KRUGMAN_WELLS_MACRO_CHAPTER13 - > Money Banking and the...

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>> he birth of economics as a discipline is usually dated to 1776, when Adam Smith published The Wealth of Nations . His book is most famous for its early appreciation of the “invisible hand” of markets, which harnesses private inter- est to the public good. But there’s a lot more in The Wealth of Nations . Among other things, it contains a passionate de- fense of what were, in Smith’s time, new- fangled inventions: banks and paper money. Today we take it for granted that we can trade pieces of elaborately printed paper— green paper, in the United States—for al- most any good or service. We also take for granted that in many cases we don’t even need the pieces of paper: we can write a check or swipe a card, both of which amount to promises that a bank will pro- vide green paper or its equivalent at a later time. In Adam Smith’s time, however, most of the world’s business was still conducted with gold or silver coins. Paper money and bank accounts—though well established in his native Scotland—were still regarded with suspicion in much of the world. That’s why Smith felt it necessary to explain the virtues of a modern monetary system that would allow a nation to conduct its business A WAGGON-WAY THROUGH THE AIR What you will learn in this chapter: The various roles money plays and the many forms it takes in the economy. How the actions of private banks and the Federal Reserve deter- mine the money supply. How the Federal Reserve uses open-market operations to change the monetary base. Erik Dreyer/Stone/Getty T chapter 321 13 Money, Banking, and the Federal Reserve System while freeing up that gold and silver for other uses. Using paper money instead of gold and silver coins, he said, was like finding a way to build a road without di- verting any land from other uses—build- ing “a sort of waggon-way through the air.” In this chapter, we’ll look at how a mod- ern monetary system works and at the in- stitutions that sustain and regulate it. This topic is important in itself, and it’s also es- sential background for the understanding of monetary policy, which we will examine in Chapter 14. According to an old proverb, “With money in your pocket, you are wise, and you are handsome, and you sing well, too.”
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322 PA R T 5 SHORT-RUN ECONOMIC FLUCTUATIONS UNCORRECTED Preliminary Edition Money is any asset that can easily be used to purchase goods and services. Currency in circulation is cash held by the public. Checkable bank deposits are bank ac- counts on which people can write checks. The money supply is the total value of fi- nancial assets in the economy that are considered money. The Meaning of Money In everyday conversation, people often use the word money to mean “wealth.” If you ask, “How much money does Bill Gates have?” the answer will be something like, “Oh, $40 billion or so, but who’s counting?” That is, the number will include the value of the stocks, bonds, real estate, and other assets he owns.
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