ECON Readings 3-Money and Banking

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University of Maryland Global Campus (UMGC) *

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201

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Economics

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Jan 9, 2024

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9/6/23, 6(13 PM Money and Banking Page 1 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html Money and Banking In this sec ! on, we discuss the most important aspect of the economy: money. We explain the factors that determine the supply and demand of money as well as the ways in which the government keeps the value of money rela ! vely stable. Func ! ons of Money Economists describe money as having three func ! ons: medium of exchange. People use money for acquiring and selling merchandise and property. unit of account. Prices for all goods and services are stated in dollars and cents. store of value. People can save money for future payments rather than spending it now. Supply of Money There are three defini ! ons, or aggregates, of money. An aggregate is the combina ! on of di ff erent units into one unit. M1 is the narrowest aggregate. It includes currency in the form of coins and paper money in the hands of the public, and all checkable deposits. All the financial holdings (currency and checkable deposits) held by the federal government, the Federal Reserve System, and other financial ins ! tu ! ons are excluded from the money supply. This money is not in circula ! on; hence, it is not available to people as a medium of exchange or as a store of value. M2 is comprised of all the forms of money in M1, plus some near-monies , or highly liquid financial assets that can be easily converted into currency or checkable deposits. M2 includes savings deposits, including money market deposit accounts (MMDAs); small ! me accounts of less than $100,000 (such as cer ! ficates of deposit, or CDs); and money market mutual funds (MMMFs) that can be redeemed through phone calls, checks, or the internet. M3 is the broadest aggregate. It includes all the forms in M2, plus large ! me deposits ($100,000 or more). In 2006, the Board of Governors of the Federal Reserve System stopped calcula ! on and publica ! on of the M3 money aggregate. This decision was based on the fact that M3 money aggregate is not important for Learning Resource

9/6/23, 6(13 PM Money and Banking Page 2 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html monetary policy, and the cost of collec ! ng, preparing, and publishing data for M3 money aggregate exceeded the benefits of the data. Economists define money in three di ff erent ways, depending on the form it takes. Check Your Knowledge: Aggregates of Money Indicate which forms money can take. Ques ! on 1 Currency M1 M2 but not M1 M3 but not M2

9/6/23, 6(13 PM Money and Banking Page 3 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html Ques ! on 2 Checkable deposits M1 M2 but not M1 M3 but not M2 Ques ! on 3 Large ($100,000 or more) ! me deposits M1 M2 but not M1 M3 but not M2 Ques ! on 4 Money market mutual funds (MMMFs) M1 M2 but not M1 M3 but not M2 Ques ! on 5 Saving deposits, including money market deposit accounts (MMDAs) M1 M2 but not M1 M3 but not M2

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9/6/23, 6(13 PM Money and Banking Page 4 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html Demand for Money The demand for money involves two components: transac ! ons demand , or the need to buy goods and services. This component changes directly with the level of GDP. asset demand , or the need to keep money as a store of value for future usage. The main factor that determines the asset demand for money is the interest rate. When the interest rate is high, people want to invest money rather then hold it. When the interest rate is low, people want to hold onto money rather than invest it. Ques ! on 6 Small (less than $100,000) ! me deposits M1 M2 but not M1 M3 but not M2 Ask Yourself: Forms of Money Ques ! on 1 Are credit cards a form of money? Why or why not? Show Answer Ques ! on 2 Are debit cards a form of money? Why or why not? Show Answer Ques ! on 3 Are checking account balances a form of money? Why or why not? Show Answer

9/6/23, 6(13 PM Money and Banking Page 5 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html The supply of money is determined by the federal government and by financial ins ! tu ! ons. These two forces make a certain stock of money available to the public. The intersec ! on point of demand and supply reveals the equilibrium price. This "price" is actually the interest rate, which symbolizes the price paid for an item using money. Check Your Knowledge: Determinants of Demand for and Supply of Money Determine how di ff erent factors a ff ect the demand for money and the money supply. Ques ! on 1 The size of the M1 aggregate in January 2006 was $1,382 billion dollars. The size of the aggregate in January 2005 was $1,367 billion dollars. This change in size shows a(n) ___________. increase in the demand for money decrease in the demand for money increase in the money supply decrease in the money supply Ques ! on 2 During a year, the economy experiences a significant increase in nominal GDP. This increase leads to a(n) ___________. increase in the demand for money decrease in the demand for money increase in the money supply decrease in the money supply Ques ! on 3 During a year, the interest rate in the economy rises. This rise leads to a(n) ___________. increase in the demand for money decrease in the demand for money increase in the money supply decrease in the money supply

