13| Money, Banks, and the
Federal Reserve System
Brief Chapter Summary
13.1 What Is Money, and Why Do We Need It? (pages 422–425)
Money is anything that people are generally willing to accept in exchange for goods or services or in payment of debts. Money has four functions: a medium of exchange, a unit of account, a store of value, and a standard of deferred payment.
13.2 How Is Money Measured in the United States Today?
The narrowest definition of the money supply in the United States today is M1, which includes currency, checking account balances, and traveler’s checks.
13.3 How Do Banks Create Money? (pages 429–436)
The key role that banks play in the economy is to accept deposits and make loans. By doing this, they create checking account deposits.
13.4 The Federal Reserve System (pages 437–442)
The Federal Reserve System is the central bank of the United States. It was established to stop bank panics, but today its main role is to control the money supply. The Fed’s three monetary policy tools are open market operations, discount policy, and reserve requirements.
13.5 The Quantity Theory of Money (pages 442–444)
The quantity theory of money provides insight into the long-run relationship between the money supply and inflation: In the long run, inflation results from the money supply growing at a faster rate than real GDP.
Asset, p. 422. Anything of value owned by a person or a firm. Bank panic, p. 437. A situation in which many banks experience runs at the same time. Bank run, p. 437. A situation in which many depositors simultaneously decide to withdraw money from a bank. Commodity money, p. 422. A good used as money that also has value independent of its use as money. Discount loans, p. 437. Loans the Federal Reserve makes to banks. Discount rate, p. 437. The interest rate the Federal Reserve charges on discount loans. Excess reserves, p. 430. Reserves that banks hold over and above the legal requirement. Federal Open Market Committee (FOMC), p. 438. The Federal Reserve committee responsible for open market operations and managing the money supply in the United States.
Federal Reserve, p. 424. The central bank of the United States. Fiat money, p. 424. Money, such as paper currency, that is authorized by a central bank or governmental body and that does not have to be exchanged by the central bank for gold or some other commodity money. Fractional reserve banking system, p. 437. A banking system in which banks keep less than 100 percent of deposits as reserves. M1, p. 426. The narrowest definition of the money supply: The sum of currency in circulation, checking account deposits in banks, and holdings of traveler’s checks. M2, p. 428. A broader definition of the money supply: It includes M1 plus savings account balances, small-denomination time deposits, balances in money market deposit accounts in banks, and noninstitutional money market fund shares. Monetary policy, p. 438. The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives. Money, p. 422. Assets that people are generally willing to accept in exchange for goods and services or for payment of debts.
Open market operations, p. 439. The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply. Quantity theory of money, p. 442. A theory about the connection between money and prices that assumes that the velocity of money is constant. Required reserve ratio, p. 430. The minimum fraction of deposits banks are required by law to keep as reserves. Required reserves, p. 430. Reserves that a bank is legally required to hold, based on its checking account deposits. Reserves, p. 430. Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve. Security, p. 440. A financial asset—such as a stock or a bond—that can be bought and sold...