks make up the next level. The organization of the Fed also includes the Federal Open Market Committee and three advisory councils. The Federal Reserve has as stockholders the commercial banks that are members of the system.

• The Fed, as overseer of the nation’s monetary system, has many important duties: lender of last resort, regulating and supervising banks, supplying services to banks and to the government, foreign exchange operations, and controlling the money supply and interest rates.

• The main responsibilities of the Fed is that of formulating and implementing monetary policy which consists of changing the economy’s money supply to help the economy in achieving maximum output and employment and also stable prices. The Fed used three policy instruments to influences the money supply: open market operations, the discount rates, and the reserve requirements.

When banks makes loans, the money supply changes.  Remember that M1 = currency + checkable (demand) deposits.

Start by depositing $100 in a bank

First National loans part of the money and creates and addition $90 that goes into 2nd National.

Each time the money is deposited and a bank loan is created, more money is created.

Definition of Open Market Operations: the purchase and sale of U.S. government bonds by the Fed.

a. If the Fed wants to increase the supply of money, it creates dollars and uses them to purchase government bonds from the public.

b. If the Fed wants to lower the supply of money, it sells government bonds from its portfolio to the public. Money is then taken out of the hands of the public and the supply of money falls.

Definition of Discount Rate: the interest rate on the loans that the Fed makes to banks.

a. When a bank cannot meet its reserve requirements, it may borrow reserves from the Fed. (See the Reserves in the T-account above.)

b. A higher discount rate discourages banks from borrowing at the Fed and likely encourages banks to hold onto larger amounts of their reserves. This in turn lowers the money supply.

c. A lower discount rate encourages banks to lend their reserves (and borrow from the Fed). This will increase the money supply.