Money and the Federal Reserve

Objective
In this lesson, you will

Glossary
TERM DEFINITION
store of value the ability of a good to retain its value if stored and used at a later time
medium of exchange an instrument that determines the value of goods and services and can be exchanged to purchase those goods and services

unit of account a property that allows comparing the values of goods and services
limited supply
the limited availability of a good or service
money supply all the money available in an economy

durability an object’s ability to withstand physical wear and tear

divisibility an object’s ability to be divided into smaller units

uniformity
a condition in which any two units of an object have the same characteristics

portability the property of a good that makes it able to be carried from one place to another
acceptability the property of a good or service being universally acceptable in an economy

M1 the portion of the money supply in an economy that includes notes, coins, and funds in all
accounts that are immediately convertible to cash, such as checking accounts
M2 the portion of the money supply in an economy that includes M1 as well as funds that are
less easily converted to cash, such as savings deposits and mutual funds
debit card a card used for electronic cash transactions and money withdrawal

credit card a card used to buy goods and services on credit based on the holder’s promise to pay for
these goods and services plus the interest charged if the balance is not paid each month
commodity money an object that has value in itself and can also be used as money

representative money an object that has no value on its own but can be exchanged for something else of value

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 fiat money money that has value because the government orders that it is an acceptable means to pay
debts

central bank the bank that implements a government’s monetary policy and regulates commercial
banks
monetary policy the actions of the Federal Reserve to influence real GDP and the inflation rate in the
economy
Federal Open Market a Federal Reserve committee that makes key decisions regarding interest rates and the
Committee (FOMC) growth of the US money supply
discount rate the interest rate the Federal Reserve charges commercial banks for short-term loans

federal funds rate the interest rate banks charge each other for overnight loans
open market the buying and selling of government securities to alter the money supply in the economy
operations
required reserve ratio the fraction of deposits that the Federal Reserve requires banks to keep on hand as cash

reserve Bank one of 12 regional banks of the Federal Reserve that help the central bank

government security a tradable financial instrument issued by the federal or a state government
Board of Governors a seven-member board that oversees the Federal Reserve System

Types and Uses of Money

forms
Money comes in different _____________ uses
and has different _______________. It also has certain
characteristics
_____________________ recognizable
that, whether we realize it or not, make it _____________________ to us as money.

Uses of Money
Money has three uses:
$ a store of value $ a medium of exchage $ a unit of account

Money as a Store of Value

value
Store of value is the ability of a good to retain (keep) its ______________ stored
if it is ____________ and used later.

Money as a Medium of Exchange

instrument
A medium of exchange is an _____________________ value
that determines the _________________ of goods and
exchanged
services and can also be ______________________ to purchase goods and services.

Money as a Unit of Account

compare
Unit of account is a property that allows us to ________________ values
the ______________ of goods and services.

Characteristics of Money
To be an effective medium of exchange, any form of money needs to possess six characteristics.

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 Limited supply, or the limited availability of a good or service, is necessary so money
retains its value.
Limited Supply$ An unlimited supply would lead to an uncontrolled increase in the supply of money,
which would cause a rapid drop in its value.

$ an objetc's ability to withstand physical wear and tear

Durability
$ money needs to be durable so that peope can use it reapeatedly

$ any two units of an object have the sme characteristics

Uniformity $
all units of money should have th same shape, size, and value so people cam easily count and
measure them acuractely

$ an object's ability to be divided into smaller units

Divisibility
money should be divisible to allow exchange of goods of various values
$

$ Portability means something can be carried from one place to another.

Portability $ People should be able to easily carry money from one place to another or be able to
transfer money to another person.

$ a good or service is universlly aceptable to all the people in its economy

Acceptability
$ to facilitate an exchange, money should be acceptable by everyone

Money Supply
available
Money supply is ____________some of _________all the money _________________ in an economy.
It includes coins, paper bills, checking deposits, and other readily available money. Economists divide money
into two types: M1 and M2.

M1 M2
M1 is money that people can m1
M2 includes ________ deposits
as well as other _____________ that
access
______________ easily and use to buy converted
can be easily ________________ to cash, such as savings
various goods and services. This money deposits and money market accounts. People
notes
includes ____________, coins, and cannot
_________________ directly use these deposits as cash.
funds
________________ in all bank accounts canvert
However, they can ________________ the deposits into
that people can withdrawing
cash by _______________________ money from the
immediately
____________________ convert into accounts, depositing it into a checking account, and then
cash. using the money as cash.

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 electronically
In recent years, people started to make many payments _________________________ with debit cards and
credit cards.

Debit Card
electronic
Debit cards are used for __________________ withdrawing
cash transactions and __________________ money. When
message
someone uses a debit card to pay for purchases, the card is used to send a ________________ to the bank to
transfer
directly ________________ the money from the person’s checking account into the store’s bank account.

Credit Card
loans
A credit card entitles its holder to buy goods and services using short-term _______________. In other words,
credit
a credit card allows a user to make purchases on _______________.
bank
→ For example, when Julian uses a credit card to make a purchase, the _______________ that issued the
credit card pays the store on his behalf. Julian can repay the loan to the bank in monthly
installments
___________________, interest
with ___________________ after the first 28 days. However, if he
misses
_____________ penalty
a payment, he will pay a ________________ in the form of fees and an increased
interest rate.

Types of Money
commodity
The three types of money that are less familiar are _____________________ money, representative money,
fiat
and ________ money.

Commodity Money Representative Money Fiat Money

object
an __________ that has an object with has value because the
inherent (internal) ________some________no government
________________ decrees it an
value
______________, so people inherent value that can be acceptable means to pay
can also use it as exchanged for something of value. debts
_____________.
money
________________.

