Instructor14Commentary - 1 INSTRUCTOR COMMENTARY Chapter...

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INSTRUCTOR COMMENTARY Chapter Reference: Chapter 14 Money and the Banking System 1. Chapter 14 focuses on the following important concepts: A. The functions of money. Money serves as a medium of exchange, a store of value and a unit of account. Money allows economies to avoid barter exchange (which is less efficient because it limits the extent of specialization and division of labor). (text, pp. 355-357) B. What constitutes the money supply in the U.S. economy? The U.S. money supply is essentially comprised of coins, currency, (paper money), traveler’s checks and various types of deposits. There are two definitions of the money supply in the U.S. economy: M1 and M2. Each includes (successively) less liquid assets, with M1 including only those components of the money supply than can be used to purchase goods and services, with M2 including savings and time deposits of increasingly large values. (text, pp. 359-360) C. Why credit cards are not part of the U.S. money supply. Credit cards can be used as a medium of exchange, but they do not constitute a store of value. Credit card charges are essentially short-term loans from financial services firms to credit card users. (text, p. 357) D. What “stands behind” the U.S. money supply today? Historically, the U.S. money supply has been backed by both gold and silver and, in a more recent time, gold alone. Today the U.S. money supply has no link whatsoever to gold or silver reserves held by the U.S. government. The U.S. dollar cannot be converted into any precious metal and is “backed” today only by the confidence that the holders of U.S. dollars have that the FED will retain its purchasing power over time by controlling future increases in the price level. (text, pp.358-359) E. The functions of the FED. 1
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The principal responsibilities of the Federal Reserve System are: (1) to provide the economy with currency (paper money) in the amounts chosen by households and business firms; (2) to control the total money supply (monetary policy); (3) to act as a fiscal agent for the federal government (hold deposits and pay checks on demand); (4) to supervise the activities of deposit-holding institutions; and (5) to provide for the clearing and collecting of checks. (Note: your text, p. 343) adds yet another function: protecting consumers.) (text, pp. 365-367) F. The structure (and independence) of the FED. The FED was designed to insulate the control of the money supply from the political process. The FED is comprised of 12 Federal Reserve District Banks, each with its own president elected from candidates within that district. The 12 district bank presidents comprise the Federal Advisory Council which advises the Board of Governors on monetary policy. Five of the 12 district bank presidents serve on the Federal Reserve Open Market Committee, the group that implements monetary policy in the U.S. economy. The seven members of the Board of Governors are selected by the
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Instructor14Commentary - 1 INSTRUCTOR COMMENTARY Chapter...

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