Money, Banking & Monetary Policy

Transcription

1 Money, Banking & Monetary Policy

2 money ( m u n e ) n. Money, the banking ytem and monetary policy mut work together ally accepted a a people to exchange good and ervice without having to rely on a ytem and a meaure and to borrower and earn interet in the proce, and it give borrower a banking (bank eng) i ufficient money in the economy to keep it growing, but not o much bank, in which aver i inflation. Inflation too much money chaing too few good create brought together for productivity and lower the economy long-term rate of growth. Thi

3 omething gener- moothly for the economy to run well. Money make it poible for medium of exchange, of bartering. Banking provide a mean for aver to lend their money tore of value. place to go for loan. The aim of monetary policy i to enure that there n. the buine of a that the economy overheat. When the economy overheat, the reult and borrower are an inefficient price ytem. It alo ditort deciionmaking, reduce mutual benefit. reult in lower living tandard for everyone.

4 Anything people will accept in exchange for good or ervice can be conidered money. Jut imagine being an American oldier during World War II. Becaue paper currency wa carce, ervicemen and women overea often ued chocolate, cigarette and even ilk tocking a medium of exchange. It wa all part of a very baic barter ytem. Still, it wan t nearly a implitic a the one ued by the people of the South Pacific iland of Yap, who, at the ame time, ued rock of variou ize a money.

5 ometime quite difficult, a people weren t alway able to agree on their comparable value. Currency and coin Over the coure of hitory, bead, rock, hell, hook, fih, grain and cattle were ued a money. However, uing uch good in tranaction wa W h a t I M o n e y? We may not think we have enough of it, but in many way, we tend to take money for granted. When you buy a pair of jean or a CD, for example, you never wonder whether the merchant will accept the bill and coin in your wallet a payment. But uppoe money a we know it didn t exit. How would you pay for the thing you want to buy? That wa the ituation in the early day of the American colonie. Britih money wa carce, o colonit ubtituted baic product of their local economie that were alway in demand thing like tobacco, grain and fih. For mall change, they often received nail and bullet. But their ytem, called barter, had many hortcoming. How many fih would it take to buy a bag of flour or an oil lamp, for example? Suppoe the merchant didn t want fih, or they poiled before he could trade them to omeone ele? Later, a trade developed with other colonie and countrie, colonit ued variou foreign coin, uch a gold Spanih reale. That when money a we know it finally gained a foothold in the U.S. economy. with pecified denomination enabled all partie to trade on a level playing field. 5

6 The firt iue of paper currency in North America wa in A paymater in the French army Money i a medium of exchange accepted by the community, meaning it what people buy thing with and ell thing for. Money provide a tandard for meauring value, o that the worth of different good and ervice can be compared. And latly, money i a tore of value that can be aved for later purchae. The young United State experimented with a variety of monetary mechanim for well over a century before ettling on a ytem that wa baed on coin, paper currency and money in bank checking account. The early government tried unuccefully everal time to make paper money work, but people relied motly on gold, ilver and copper coin becaue they were made of preciou metal that had intrinic value. Today, though, our coin don t contain any gold or ilver. You can ee thi for yourelf by looking at the edge of a dime or quarter; you ll ee a copper core, andwiched between ilvery nickel. The metal value of modern American coin i much le than it worth a money. American currency no longer i backed by gold or ilver either, but it no longer really matter. decided to iue playing card with aigned value and an official eal to retle troop in Canada That becaue what give money real value i it purchaing power, not what it made of. In fact, any economy health can be meaured not by how much money people earn, but by how much their money buy. The overall aortment and quantity of good and ervice your money let you buy reflect your tandard of living. Like diamond, money i relatively carce on purpoe and that jut what make it valuable. You a an individual want to earn a much a you can, of coure. But the national economy can actually have too much money. When 6

7 the amount of money circulating grow fater than the rate at which good and ervice are produced, the reult i inflation. Say you want a new pair of jean, for example. Lat year, they cot $40, but thi year an identical pair cot $45. If price of mot other good have alo rien, then you are probably dealing with inflation too much money chaing too few good. Price have inflated, and your $40 buy le than it did. You mut earn more jut to tay even. T h e F e d R o l e Keeping price table i part of the job of the Federal Reerve, which wa created by Congre in There had been two attempt at etablihing a central bank in the United State in the 19th century, but politic killed them even though they were ucceful. Back then, tate-chartered bank iued their own paper money backed only by their individual gold and ilver reerve. A a reult, there were once more than 10,000 different kind of bank note in circulation. who were growing tired of waiting for a hip from France carrying their pay. The card were even circulated a currency for a hort time, Suppoe you owned a tore in thoe day. How would you know which bank had enough gold reerve to make their currency worth it face value? Should you decreae the value of bill from a weaker bank? And how would you keep track of all thoe bank note? You can imagine the hopkeeper dilemma. If a bank went broke, it currency wa intantly worthle, and thoe who held it note could loe everything. but were redeemed for French coin within three month. 7

8 national bank 20% reerve requirement national bank

9 20% reerve requirement national bank 20% reerve requirement It may not eem to make much ene, but bank actually create money when they lend it. How do they do it? They take a portion of the money that ha been depoited in the bank and make a loan to an individual or buine. When that individual or buine ue the loan to make a purchae, the eller depoit the money in a bank, which then lend a portion to another individual or buine. The proce goe on and on, providing a continuing ource of fund to keep the economy moving forward.