People can use such objects The governments of many countries People accept fiat money as a form
purchase
to _____________ something have issued representative money of payment because of the
or consume them currency gold
in the form of paper ___________. order
government’s _____________.
directly
________________. The printed notes could redeem a Typically, the only way to pay taxes
certain amount of __________. is with fiat money.

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The Federal Reserve
monitors
The regulatory body that _________________ currency
the amount of ___________________ in
circulation
___________________ supply
is called the Federal Reserve System. This body controls the ______________ of
economy
money and how it affects the overall ____________________ of the country.
fed
In its role as the central bank of the United States, the Federal Reserve System, or the _________, interacts
local
with ________________ monetary
member banks. A central bank implements a government’s ________________
policy
________________ regulate
and _______________________ commercial banks.

Monetary Policy
decisions
The FOMC (Federal Open Market Committee) of the Federal Reserve can make __________________
policy
regarding monetary ___________. money
These decisions affect the country’s _____________ supply
_____________.

Federal Reserve Tools

actions
Monetary policy is the ___________________ GDP
the Federal Reserve takes to influence real _________and
iflation
the ____________ rate
_________ in the economy. Federal Reserve tools for implementing monetary policy:

Tool Description
Required Reserve The Federal Reserve requires all banks to keep a fraction of deposits on hand as cash.
Ratio The required reserve is kept in bank vaults or on deposit at a Reserve Bank.

Federal Funds the interest rate that banks charge each other for overnight loans is called the
Rate federal funds rate

the interest rate that the FEderal Reserve charges commercial banks for short
Discount Rate term loans is called the discount rate

Open Market red reserve buys and sells government securities to alter the money supply in
Operations the economy.

Expansionary Monetary Policy Contractionary Monetary Policy

increased
It helps ________________ the money supply in reduce
It helps to ____________ the money supply in an
the economy. Needed when a country’s excess
economy. Required when ___________ money in
slow
economic growth has ____________ down, such inflation
an economy leads to rapid _______________.
as during a recession. reduce the purchasing power of
❖ Inflation __________
❖ By increasing the money supply, the government
money because people can buy less than they could
spending
aims to increase consumer _______________
previously with the same amount of money.
and motivate businesses to expand. Increasing income
Inflation reduces real _____________ and
gdp but
the money supply not only increases ______ discourages savings and investment.
______________
unemployment in a country.
also reduces ________________ Copyright © 2019 Edmentum Inc. All Rights Reserved.
Required Reserve Ratio
amount
The required reserve ratio determines the __________________ lend
a bank can _____________.

When the Federal Reserve wants to implement expansionary monetary policy, it

__________increases__________decreases the reserve ratio. Decreasing the reserve ratio means banks can
loans
make more _________________, money
which increases the total __________________ supply
_______________ in the
economy.

When the Federal Reserve wants to implement contractionary monetary policy, it increases the
reserve
______________ ratio
_____________. hold
Increasing the reserve ratio means banks need to ___________ more
lend
money in reserve, which reduces the amount they can _____________. As a result, the total money supply in
decrease
the economy will ________________.

Discount Rate
borrow
Some banks _______________ money directly from the Federal Reserve. The discount rate is the
interest
______________ rate
____________ that the Federal Reserve charges commercial banks for these short-term
reserve
loans. The ____________ board
Banks and the ____________ governors
of _______________ of the Federal Reserve decide
the discount rate.

They charge a __________higher__________lower discount rate when implementing an expansionary

monetary policy and a __________higher__________lower discount rate for a contractionary monetary
policy.
cheaper
When the discount rate is low, banks find it _________________ to borrow money from the Federal Reserve.
loans
$ They can then use this money to make ____________ to businesses and individuals while
keeping
_______________ economy
their required reserves. The loans add money into the ___________________.
expensive to borrow from the Fed.
On the other hand, when the discount rate is high, banks find it more _____________
increase
$ The banks then _________________ fewer
their own interest rates and give out ____________ loans,
supply
________increasing_______decreasing the total money _____________ in the economy.
federal
Another interest rate that the Federal Reserve influences is the ______________ funds
______________ rate.

Some banks maintain a __________higher__________lower reserve than mandated by the required reserve
ratio. In such cases, these banks can lend their excess reserves to other banks as short-term loans.
target
The FOMC decides a ___________________, called the federal funds rate, at which these banks may
loans
give or receive ____________.
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To implement expansionary monetary policy, the FOMC would __________reduce__________increase the
target rate to make loans cheaper.

Open Market Operations

influential
One of the most ____________________ and frequently used tools that the Federal Reserve calls on to
open
implement monetary policy is _________ market
______________ operations. The FOMC buys or sells government
securities to influence the federal funds rate.
buying
When the Federal Reserve wants to foster economic growth, it starts _____________________ government
securities
____________________. Buying securities injects money into the economy and increases the money supply.
When the Federal Reserve wants to __________reduce__________increase economic growth, it starts
selling
_______________ securities. Selling securities takes money out of the banking system because the money to
purchase the securities comes from the investors’ accounts.
The Federal Reserve has several tools it can use to affect the economy.
▪ To boost economic growth using monetary policy, it can
→ decrease the required reserve ratio, the federal funds rate, and discount rate
→ buy government securities in the open market

▪ To control economic growth using monetary policy, the Federal Reserve can
→ increase the required reserve ratio, the federal funds rate, and the discount rate
→ sell govt. securities in the open market

Summary
Why is money effective and what are its different forms? What is the Federal Reserve and what its role?

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