Federal Reserve

What are the requirements for something to be considered money? Why does the dollar have value?

Money is a very crucial economic feature. For something to be considered as money, it must have the following function: it should act as an exchange measurement unity, exchange medium as well as exchange value store for the forthcoming use (Mankiw, 2015). Things that lose their value cannot be considered as money. For instance, things like tomatoes physically deteriorate, thus losing their value with time. Such commodities that lose their value with time cannot be used for money and is illegal for instance in the united states for one to make these things to be money. As a result, gold is the common commodity used as money since it is scarce. Therefore, there is no probability of it deteriorating, but it will always meet the functions and properties mentioned above (Mankiw, 2015).

The dollar has value because of the tax liabilities. The United States dollar contains value as a result of the government taxes around 3 trillion dollars in tax liabilities every year and accepts this money in terms of the United States dollars (Mankiw, 2015). There are also some credible penalty threats if one does not use these dollars in payment. As a result, all people are made to be dollar chasers (Mankiw, 2015).

Money supply involves the physical cash in circulation plus any money held in the savings as well as the checking accounts. This money excludes other wealth forms such as assets, investments and home equity (Mankiw, 2015). The United States money supply is measured by the Federal Reserve using the M2 and the M1. The frequent liquid money form is the M1, which includes the currency in circulation and does not involve the money in the Federal Reserve Bank, bank vaults and the U.S treasury (Mankiw, 2015). M2 involves all things in M1, and certain long-time deposits, as well as funds for mutual market money M3, includes the M2 and the deposits that are long time and funds for markets. M4 also includes the M3 and the various deposits. As of February 2018, the circulating money supply was 3 855 088 United States dollars million. M1 was 3 967 008 United States dollars million, and M2 was 5 855 088 United States dollars million (Mankiw, 2015).

What are the primary functions of the Fed?

The Federal Reserve, also called the Fed or the Federal Reserve System, is the central bank of the United States. It was formed to provide the nation with a more flexible, more stable and safer financial and monetary system. Currently, the responsibilities of the Fed are classified into four areas: the state monetary polyconduction through the credit and influencing conditions in the U.S economy in full employment pursuit as well as stable prices, regulating and supervising banks and various crucial financial institutions for financial and state’s banking system safety and customer credit rights protections, maintaining the financial system stability as well as contain systemic risks that are in the financial markets and providing some financial services to the financial institutions, government, and foreign institutions in the united states and overseeing the payment systems of a nation.

What role does the Federal Open Market Committee (FOMC) play in our economy?

The FOMC is a body in the Fed that sets the monetary policy of the state. The decisions of FOMC influence the credit and costs available to borrowers as well as the returns that servers earn. The FORM makes targets to be attained by the federal funds (Mankiw, 2015). The target changes are seen in the bank’s deposits and interest rates and rates in market interests. It also makes decisions concerning the composition and the size of the Fed asset holdings as well as its communication about the future monetary policy courses to the public.

What role do the financial institutions (commercial banks and other institutions) play in our financial system?

The functions of a financial institution in the United States’ financial system include providing Commercial Loans, accepting Deposits, providing Real Estate Loans, providing Mortgage Loans as well and issuing Share Certificates. Various financial companies give Indirect Customer Loans, they finance the business inventories as well as the providing the loans. The companies give bonds, among other obligations (Mankiw, 2015). The companies also do functions such as commodity markets, currency, optional exchange and stock exchange that are very critical in the United States economy. These institutions as well are involved in maintaining the market liquidity as well as managing the risks resulting from the price change in the financial systems.

What are the tools available to the FED for controlling the money supply? Which are used most often? Which are most effective?

There are several tools that the Fed uses in governing the U.S. money supply. The most often used include (1)the reserve requirement establishment for banks, (2) the loan volumes extended to various banks as well as other banking institutions, (3) the various interest rates paid to banks as funds from the reservoir, and (4) selling and buying the united states securities among other assets from the open market (Mankiw, 2015).

Reserves Requirements

The Fed gives the reserves levels that various banks must maintain against a checking of their customers’ deposits. For instance, when the Fed wishes to expand the supply of money, it reduces the reserve requirements, creating additional reserves for the banks.

However, this reserve requirement is a blunt tool. Therefore Fed rarely used it to change the money supply.

Open Market Operation

This is the most common tool that the Federal Reserve uses in altering the money supply. It includes the selling as well as buying of the United state security, among other assets in the open market (Mankiw, 2015). For almost six decades Fed sold and purchased United States securities in conducting open markets operations. In reducing the money supply, it sells some of the financial assets holdings.

