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Monetary System Discussion

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Monetary System Discussion

Money is generally a medium of exchange that must be widely accepted as a mode of

payment for various goods and services. It can take the form of coins, notes, or digital currency.

For money to be accepted as a mode of payment, it must possess some properties which identify

and verify it as a mode of payment. Some of these attributes are; it must be acceptable and

recognized as a mode of exchange; that is, every citizen needs to accepted and easily recognize

it. Money must be used to store value for future use; people need to have trust in the currency. It

needs to be usable as an accounting unit; this implies that the fiat currency needs to be used in

accounting, measurement, and reporting of the value of quantifiable assets. Lastly, money needs

to be scarce in supply. It should be easily liquefiable and easily divisible into desired

denominations.

The value of a given currency is influenced by a number of factors, which cut across

many countries and states. For instance, the value of a dollar is influenced by factors like rates of

inflation, exchange rates and rates of interest. A low inflation rate depicts a higher currency

value, while a higher inflation rate indicates depreciation in currency value. Exchange rates and

interest rates also impact the dollar value such that an increase in either of them results to value

appreciation. Exchange rates in the foreign exchange markets are determined by the amount of

foreign capital in the respective country. Lastly, the level of import and export value determines

the currency value. An increased value in export with reduced imports creates an increase in

demand for the country’s currency, thus a rise in dollar value.

In the United States of America, the money supply is mainly comprised of total

currencies such as fiat currency and dollar bills given by both the US Treasury and the Fed. It

also entails all the other kinds of deposits held by the commercial banks and financial
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institutions, which include credit unions and thrifts. The money supply is, therefore, the total

amount of currency in circulation in a particular economy of a state or country measured in a

fiscal year. The money supply is measured using three definitions; M1 is a measure whose focus

is laid on the function of money as an exchange medium, M2 is another measure whose

emphasis is on the function of money as a store of value. M3 is the last definition used by the

Federal Reserve, which is a measure of money with its close substitutes such as valuable

minerals.

Currently, the total amount of money in supply in the united stated s of America is

eighteen trillion dollars as at the end of the year two thousand and twenty. This is a remarkable

rise in comparison to the total money supply of the year twenty nineteen, which was fifteen

trillion dollars (The Fed,2018). The year 2020 marked a twenty percent increase in the amount of

money in circulation in the US economy.

The Federal Reserve System is a monetary authority in the US whose function entails the

following; it conducts the country’s monetary policy, which regulates and controls all issues

relating to money. The Fed promotes stability in the financial system of the US, which is

achieved by monitoring financial risks and mitigating them early enough for a healthy economy

(Federal Reserve Board,2019). It supervises and regulates financial institutions, and their

activities-the Fed ensures financial institutions and commercial banks ensure fair play in the

banking industry. The Federal Reserve is also charged with the responsibility of ensuring a

system for transactions involving the US dollar. It works to provide a transacting environment

that is efficient, easily accessible, and safe. The Federal Reserve System, therefore, oversees all

monetary matters in the United States of America.

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The Federal Open Market Committee, on the other hand, is the Federal Reserve body that

is charged with the responsibility of making monetary policies to be adhered to by financial

institutions and commercial banks. It is also the body that manages the money supply in the

economy of the United States of America. The FOMC achieves its role by having regular

meetings aimed at overseeing the national economy and reviewing the formulated monetary

policies.

Financial institutions play very crucial roles in a particular system. In the US, they are

regulated and monitored by the Federal Reserve. Generally, such institutions assist in channeling

savings into profitable investments. Financial institutions assist in the regulation of the money

supply in the economy. The regulation maintains and ensure stability and also aid in controlling

inflation. Commercial banks provide the customer with banking services, which ensures

customers have access to deposits and savings accounts. Insurance companies in the financial

system provide pension fund services, insurance, and assurance services (Mankiw,2017). They

help in the mobilization of savings into productive investments. Financial institutions help in

capital formation, which is achieved by a rise in capital stock. Lastly, these institutions provide

investment advice to businesses and potential individuals who wish to make some investments.

