Money is a form of medium of exchange used to purchase goods and services. It is the generally accepted unit of exchange, which is used to pay for purchases. Money is created in the mint by the federal bank of the country. Thus, the government issues coins and paper currency, which is considered money in general.
The money supply of the US relates to the supply of money done by the Federal Reserve Bank (Fed).
There are different kinds of money. From the standard presented by the Fed the assets are to be presented in the households and businesses and can be used to make payments. One of the measures of money supply is the usage of monetary base such as M1 and M2 demonstrating the sum of currency notes in circulation released by the Fed. Thus, one definition of money supply may be the cash issues by the Fed in form of paper currency, coins, or non-bank issues of traveller’s cheque, except for the cash kept in vaults.
Checking account balances are added to the money, except for those that are owned by domestic banks and the US treasury. M1 is the supply of immediate spendable money, while M2 is that money which cannot be easily liquidated. Therefore, money supply is equal to a summation of checking account component and the cash in form of coins and currency notes.
In the US, only the Fed and the US Treasury has the legal authority to create money. The money supply excludes all currency held in federal banks, thus, creating the issue of exchange of one kind of money with the other, resulting in withdrawal of cash.
Velocity of money is defined as the number of purchases done with a currency bill of domestic goods. One must note that this considers only the purchase of current domestic output and not prior or foreign goods. Thus, the people using the domestic currency and purchasing domestically made goods determine the velocity of money. Thus, people who spend more at a quicker rate usually help in influencing the velocity of money.
There lies a discrepancy in the theoretical and practical valuation of velocity of dollar. Practically, it is observed that spending of dollar was faster than printing of paper currency. The reasons behind this are: (1) the clause in the definition of considering only domestically produced goods, while many purchases of foreign-made goods are done, and (2) circulation of dollar outside domestic boundaries.
Money and gold are connected in order to create the value of paper currency. Gold exchange is essentially accumulation of gold amounting to the currency notes in circulation. The valuation of the notes and that of the gold must be same in order to retain parity in the gold reserve and currency afloat.
This chapter begins with the study of the US Treasury Department (Treasury). The Treasury is an executive branch that handles the financial affairs of the Fed. The internal revenue service handles the collection of revenue and the rest is raised through the treasury securities. The Treasury also handles the Mint in the US and the US Bureau of Engraving and Printing. The Fed is an independent organization operating out of the aegis of the Congress. Thus, its institutional independence provides it with ample opportunity to handle its own actions.
However, the Congress or the Senate has the power to dissolve the Fed if it feels that the organization’s performance is unsatisfactory. There are in total twelve Feds and they are privately owned corporations. Other banks in the district that have voluntarily become members of the Federal Reserve System own the stocks of the banks. The operations of the banks provide enough revenue to cover the operating costs and creating dividend for the stockholders of the bank.
This chapter describes the functions of the Federal Reserve System. The Fed is responsible for regulating the volume of money supply in the nation. The Fed collects economic data and interprets it with the aid of analytical techniques to control and determine the future course of money supply. Further, the Fed is also responsible for serving as a banker to all other banks. They maintain a Treasury with the accounts of other banks and perform other fiscal services. The third function of the bank is the Fed is serving as a banker from the US to international organizations like the World Bank and the International Monetary Fund.
The Fed holds account for the World Bank and IMF and provides usual banking services to them. Fed also serves as banker to other foreign governments. The Fed also participates with other regulatory agencies like the Treasury Comptroller of the Currency, state banking authorities, Fed Deposit Insurance Corporations, etc. in order to assure that the charter is followed. The Fed serves as the banker to other banks. Other banks have to keep a research account wherein they deposit a part of their total money with the Fed, which is called Federal Reserve.
This chapter deals with the function of the Treasury and the money supply in the US. The chapter deals with taxes and loans from the public, the coins, and currency creation, if a bank lends to the treasury, and Fed reserve lends. The Treasury has created taxes and loan accounts for other banks throughout the country. The taxes paid by the people of a region are collected with the Treasury; the IRS then deposits the money in the banks in the area. Similar procedure happens when people purchase government securities from the US Treasury.
