Chapter30 Additional Insights

Chapter30 Additional Insights - Chapter 30: The Financial...

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Chapter 30: The Financial Sector and the Demand for Money {Note: In this chapter, please read the main chapter material. You may skip Appendix A and Appendix B.} In the previous chapter, we looked at the Classical and Keynesian interpretations of how the 4 major participants (households, firms, government, and the international sector) interact at the aggregate economic level. The Classical view maintains that the economy should be left alone in order for the individual markets to strive for equilibrium. The Keynesian view makes a distinction between the short run and the long run and the short run analysis opens the door for government intervention (i.e., fiscal policy – government spending and taxation) to influence the aggregate economy. We now leave fiscal policy aside and change our focus to the monetary sector. Monetary policy is, specifically, a policy of influencing the economy through changes in the banking system’s reserves that influence the money supply and credit availability in the economy. More simply, monetary policy is deliberate policy actions aimed at influencing the money supply with the intent of having an effect on the aggregate economy. In the U.S. economy, monetary policy is conducted by the Federal Reserve Bank of the U.S., otherwise known as the “Fed”. Before looking at the structure, organization, and tools of the Fed, we will first look at money and the role of banks and the general public in determining the money supply. Money : We have been studying markets and market interaction as a mechanism that allows people to reflect their values. A market is an arrangement in which two parties (the buyer and the seller) come together to trade. When they come together in a market, they reveal their values of the good or service being traded. If the two parties reach a common price- quantity combination, the transaction occurs. Money is NOT necessary for trade to occur. Trade can occur in which two parties trade goods or services without the use of money. Suppose you grow tomatoes and at the end of the summer, you have more tomatoes than you can use yourself. You might freeze or can some of the tomatoes and make sauce out of other tomatoes…and you still have tomatoes left over. Your neighbor grows zucchini and at the end of the summer, your neighbor has more zucchini than he/she can use. You get together with your neighbor and trade tomatoes for zucchini. This is done without the use of money. This type of transaction is a “barter” transaction. Barter trade is not uncommon. So then why do we have/need/use money? Money allows us to trade more efficiently. If
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Chapter30 Additional Insights - Chapter 30: The Financial...

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