Chapter 13 - MONEY AND THE BANKING SYSTEM
See opening quote, page 262, by Milton Friedman.
We will now switch from fiscal policy to monetary policy in the next two chapters. We first look at
Money and the Banking System and then focus on monetary policy in the next chapter. Fiscal policy
is conducted by Congress and the President (or Parliament and Prime Minister), Monetary policy is
conducted by the
Central Bank (Federal Reserve Bank)
, which is a "quasi-governmental" institution
that supervises the banking system and regulates the supply of money in the economy.
WHAT IS MONEY?
Money is what we use to make payments for our debts, goods, services, products, and financial assets.
But unlike gold or silver money, modern money has no real value - it is just green paper with no
intrinsic value - but everyone wants more of it. Why? Because Money is an asset that performs three
very important functions in the economy:
1. Medium of exchange -
money is an asset used as a means to make final payment. We use dollars to
pay for goods and services. Increases efficiency of trade and exchange. Without money in the
economy, we would have a barter economy, where we would trade goods for goods, or services for
goods, etc. instead of money for goods or services. Barter is inefficient because it relies on the "double
coincidence of wants."
For example, to get food, you would have to find a farmer who has what you want and you would have
to have something the farmer wants. To get medical service, the farmer would have to find a doctor
who wants a cow or milk, etc. Barter is extremely inefficient.
Compared to barter, money is extremely efficient. The farmer can sell a cow for money, and then go
out and buy whatever he/she wants with the cash - medical services, electricity, etc. Money eliminates
the "double coincidence of wants" and makes the economy operate much more efficiently.
When is barter efficient? - baseball card convention, coin/stamp trading, etc. Market for
dating/marriage. Russia - Pepsi/Stolys. To avoid high taxes. Or during hyperinflation.
. Money is used as a unit of account.
In the US, everything is priced in dollars, so we have a
standard unit of measurement (dollars) to measure value in the economy, just like we use standard units
to measure distance (yards, feet, miles, kilometers, etc). Money is a measuring rod of value. By having
a common unit of account (measurement), we can compare prices/values easily since economic value is
stated in dollars.
Another reason that a barter economy is inefficient - there is no standard unit of measurement. Makes
comparison shopping very difficult.
3. Store of value/wealth -
money is used as a financial asset to transfer purchasing power from the
current period to a period in the future. You can put $100 bills under your mattress and transfer
MGT 551: BUSINESS ECONOMICS CH – 13
Professor Mark J. Perry