ECO 181 1nd EditionExam # 3 Study Guide Lectures: 15, 16, 33, and 17ECO EXAM 3Study GuideCHP 15: I. The Monetary System:- Moneyo The set of assets that people use regularly to buy goods and serviceso Money doesn’t hold interest when are holding it Some consider that a problem- Wealtho Total accumulation of all asseso Physical assets have value; exchanged for something of valueII. Importance of Money- Without money, trade would require barter; the exchange of one good or service for another- Every trade would require a double coincidence of wants which is where one person is seeing what you want, and they want what you are selling- Would require a lot of resources, thus money makes trade easier- Permits specialization, facilitates efficiency and growthIII. 4 Functions of Money- 1. Medium of Exchange:o An item buyers give to sellers when they want to purchase goods and services- 2. Unit of Account:o The yardstick people use to post prices and record debts- 3. Store of Value:o An item people can use to transfer purchasing power from the present to the future Many assets can take on the form of stores of valure (and most are better stores of value due to inflation) but only money can take on all 3 functions of moneyo Bonds are interest – paying assetso Money isn’t a perfect store of value due to inflation- 4. Form of Deferred Payment:o A property of an item that makes it desirable for use as a means of settlingV. What is counted as money?- Credit card are liabilities not assets and are not counted as money- Two kinds of money- Commodity Money:o Takes the form of a commodity with intrinsic valueo Ex) gold coins, ciggartees in POW camps- Fiat Money: o Money without intrinsic value, used as money because of government degreeo Ex) U.S. DollarVI. What Backs Money?- For commodity money its is its intrinsic valueo Waste of valuable resources- For convertible money it can be exchanged for something of value- For fiat money it is the promise of the governmentVII. Fiduciary Monetary System- A system in which currency is issued by the government and its value rests on the publics confidence that it can be exchanged for goods and servicesVII. Most important properties of money- Liquidity refers to how easily an asset can be turned into a medium of exchangeo Currency and coins and transaction deposits are perfectly liquid Transactions deposits can be accessed by a check or a debit card- Money supply is the quantity of money in the economyVIII. Transactions Approach- A method of measuring the money supply by looking at money as a medium of exchange- M1 = Currency and Coins + Checking deposits and travelers checkso M1 is perfectly liquid assets- Transaction deposits are money in checking accounts- M1 has increased a lot since great recession due to actions of the FedIX. Liquidity Approach- A method of measuring the money supply by looking at money as a temporary store of value- Since savings can be easily converted to a medium of exchange, many believe that is should be counted as money- M2 = M1 + Savings + Small Time Deposits + Money Market Mutual Fundso M2 counts all of M1- < 10,000- People thing M2 is better than M1 because you can easily transferX. Financial System- Is the group of institutions that helps match the savings of one person to the borrowing of another institutionXI. Two Types of Financial Systems- 1. Financial Markets:o Institutions (business or government) through which savers can directly provide the funds to borrowers: Bond market sand stock market- Company can sell bonds o Finance spending (debt financing)- Company can sell stockso Equity financing Giving up partial ownership- 2. Financial Intermediaries:o Financial intermediaries accept funds from customers and invest them through lendingXII. Reasons why Financial Intermediaries are preferred method of saving- 1. Asymetrix information: Information possessed by borrower in a financial transaction but not by the othero Financial Intermediaries can do research- 2. Adverse Selection: The likelihood that borrowers may use their borrowed funds for riskier projectso People who need to borrow are likely a riskier investment- 3. Moral Hazard: The possibility that a borrower might engage in behavior after a loan has been obtained- 4. Large Scare and Lower Management Costso A. People can pool funds in an intermediary, reducing individual costso B. Ex) pension funds, government sponsored financial institutions such as federal national mortgage associationXIII. Overview of the FED- Central Bank: o An institution that oversees and regulates the banking system, and influences the moneysupply (both domestically and in the foreign currency market)- Federal Reserve (Fed)o The central bank of the U.S – established in 1913 by the Federal Reserve Act; signed by president Woodrow Wilson Creates price stability and reduce bank runsXIV. Roles of the Fed:- 1) Monetary Policy: o The setting of the influence money supply and interest rates by policy makers in the central bank in order to influence AD and thus RGDP, PL, and U (unemployment)- 2) The Fed regulates the banking system- 3) They are banker to other bankso Meaning that they hold banks money (known as reserves at the Fed)  done for check clearing- 4) The fed sometime loans money to bankso Known as the lender of last resort- 5) The Fed also acts to influence the value of the $ in the foreign exchange marketXV. Two Congressional Mandates of the Fed- 1. Keep inflation low!o Price and stability approx. 2% per year  financial sector- 2. Keep unemployment low! (U= Un)- If the fed a part of the government?o The FED is an autonomous institution meaning that they can make policy without presidential and congressional approval o No action lagXVI. Structure of the Fed- 1. Board of Governors (located in DC)o 6 members nominated for 14 year termso 1 chairperson … Current one is Janet Yellon nominated for 4 year termso TOTAL: 7 MEMBERS- 2. 12 regional banks – issue new currencyo Hold banks reserveso Check clearingo 4 rotating presidents from the 12 regional banks + NY Fed president- 3. 7 Board Members + 5 Presidents = Federal Open Market Committee (FOMC)o Meet every 6 weeks to vote on policyo FOMC decides on the amount of monetary policyXVII. Banks affect on money- The U.S is a Fractional reserve banking system:o Banks keep a fraction of deposits as reserves and use the rest to make loans (or buy other assets)o Reserves can be held at fed or in vault- The FED