9/6/23, 6(13 PM Money and Banking Page 6 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html The Federal Reserve and the Banking System The Federal Reserve System (the "Fed") was established by Congress in 1913. It holds power over the country’s money and banking system. The Board of Governors of the Federal Reserve serves as the monetary authority in the United States. The Board consists of seven members who the president appoints for a term of 14 years. The Board of Governors keeps under control the ac ! ons of the 12 Federal Reserve Banks. The Federal Open Market Commi # ee (FOMC) includes the seven members of the Board of Governors and five presidents of the Federal Reserve Banks (the president of the New York Federal Reserve Bank and four presidents of other Federal Reserve Banks on a one-year rota ! ng basis). The FOMC sets policy governing the buying and selling of government securi ! es. The 12 Federal Reserve Banks Each of the 12 Federal Reserve Banks is considered quasi-public. The banks are supervised by the Federal Reserve Board, but they are owned by private commercial banks. They perform the role of "bankers' banks" by receiving reserve deposits and lending money to banks and other financial ins ! tu ! ons. Commercial Banks and Thri " s Ques ! on 4 During a three-year period, the interest rate in the economy drops significantly. This drop leads to a(n) ___________. increase in the demand for money decrease in the demand for money increase in the money supply decrease in the money supply Ques ! on 5 In 2001, the US economy experienced a substan ! al decrease in nominal GDP. This decrease led to a(n) ___________. increase in the demand for money decrease in the demand for money increase in the money supply decrease in the money supply

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9/6/23, 6(13 PM Money and Banking Page 7 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html Commercial banks are privately owned banks. They can be large na ! onal banks or state banks. Thri $ ins ! tu ! ons include credit unions, savings and loan associa ! ons, and mutual savings banks. Func ! ons of the Federal Reserve System The Fed performs the following func ! ons: issuing the paper currency used in the US; controlling the money supply and establishing monetary policy; se % ng up reserve requirements and holding the reserves of banks and thri $ s; lending money to banks and thri $ s; providing a check collec ! on service for banks; and serving as the fiscal agent of the federal government by providing financial services for the government (The government uses the Fed's facili ! es for tax collec ! on and government spending.) The Board of Governors of the Federal Reserve System presents the size of the M1 and M2 money aggregates in the United States. Use the October 4, 2018 Money and Stock Measures data (h # ps://www.federalreserve.gov/releases/h6/20181004/) for the period of September 2016 to August 2018 to answer the ques ! ons below. Check Your Knowledge: US Money Aggregates Ques ! on 1 In Table 1, was the M1 aggregate stable from September 2016 to August 2018? Show Answer Ques ! on 2 How much greater was the M2 than the M1 aggregate in August 2018? Show Answer Ques ! on 3 From Table 3, what is the main component of M1 money aggregate? Show Answer

9/6/23, 6(13 PM Money and Banking Page 8 of 8 https://leocontent.umgc.edu//content/umuc/tus/econ/econ201/2225/learning-resourcelist/money-and-banking-umuc.html References Board of Governors of the Federal Reserve System. Money Stock and Debt Measures - H.6 Release. Retrieved from h # ps://www.federalreserve.gov/releases/h6/20181004/ Board of Governors of the Federal Reserve System. Policy Tools: Reserve Requirements. Retrieved from h # p://www.federalreserve.gov/monetarypolicy/reservereq.htm © 2023 University of Maryland Global Campus All links to external sites were verified at the ! me of publica ! on. UMGC is not responsible for the validity or integrity of informa ! on located at external sites. Ques ! on 4 Table 4 includes all items of M1 plus addi ! onal items. What is the main component of M2 that is not included in M1? Show Answer Ques ! on 5 If households in the economy decide to take money out of checking account deposits and put that money into savings accounts, this will ini ! ally... decrease M1 and not change M2 decrease M1 and decrease M2 increase M1 and decrease M2 decrease M1 and increase M2

ECON Readings 3-Money and Banking

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