Chapter 5
Money and the
Federal Reserve
These slides supplement the
textbook, but should not
replace reading the textbook
1
What is barter?
The practice of trading one
good or service for another
2
What is a double
coincidence of wants?
A situation in which two
traders are willing to
exchange their
products directly
3
What is currency?
Anything that can be
used to signify
someone’s credit and
someone’s debit in a
financial transaction
4
What are the 4 basic
functions of money?
Medium of exchange
Unit of account
Store of value
Standard deferred payment
5
What is a
medium of exchange?
Money is accepted
in exchange for a
good or service
6
What a
unit of account?
Money is used to
compare the relative
value of different
goods and services
7
What is a
store of value?
Money is used as a
means of saving
8
What is a
standard of
deferred payment?
Money is used to keep
track of the method and
the amount of money is to
be paid back in the future
9
What are the
properties of money?
Scarcity
Portability
Divisibility
10
What is
commodity money?
Anything that serves
both as money and
as a commodity
11
What is
token money?
Money that exceeds
the value from which
it was made, for
example, quarters
12
What are examples
of money?
Federal Reserve Notes
Coins
Checks
Travelers checks
13
What does the term
liquidity mean?
The easier something is to
spend the more liquid it is,
the more difficult it is to
spend the less liquid it is
14
Which form of money
is most liquid?
It all depends on the
circumstances
15
What is fiat money?
Money not redeemable for
any commodity; its status
as money is conferred by
the government
16
What is legal tender?
Currency that constitutes
a valid and legal offer of
payment for debts
17
Does gold or silver
back up our money?
No, our money is not
backed up by anything
18
What happened
in 1968?
U.S and a number of
European nations stopped
selling gold on the London
market, allowing the
market to freely determine
the price of gold
19
What happened
in 1971?
From 1968 to 1971, only
central banks could trade
with the U.S. at $35/oz.
Finally, in 1971, even this
bit of gold convertibility died
20
Why does money
have value?
It is useful and
relatively scarce
21
What determines the
value of money?
The general price level
22
Why are banks called
depository institutions?
Because they accept
deposits from the public
23
What are
commercial banks?
Depository institutions
that make loans to
the public
24
What are
demand deposits?
Accounts at financial
institutions that pay no
interest and on which
depositors can write checks
to obtain their deposits
25
How do banks
make profit?
After interest paid or
services rendered minus
costs equals bank’s profit
26
Who were the
first bankers?
Goldsmiths in the middle ages
27
What is the Federal
Reserve System?
The central bank and
monetary authority of
the United States;
known as “the Fed”
28
What is the function
of the Fed?
To ensure the availability
of enough money and
credit in the banking
system to support a
growing economy
29
When was the
federal reserve
system established?
The Federal Reserve
Act of 1913
30
Does the Fed loan
money to private
companies?
No, they only do
business with
financial institutions
31
Why would the Fed
want to decrease the
money supply?
To lower inflation
32
Why would the Fed
want to increase the
money supply?
To stimulate employment
33
How many Federal Reserve
banks are there?
The U. S. is divided into 12
Federal Reserve districts,
each district has a Federal
Reserve Bank
34
Who makes the
decisions for the
Federal Reserve?
The Board of Governors
and the Open Market
Committee
35
How long do most
board members serve?
14 years, after which they
cannot serve again
36
How long does
the chairman of
the board serve?
The Chairman serves
4 years, but can
serve again
37
What is the Federal Open
Market Committee?
Made up of the 7 board
members and 5 presidents
of Federal Reserve Banks
38
What is the role of
the Federal Open
Market Committee?
The FOMC makes
decisions as to the
buying and selling of
government securities
39
Member Banks
 owns stock in Federal
Reserve
 only national banks are
required to be members
40
What do the letters
FDIC stand for?
The Federal Deposit
Insurance Corporation
41
When was the FDIC
established?
1933
42
What is the function
of the FDIC?
To ensure deposits in any
banking institution that
purchases FDIC insurance
43
How much are
deposits insured for?
Each account in a bank is
insured up to $250,000
per depositor per bank
44
What is the name of the
market where money is
bought and sold?
The loanable funds market
45
Why would the Fed
want to expand the
money supply?
If we have
unemployment the Fed
wants to increase the
money supply to
stimulate employment
46
Why would the Fed
want to contract the
money supply?
If we have inflation the
Fed wants to decrease
the money supply to
bring down prices
47
What does the term
liquidity mean?
A measure of the ease
with which an asset can
be converted into money
without significant loss in
its value
48
What does liquidity
have to do with the
money supply?