Fractional reserve banking is a banking system whereby only a specific portion of all

deposits made to a bank are backed up by tangible cash and are readily accessible for

withdrawal. This method, in major scenarios, is done theoretically so as to expand and enhance

the economy by providing more capital for lending facilities. Commercial banks are required by

the central governing body of a particular country to keep bank reserves to cater for withdrawals.

They are free to invest or lend out the other portion of the deposits. However, fractional reserve

banking impacts the consumer in various ways. A commercial bank may not be able to cater for
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the depositor withdrawals at a given time. For example, on business days, withdrawals tend to be

high. Banks may run out of cash at hand, thus inconveniencing the depositor who entrusted them

with his or her funds. Sometimes once banks invest the money of depositors, the investments

may go sour, which results in banks going bankrupt. In such scenarios, a depositor may end not

being entirely paid.

According to (The Fed,2018), the Federal Reserve System uses a couple of tools that

assists it in controlling the money supply in the economy. The reserve ratio is one of the tools

used- it is the percentage of bank reserves that banks hold against the total deposits received. A

drop in this ratio enables banks to lend more hence a rise in money supply, while the opposite is

also true. The Fed charges commercial banks discount rates for borrowing additional reserves. It

set this rate and not the market demand and supply. A higher discount rate discourages

borrowing and spending by commercial banks, thus reducing the money supply in the economy

and vice versa. Importantly, the Fed uses open market operations to control the money supply.

Suppose it buys securities such as treasury bills results in an increased money supply since it

gives money back to the public. In the event of buying financial assets, it takes money away

from the public, thus decrease in the money supply. The use of discount rates and open market

operations are the most common and most effective tools of controlling the money supply in the

economy used by the Federal Reserve.

A money multiplier can be used to evaluate and determine the effects arising from the

monetary policies in the economy of a given state or country. The most commonly used method

of evaluating the multiplier effect is achieved by dividing the change in income by change in

spending. It is used in the corporate industry to assess the efficiency of an investment. Therefore,

the money multiplier takes into account the multiplier effect from a more critical perspective of
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banking with respect to money and supply. The money multiplier is comprised of the reserve

requirement, which is usually set and sanctioned by the board of governors of the United States

of America Federal Reserve System. It, however, varies from institution to institution depending

on the total amount of liabilities held by the respective depository of the relevant institution. The

money multiplier hence determines the implications of the monetary policy depending on the

total amount of money in circulation influenced by bank reserve ratios.

The government, through the Federal Reserve System, uses either monetary policy or

fiscal policy to implement the appropriate economic practices and policies. Fiscal policy is aimed

at determining the ways through which the central government earns revenue through imposing

taxes and how the money earned is spent. By contrast, the monetary policy defines the

management of money supply in the economy and rates of interest by the central bank. Monetary

policy effects are characterized by a long-time lag, while those of fiscal policy have a short time

lag. This implies that the effects of a fiscal policy can be noted much quicker as compared to

monetary policy. Using monetary policy can be easy to implement as compared to fiscal policy,

which must be politically encouraged. Lastly, fiscal policy can create a budget deficit, whereas

monetary policy can be used to regulate inflation in the economy.

Summary

 For anything to be considered as money, it must be able to store value, be an accepted

mode of exchange, and be used as an accounting unit.

 The Federal Reserve System controls and regulates financial institutions in the US.

 The Federal Open Market Committee makes monetary policies and controls the money

supply.

 Banks are required to hold fractional reserves to cater for depositor’s withdrawals.
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 The Fed used reserve ratios, discount rates, and buying and selling of financial securities

to regulate the money supply in the economy.

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References

Federal Reserve Board - Purposes & Functions. (2019). The Fed.

https://www.federalreserve.gov/aboutthefed/pf.htm

Mankiw, G. N. (2017). Principles of Economics (8th ed.). Cengage Learning.

The Fed - What is the money supply? Is it important? (2018). Board of Governors of the Federal

Reserve System. https://www.federalreserve.gov/faqs/money_12845.htm