10 During inflationary period in the economy, one of the factor that can contribute to the continuation of inflation i Naturally, people hurried to withdraw their money at the firt hint of trouble in the economy. The reult wa periodic financial panic that could devatate the national economy for year. Finally, after a particularly bad panic in 1907, Congre decided to olve the problem. In 1913, it etablihed the Federal Reerve Sytem to provide for a afer and more flexible banking and monetary ytem. With the Fed a afeguard, bank can perform their proper role of bringing aver and borrower together for the benefit of both. For any economy to be ucceful, a country firt need political tability o it citizen feel afe; then it need a table financial ytem that include both trutworthy money and reliable financial intitution. Healthy, profitable bank, therefore, are a vital part of the nation economic welfare. Bank provide many ervice, but for mot people, banking conit of depoiting their income into a checking account and writing check or uing a debit card on that account to buy thing that cot more money than they want to carry in their wallet. People alo have aving account in which they depoit money they don t need right away or they are aving for a particular purpoe. The bank pay interet, or a price paid for ue of the money, on aving account and often on checking account, too. imply that people expect it to continue. When people believe a high inflation rate i the norm, buinee and worker will attempt to upwardly 10

11 Very little of thi money i kept in the bank vault, however. While the Federal Reerve require bank to keep a pecified percentage of cutomer depoit on hand (reerve) to meet routine withdrawal, they lend the exce. Bank, like any other buine, mut make a profit to tay in buine. Their profit come from interet people pay on the money they borrow. In the United State, check didn t come into widepread ue a a medium of exchange H o w B a n k C r e a t e M o n e y Bank actually create money when they lend it. Here how it work: Mot of a bank loan are made to it own cutomer and are depoited in their checking account. Becaue the loan become a new depoit, jut like a paycheck doe, the until depoit banking became etablihed in the late bank once again hold a mall percentage of that new amount in reerve and again lend the remainder to omeone ele, repeating the money-creation proce many time. The tricky part of monetary policy i making ure there i enough money in the economy, but not too much. When people have the money to demand more product than the economy can upply, price go up and the reulting inflation hurt everyone. While in the United State we get concerned when inflation climb above 3 percent a year, we ve been more fortunate than ome other countrie. Jut imagine trying to urvive in pot-world War II Hungary, for intance, where for awhile inflation averaged nearly 20,000 percent per month! adjut price and wage to compenate for the higher price they believe are on the way. 11

12 One of the mot important function of the Federal Reerve Sytem i protecting the value of money. Like a doctor monitoring a patient, the Fed check the economic health of the nation contantly, making ure there in t too much or too little money in the economy. Too much money could caue inflation. Too little could caue a receion. The goal of the Fed i to find a happy medium to make ure price remain table and the nation economy tay healthy.

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14 M o n e t a r y P o l i c y a n d t h e E c o n o m y Controlling the money upply to help the economy grow teadily without inflation i the Federal Reerve job. Called etting monetary policy, the Fed doe thi primarily by buying and elling Treaury ecuritie on the open market. Buying ecuritie on the open market can make it eaier for bank to loan money and can give the economy a boot, while elling ecuritie can retrict lending and can help cool down an overheated economy. When the Fed buy ecuritie, the Fed pay for them by crediting the reerve account of the eller bank. With more money in their reerve, bank can lend more. By contrat, when the Fed ell ecuritie, the Fed collect for the ale by debiting the reerve account of the buyer bank. With le money in their reerve, bank can t lend a much. Soon after Congre created the Fed, it monetary policy role wa ubtantially trengthened by the outbreak of World War I. A countrie began refuing to hip gold to one another Conducting monetary policy i a tremendou reponibility, for the nation economic health i at take. You can ee why politician might want to control the money upply for hort-term interet. For that reaon, the Fed, by law, i not government controlled or funded by Congre. While it i a centralized banking ytem compriing 12 regional bank, it i independent in operation. Beide conducting monetary policy, the Fed alo act a the banker bank. A people withdraw more currency to buy thing when the economy i booming, the bank in turn pull additional currency from their own reerve account with the Fed. When the economy low down and people increae their aving, bank for payment of international debt, the need 14

15 new monetary criteria and tandard to replace gold automatic operation. Fortunately, the groundwork for thee new aroe for criteria and tandard had already been laid with paage of the Federal Reerve Act jut a year earlier. return the urplu to their reerve account. The Fed handle check proceing for bank a well, to make ure the billion and billion of dollar in check written each year move moothly from one bank to another. The Fed ha other function alo. It help regulate and upervie bank to keep them financially ound, and it erve a the government banker by maintaining the U.S. Treaury checking account. T h e F i g h t A g a i n t I n f l a t i o n It a complex ytem, but the goal i imple: to keep the economy table and growing at a pace that can be utained without inflation. Economic ecurity underlie nearly every hope and dream people have. It enable buinee to know they can afford to hire more worker, and it let people plan for the future. If you are aving for college now, for intance, you want to know how much you need altogether and how much you mut et aide each month. An inflationary economy can wreck your plan what you ve aved in t nearly enough anymore, and you don t know how much more will be needed. A healthy monetary policy, enitive to changing economic condition, help prevent uch worrie, o you can get on with the buine of working to turn your dream into reality. 15

16 Federal Reerve Bank of Dalla El Pao Houton San Antonio For additional copie of thi publication, contact: Public Affair Department, Federal Reerve Bank of Dalla, 2200 N. Pearl St., Dalla, TX ; call (214) or (800) , ext. 5254; or viit our web ite at Revied 5/07