Ec 111 1st Edition Lecture 12Outline of Last LaectureI. Cyclical Unemployment vs The Natural RateII. Explaining the Natural Rate: An OverviewIII. Job SearchIV. Public Policy and Job SearchV. Unemployment InsuranceVI. Explaining Structural UnemploymentOutline of Current LectureI. What is Money and why is it Important?II. The Three Functions of MoneyIII. The Two Kinds of MoneyIV. The Money SupplyV. Measures of the US Money SupplyVI. Where is All the Currency?VII. Central Banks and Monetary PolicyVIII. The Fed’s OrganizationIX. Federal Open Market CommitteeX. The Structure of the FedXI. Bank ReservesXII. Bank T-AccountsXIII. Banks and Money SupplyXIV. The Money MultiplierCurrent LectureWHAT IS MONEY AND WHY IT’S IMPORTANT?- Without money, trade would require barter, the exchange of one good or service for another- Most people would have to spend time searching for others to tradeo Huge waste of resources- This searching is unnecessary with money, the setoff assets that people regularly use to buy goods and services from other peopleThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.THE THREE FUNCTIONS OF MONEY1. Medium of Exchange: an item buyers give to sellers when they want to buy goods and services2. Unit of Account: how debt is recorded. The yardstick people use to post prices and record debt3. Store of Value: an item people can use to transfer purchasing power from the present to the future (how wealth is measured)THE TWO KINDS OF MONEY1. Commodity Money: takes the form of a commodity with intrinsic valuea. Gold coins, cigarettes in POW camps or prison2. Fiat Money: money without intrinsic value, used as money because of government decreea. The US dollarTHE MONEY SUPPLY- Money (stock) Supply: the quantity of money available in the economy- What assets should be considered part of money supply?o Currency: the paper bills and coins in publico Demand Deposits: balances in bank accounts that depositors can access on demandMEASURES OF THE US MONEY SUPPLY- M1: currency, demand deposits, traveler’s checks, and other checkable deposits- M2: everything in M1 plus savings, deposits, small-time deposits, money market funds, and a few minor categories- M3: M1 and M2 plus large time deposits, repurchase agreements, and other categories- The distinction between M1 and M2 will usually not matterWHERE IS ALL THE CURRENCY?- 2013: $1.1 trillion currency outstandingo The average adult holds about $4490 of currency o Much currency is held abroado Much of the currency is held by drug dealers, tax evaders, and other criminals- Currency is not a particularly good way to hold wealtho Can be lost or stoleno Doesn’t earn interestCENTRAL BANKS AND MONETARY POLICY- Central Bank: an institution that oversees the banking system and regulates the money supply- Monetary Policy: the setting of the money supply by policy makers in the central banks- Federal Reserve (Fed): the central bank of the USTHE FED’S ORGANIZATION- The Federal Reserveo Created in 1913 from the Federal Reserve Act o After a series of bank failures in 1907o “The Panic of 1907” also called “Knickerbocker Crisis”…the failure of the Knickerbocker Trust Companyo Purpose: to ensure the health of the nation’s banking system- Board of Governorso 7 members that serve 14 year terms Appointed by the president and confirmed by the senateo The Chairman Directs the Fed staff Presides over board meetings Testifies regularly about Fed policy in front of congressional committees Appointed by the President (4 year terms) Janet Yellen is the current chairwoman- The Federal Reserve Systemo Federal Reserve Board in Washington DCo 12 regional Federal Reserve Banks Major cities around the country There are presidents of each Federal Reserve Bank- Presidents chosen by each bank’s Board of Directors- The Fed’s Jobso Regulate banks and ensure the health of the banking system Regional Federal Reserve Banks Monitors each bank’s financial condition Facilitates bank transactions-clearing checks Acts as a bank’s bank The Fed-lender of last resorto Control the money supply Quantity of money available in the economy Monetary Policy- By the FOMC- Setting of the money supplyFEDERAL OPEN MARKET COMMITTEE FOMCo 7 members of the board of governorso 5 of the 12 regional bank presidents All 12 regional presidents attend each FOMC meeting, but only 5 get to vote New York regional president always votes- This is because the bond market is in New Yorko Meets about every 6 weeks in DC  During a crisis, they will meet more ofteno Discus the condition of the economyo Consider changes in monetary policyTHE STRUCTURE OF THE FED The Federal Reserve system consists of:o Board of Governors (7) in DCo 12 regional Federal Banks located around the USo Federal Open Market Committee (FOMC) 7 Board of Governors BANK RESERVES Fractional Reserve Banking System: banks keep a fraction of deposits as reserves and usethe rest to make loans Reserve Requirements: regulations on the minimum amount of reserves that banks musthold against deposits established by the Fed. o Banks can hold the reserves in a vault or deposit at the Fedo Banks may hold more than the minimum amount Reserve Ratio: transaction of deposits that banks hold as reservesBANK T-ACCOUNTS T-Account: a simplified accounting statement that shows a bank’s assets and liabilities Bank’s liabilities include deposits, assets include loans and reservesBANKS AND MONETARY POLICY No Banko Public holds all currencyo Money supply=cash supply 100% reserve systemo Banks do not affect size of money supply Fractional Reserve Banking system (US policy)o Money supply=deposits+borrowerso When banks make loans they create money A fractional reserve banking system creates money, but not wealth Money keeps ending up in other banks which keeps increasing the money supply Money is created with each new loanTHE MONEY MULTIPLIER Money Multiplier: the amount of money the banking system generates with each dollar of reserveso Calculated as: 1/R* the initial