BU204_Krugman_Chapter 13 - > Money Banking and the Federal...

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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
interest 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
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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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PA R T 5
SHORT-RUN ECONOMIC FLUCTUATIONS
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.