When a customer to a bank deposits a treasury cheque, the bank takes the cheque, deposits the amount in the customer’s account, and demands compensation from the Treasury for the cheque amount. The whole process will result in the loss of money for the bank if there is higher dollar sent to the Federal bank than what the government of the region spends.
The coin and currency that is created in the US Mint is headquartered in Washington, DC and has other facilities at Denver, Philadelphia, San Francisco, and West Point (NY). The Federal Bank spends all the newly created coins and paper currency to the twelve Feds for storage in their vaults. However, it should be noted that this new cash minted out of the plants is not considered in the “money” calculated for the nation.
This money is deposited with the Fed. The Fed can reduce or increase the amount of money deposited with them, thus, aiding in increasing or decreasing money supply to the economy. Further, this process helps in creation of money as the cheque when cashed is transformed in currency notes or coins, which is then added to the volume of money in the economy. When the banks have a low level of cash, they can borrow money from the Fed.
The mode of borrowing money by the Treasury is through auctioning of its securities to the banks. If the banks buy the bonds, they pay through reserves to the Treasury and not money. However, usually banks refrain from purchasing Treasury securities. They can purchase reserve funds in order to get lucrative customer loans. The banks only buy that amount of Treasury security that is obligatory for them in accordance to the regulator’s insistence. This acts as a secondary reserve for the banks. Further, the Treasury does not directly borrow from the Fed.
This chapter deals with the money supply and the function of banks. The chapter deals with primary, secondary, and working reserves of banks. It shows how lending to banks can create money, and how banks can acquire excess reserves and how they may loose excess reserves.
According to the banking regulations in the US, banks have to keep a minimum reserve that equals some specified percentage of the reserves held by its customers. This is called primary reserves. However, it should be noted that the customer’s money is not used as a reserved, but the bank’s money that is held as reserve. The minimum percentage required for primary reserve is called reserve requirement and the amount of cash maintained is called required reserve.
The working reserve is the deposit and withdrawal of money that occurs within one banking day. According to the banker’s calculation, a bank gains one dollar of reserve for each dollar of net deposit and losses one dollar for each dollar withdrawal.
Secondary reserve relates to the excess revenue of the banks that is used to buy US Treasury Bills, which earn interest and are safe holdings, and they earn interest. These are considered revenue-earning holdings which is almost a back-up money for the bank’s primary reserve.
The chapter demonstrates how the money lent by banks can create money through the money multiplier mechanism. The bank earns money by giving out loan and this increases the borrower’s account balance, which in turn, is again added to their deposits. This is an accounting increase in money.
Chapter 5 relates to the open market operations of the banks and how the reserves are required to adjust the revenues. The chapter deals with the money supply policy of the Fed, the discount rates, and the reserve requirements for the banks. The three tools that the Fed uses to control the supply of money to the economy are open market operations, adjustment of the reserve requirement held with the banks, and changing the discount rate. Open market operations are related to the purchase or sale of government bonds and securities to reduce or raise the money supply. This is done under the aegis of the Federal Open Market Committee.
The adjustment of the bank reserves helps in creating a boom or bust for the loan given out by banks. If the reserve rates are low, more loans can be given out, thus, creating higher money supply in the economy, and vice versa.
Withdrawal of bank deposit by customers, pushes down the bank reserves, this may create a problem if a large number of deposits are withdrawn at a time. In order to avoid such a situation, banks can lend out a percent of the reserve that they are holding in order to maintain the deposit level. This is a form of borrowing from the reserves, for which the banks have to turn to federal funds market and the interest that is charged on it is called the federal fund rate.
The monetary policy employed by the government and the Fed is essentially using these three tools discussed above to control the flow of money in the economy, and thereby, control the prices, output, employment, and interest rates.