Assignment 1: Money And Our Monetary System 780501

Assignment 1 Money And Our Monetary Systemthe Monetary System In Any

Explain the requirements for something to be considered money and why the dollar has value. Describe the components of the money supply in the United States and their respective amounts. Discuss the primary functions of the Federal Reserve (the Fed) and the role of the Federal Open Market Committee (FOMC) within the economy. Analyze the role of financial institutions, such as commercial banks, in our financial system. Define fractional-reserve banking and examine its implications for consumers. Outline the tools available to the Fed to control the money supply, identifying which are most often used and which are most effective. Explain how the money multiplier helps determine the effects of monetary policy. Finally, compare the pros and cons of monetary policy versus fiscal policy in implementing economic strategies.

Paper For Above instruction

Money functions as a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. For an asset to qualify as money, it must be universally accepted, durable, divisible, portable, and stable in value (Mankiw, 2020). In the United States, the dollar meets these criteria due to its legal tender status backed by the U.S. government, its high acceptability, divisibility into smaller units, portability, and relative stability. The value of the dollar is derived from government backing, legal recognition, and the trust of the public in the stability of U.S. institutions and the economy (Federal Reserve, 2023).

The money supply in the U.S. comprises several components, predominantly categorized into M1 and M2. M1 includes the most liquid assets such as currency held by the public, demand deposits, traveler's checks, and other checkable deposits, totaling approximately $4.5 trillion. M2 expands upon M1 by including savings deposits, money market securities, and other near monies, with a total of about $21 trillion (Federal Reserve, 2023). This broad measure of the money supply reflects the total available funds in the economy for transactions and investment purposes.

The Federal Reserve plays a critical role in managing the U.S. economy through several functions: conducting monetary policy, supervising and regulating financial institutions, providing financial services to the government and commercial banks, and maintaining financial stability. The primary functions revolve around influencing interest rates and controlling inflation by adjusting the money supply (Mishkin, 2019). The FOMC, a subset of the Fed, sets the target range for the federal funds rate, directly impacting liquidity and borrowing costs, and thereby guiding overall economic activity (Board of Governors of the Federal Reserve System, 2023).

Financial institutions, including commercial banks, credit unions, and savings institutions, facilitate the functioning of the financial system by providing credit, liquidity, and safe deposit services. They are essential for channeling funds from savers to borrowers, enabling investment and consumption, and supporting economic growth (Allen & Santomero, 2001). Commercial banks, in particular, accept deposits and extend loans, serving as intermediaries that foster financial stability and economic development.

Fractional-reserve banking refers to the banking practice where banks hold only a fraction of depositors' reserves as cash and lend out the remainder. This system amplifies the money supply through the process of deposit creation, but also introduces risks if banks face sudden withdrawals, potentially leading to bank runs. Consumers benefit from increased access to credit and lower interest rates but face risks associated with bank insolvencies and the stability of the system (Diamond & Dybvig, 1983).

The Fed has several monetary policy tools at its disposal, including open market operations, the discount rate, and reserve requirements. Open market operations, involving the buying and selling of government securities, are the most frequently used and are considered highly effective in adjusting the money supply promptly. Altering the reserve requirement is less common due to its broader implications. The discount rate, the interest rate at which banks borrow from the Fed, influences banking behavior and liquidity (Mishkin, 2019).

The money multiplier reflects how initial changes in the monetary base can lead to a larger change in the total money supply. It depends on the reserve ratio and the currency-deposit ratio. By understanding the multiplier effect, the Fed can predict how policies like open market operations will influence overall liquidity and economic activity (Bernanke & Mishkin, 1997).

Monetary policy offers advantages such as quicker implementation, significantly affecting interest rates and inflation, but also has drawbacks like potential time lags and limited control over fiscal variables. Fiscal policy, involving government spending and taxation, can directly target economic issues but is often slower to implement and politicized, making monetary policy a more nimble but less comprehensive tool for economic stabilization (Romer & Romer, 2010).

References

• Allen, L., & Santomero, A. M. (2001). The theory of financial intermediation. Journal of Banking & Finance, 21(11-12), 1461-1485.
• Bernanke, B. S., & Mishkin, F. S. (1997). Inflation, money, and real activity: A monetary policy puzzle? The Journal of Economic Perspectives, 11(1), 97-116.
• Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419.
• Federal Reserve. (2023). Money stock measures, H.6 release. https://www.federalreserve.gov/releases/h6/
• Mankiw, N. G. (2020). Principles of economics. Cengage Learning.
• Mishkin, F. S. (2019). The economics of money, banking, and financial markets. Pearson.
• Romer, D., & Romer, C. D. (2010). The macroeconomic effects of fiscal policy: Estimates from data. The American Economic Review, 100(2), 763-799.
• Board of Governors of the Federal Reserve System. (2023). Monetary Policy. https://www.federalreserve.gov/monetarypolicy.htm