Loans Extension

The Fed injects some more reserves into the banking system by extending additional loans to borrowers or banks. This tool was suppressed for some time but currently, it is back with extended loan periods.

Interest Rates

During the period that the Fed needs to expand a money supply, it extends the loans through interest rate reduction even as low as zero (Mankiw, 2015). This aids in reducing the reserves and vice versa. This tool is also effective and is used.

What is meant by the term “fractional-reserve banking” in our system? What are the implications for consumers?

Fractional Banking Reserve involves the practices where the bank makes loans, investments or accepts deposits; however, it must hold reserves that are equal to the deposits fraction. The U.S. has a system of fractional reserve (Zhang & Imhof, 2017). The banks use customers’ deposits to give investments and extend their loans. The banks are needed to maintain the asset fraction in reserve form, the assets that can be used in redeeming their customers’ funds. Deposits, as well as vault cash from the central bank, serve as a reserve that aids in meeting the depositors’ demands. Therefore, this implies that all customers or consumers can get their cash at any time, even if it was used in loaning another person (Zhang et al., 2017).

How does the money multiplier help to determine the effects of monetary policy?

A money multiplier involves the money generated by a bank in each reserve dollar. The reserves include the deposit amount that the back should not land but hold. The banking reserves involve the reserve ratio to the overall deposit amount. Therefore, the money multiplier is the proportion of the deposits to the reserves (Mankiw, 2015). For example, if one is a president of the bank and the Fed needs 10 percent of the total deposit to be held, it means that for every dollar, only 0.9 can be lent out. The remaining cash aids in covering the demand of the customers since not all of the people who deposited their cash can require money at the same time (Mankiw, 2015). The formula used for the money multiplier is m=1/r, whereby m represents the money multiplier, and r represents the reserve ratio for every bank in an economy. This formula aids in portraying how the money that a bank creates depends entirely on a reserve ratio.

What are the pros and cons of using monetary policy, as opposed to the use of fiscal policy, for implementing economic policies and practices?

The monetary policy has many pros. First, a monetary policy of expansion allows more consumers and investors to come in. When the banks lower the interest rates on loans as well as mortgages, more owners of businesses are encouraged to expand their various businesses since they are given an opportunity to borrow more money that they can return with low interest rates. At the same time, the price of goods in the market will reduce since more goods will be available in the market for consumers (Hayes, 2017). Second, the reduced interest rates will also lower the payment rates of the mortgage. Third, it enables the application of the quantitative easing by the central bank. Finally, it motivates transparency as well as productivity (Hayes, 2017).

While this monetary policy contains the advantages it has disadvantages as well. First, this monetary policy does not guarantee the recovery of the economy. In times that the interests are low not business people and consumers can turn to make use of this advantage. Secondly, it is not guaranteed to reduce the interest rates. Not all banks can reduce their interest. After the central bank reduces its interest, others can decide to keep the money (Hayes, 2017). Third, it cannot be useful in the global recession. During a global crisis, even if the rates are reduced, and consumers increase, this cannot rescue the country from the global crisis. The exporters will still face challenges as well as losses. Finally, the reduction in monetary policy can result in discouragement in business expansion. When the contrary of expansion occurs many business owners get discouraged and stop expanding their business because of interest increase (Hayes, 2017).

Summary

• The government determines the value of the dollar using the tax liabilities when everyone has to pay tax in terms of dollars.
• Fed’s major role is to provide the state with a more flexible, more stable and safer financial and monetary system.
• The decisions of FOMC influence the credit and costs available to borrowers as well as the returns that servers earn.
• Financial institutions provide Commercial Loans, accept Deposits, provide Real Estate Loans, provide Mortgage Loans as well and issue Share Certificates.
• The monetary policy has many pros, such as lowering the interest rates, as well as cons, like not solving the global crisis.

References

Mankiw, N. G. (2015). Principles of economics. Stamford, CT: Cengage LearningBoard of Governors of the Federal Reserve System. (n.d.). Retrieved March 19, 2018, fromhttps://www.federalreserve.gov/default.htm

Hayes, C. A. (2017, May 17). Fiscal Vs. Monetary Policy Pros & Cons. Retrieved March 19, 2018, fromhttp://www.investopedia.com/articles/investing/050615/fiscal-vs-monetary-policy-pros-cons.asp

Zhang, S., Monet, C., & Imhof, S. (2017). Financial Stability and Fractional Reserve Banking. In 2017 Meeting Papers. Society for Economic Dynamics.