Money and the Federal Reserve

M2

People cannot directly use these deposits as cash.

Open market operations.

The Federal Reserve buys and sells government securities to alter the money supply in the economy.

when the discount rate is high, banks find it more expensive to borrow from the Fed.

The banks then increase their own interest rates and give out fewer loans, decreasing the total money supply in the economy.

Federal funds rate.

The interest rate that banks charge each other for overnight loans is called the federal funds rate.

Discount rate.

The interest rate that the Federal Reserve charges commercial banks for short-term loans is called the discount rate.

debit card

a card used for electronic cash transactions and money withdrawal

paper currency is a special mixture of...

cotton and linen fiber

Money supply

is all the money available in an economy.

limited supply

the limited availability of a good or service

Unit of account

A property that allows us to compare the values of goods and services.

When the Federal Reserve wants to implement expansionary monetary policy, it decreases the reserve ratio.

Decreasing the reserve ratio means banks can make more loans, which increases the total money supply in the economy.

Type your response in the box. As you read this paragraph, think about the various traits of money. On her way to work, Cara stops by her local coffee shop for tea and oatmeal to go. She pays cash and receives change. She then remembers that she needs to get gas. She fills up her car's tank, and charges it to her credit card. When her shift is over, she goes to the ATM to deposit her paycheck in her savings account. She stops home to change clothes before she goes to the gym. Not wanting to take her purse to the gym, she folds up a $5 bill and puts it in her pocket with her driver's license. When she pays for water and a banana at the gym, the clerk laughs at how old Cara's $5 bill is. Cara replies that it's good that all money looks the same over the past few years. List five ways this scenario references money.

Here are some possible answers: She buys items with cash. She gets change. She uses a credit card. She deposits a paycheck in the bank. She folds up cash. She hears that her cash looks old. She says that it looks the same as newer bills.

Expansionary monetary policy helps increase the money supply in the economy. Such a policy is needed when a country's economic growth has slowed down, such as during a recession.

Increasing the money supply not only increases GDP but also reduces unemployment in a country.

When the Federal Reserve wants to implement contractionary monetary policy, it increases the reserve ratio.

Increasing the reserve ratio means banks need to hold more money in reserve, which reduces the amount they can lend.

contractionary policy helps to reduce the money supply in an economy. Contractionary policy is required when excess money in an economy leads to rapid inflation.

Inflation reduces the purchasing power of money because people can buy less than they could previously with the same amount of money. Inflation reduces real income and discourages savings and investment.

M2 includes

M1 as well as other deposits that can be easily converted to cash, such as savings deposits and money market accounts.

Warm-Up Type your response in the box. This list describes recent events in a country. As you read the list, think about the role of the country's central bank. The country has seen its GDP decline and unemployment rise for three consecutive quarters. People are buying fewer cars, homes, and other goods and services. One reason people are buying less is that it is more difficult and more expensive to get loans to buy large items. The country's central bank decides to lower the interest rate on the loans it makes to the banks that people use. Banks lower their interest rates. More people take out loans. With their loans, people start buying more goods and services, especially more expensive items such as cars. Producers require more workers to make these goods and sell them. Unemployment drops, and GDP begins to rise. What action helped unemployment and GDP in this country? Justify your response.

Sample Answer: The central bank lowered its interest rates, which made it easier and cheaper for banks to make loans to people. Once people could get loans, they could buy more. The increased demand meant more people were employed to make and sell items, and output increased.

When GDP is low and unemployment is high the government might use expansionary policy to help the economy grow.

When inflation is high and GDP is growing too fast the government might use contractionary policy to slow down the economy.

They charge a lower discount rate when implementing an expansionary monetary policy and a higher discount rate for a contractionary monetary policy.

When the discount rate is low, banks find it cheaper to borrow money from the Federal Reserve.

Federal Open Market Committee (FOMC)

a Federal Reserve committee that makes key decisions regarding interest rates and the growth of the US money supply

credit card

a card used to buy goods and services on credit based on the holder's promise to pay for these goods and services plus the interest charged if the balance is not paid each month

uniformity

a condition in which any two units of an object have the same characteristics

Board of Governors

a seven-member board that oversees the Federal Reserve System

government security

a tradable financial instrument issued by the federal or a state government

money supply

all the money available in an economy

medium of exchange

an instrument that determines the value of goods and services and can also be exchanged to purchase goods and services.

representative money

an object that has no value on its own but can be exchanged for something else of value

commodity money

an object that has value in itself and can also be used as money

durability

an object's ability to withstand physical wear and tear

M1

is money that people can access easily and use to buy various goods and services.

fiat money

money that has value because the government orders that it is an acceptable means to pay debts

M1 includes

notes, coins, and funds in all bank accounts that people can immediately convert into cash.

Reserve Bank

one of 12 regional banks of the Federal Reserve that help the central bank

the Federal Reserve is...

responsible for controlling the money supply.

Monetary policy is the actions

the Federal Reserve takes to influence real GDP and the inflation rate in the economy.

monetary policy

the actions of the Federal Reserve to influence real GDP and the inflation rate in the economy

central bank

the bank that implements a government's monetary policy and regulates commercial banks

open market operations

the buying and selling of government securities to alter the money supply in the economy

required reserve ratio

the fraction of deposits that the Federal Reserve requires banks to keep on hand as cash

federal funds rate

the interest rate banks charge each other for overnight loans

discount rate

the interest rate the Federal Reserve charges commercial banks for short-term loans

acceptability

the property of a good or service being universally acceptable in an economy

portability

the property of a good that makes it able to be carried from one place to another

True currency is...

uniform