With inflation the Fed
wants banks to be less
liquid
With unemployment the
Fed wants banks to be
more liquid
49
What makes a bank
more or less liquid?
A lot of cash in excess
reserves - very liquid
Little cash in excess
reserves - less liquid
50
What is a
required reserve ratio?
The ratio of reserves to
deposits that banks are
required to hold
51
What are
required reserves?
The dollar amount of
reserves a bank is
legally required to hold
52
Where are bank’s
reserves held?
Deposits with the Fed and
cash in the bank’s vault
53
What are
excess reserves?
Bank reserves in excess
of required reserves
54
What money do
banks lend out?
Excess reserves
55
If a bank has $6,000 in
checkable deposits with a
reserve ratio of .2 how
much can the bank lend?
No more than $4,800
56
How does the Fed
influence the money
supply?
Change reserve
requirements
Change discount rate
Change federal funds rate
Buy/sell govt. securities
57
What are
reserve requirements?
The percentage of a bank’s
assets that must be kept
in cash and therefore
cannot be lent out
58
Who sets
reserve requirements?
Reserves are determined
by the Fed for all
financial institutions
59
If we have inflation
what will the Fed do to
reserve requirements?
Raise reserve requirements
thereby decreasing bank’s
excess reserves
60
If we have unemployment
what will the Fed do to
reserve requirements?
Lower reserve requirements
thereby increasing bank’s
excess reserves
61
What is the
discount rate?
The interest that banks
pay when they borrow
money from the Fed
62
What will the Fed do
to the discount rate
during periods of
inflation?
The Fed will raise the
discount rate to
discourage borrowing
and thus spending
63
What will the Fed do
to the discount rate
during periods of
unemployment?
The Fed will lower the
discount rate to
encourage borrowing
and thus spending
64
What is the
federal funds rate?
The interest rate that
banks pay to borrow
excess reserves from
another bank
65
What will the Fed do to
the federal funds rate
during periods of
inflation?
The Fed will raise the
federal funds rate to
discourage borrowing
and thus spending
66
What will the Fed do to
the federal funds rate
during periods of
unemployment?
The Fed will lower the
federal funds rate to
encourage borrowing
and thus spending
67
What is the
prime interest rate?
The interest rate that big
banks charge their
best and most credit
worthy customers
68
What is a
government security?
A short term bond that the
federal government sells
69
What is the
open market?
A place where bonds
are bought and sold
70
What are
open market operations?
The act of the Fed
buying or selling
government securities
at the open market
71
Why does the
government sell
securities?
This is its way of
borrowing money
72
What will the Fed do if
we have unemployment?
The Fed will buy
government securities
making banks more
liquid so they can lend
out more money
73
What will the Fed do
if we have inflation?
The Fed will sell
securities making banks
less liquid so they will
have less money to lend
74
Which monetary tool
is most often used?
Open-market operations
75
What is
moral suasion?
A host of different
measures that the
Fed uses to influence
the activities of banks
in one way or another
76
What is the largest
component of
assets of the Fed?
U.S. government securities
77
What is the largest
component of the
Fed’s liabilities?
Federal Reserve notes
78
Why is the Fed so
profitable?
Because it pays no interest
on its liabilities but earns
interest on its assets
79
If the Fed wants to
increase the money
supply by $1,000 million,
what should it do?
With a reserve requirement
of 10% it should increase
the money supply by
$100 million
80
What is the money
multiplier with a
reserve requirement
of 1/10?
10
81
What is the Money
Multiplier formula?
1/Required reserve ratio
82
If the required reserve
ratio is 1/10 and all
banks are exactly
meeting their reserve
requirement - how do
we calculate the
money multiplier?
83
One divided by one
tenth equals 10
.
1 .
1
X
1
10
10 =
1
Multiplier
=
10
84
$100
$90
$81
original deposit
$74
$63 total money
...
$1,000
85
If the Fed wants to
decrease the money
supply by $1,000 million,
what should it do?
With a reserve
requirement of 10% it
should decrease the
money supply by
$100 million
86
Why is the Fed better
at fighting inflation
than unemployment?
The Fed can’t force people
to borrow more money
87
What things will cause
interest rates to rise?
 Demand for money increases
 The Fed raises the Discount
or Federal Funds Rate
 The Fed sells government
securities
88
What things will cause
interest rates to fall?
 Demand for money decreases
 The Fed lowers the Discount
or Federal Funds Rate
 The Fed buys government
securities
89
What is
Quantitative Easing?
A politically polite term
for monetizing the
debt, the Fed creates
money to buy bonds
90
END
91