Chapter 16

Topics: Monetary policy, Federal Reserve System, Central bank Pages: 37 (14836 words) Published: April 9, 2015
Chapter 16: The Monetary System Chapter Contents
Book Title: Principles of Macroeconomics
Printed By: Anh Le (
© 2015, 2012 Cengage Learning, Cengage Learning

Chapter 16
The Monetary System
Chapter Introduction
16-1 The Meaning of Money
16-1a The Functions of Money
16-1b The Kinds of Money
16-1c Money in the U.S. Economy
16-2 The Federal Reserve System
16-2a The Fed’s Organization
16-2b The Federal Open Market Committee
16-3 Banks and the Money Supply
16-3a The Simple Case of 100-Percent-Reserve Banking
16-3b Money Creation with Fractional-Reserve Banking
16-3c The Money Multiplier
16-3d Bank Capital, Leverage, and the Financial Crisis of 2008–2009 16-4 The Fed’s Tools of Monetary Control
16-4a How the Fed Influences the Quantity of Reserves
16-4b How the Fed Influences the Reserve Ratio
16-4c Problems in Controlling the Money Supply
16-4d The Federal Funds Rate
16-5 Conclusion
Chapter Review
Key Concepts
Questions for Review
Quick Check Multiple Choice
Problems and Applications

Chapter 16: The Monetary System Chapter Introduction
Book Title: Principles of Macroeconomics
Printed By: Anh Le (
© 2015, 2012 Cengage Learning, Cengage Learning

Chapter Introduction
When you walk into a restaurant to buy a meal, you get something of value—a full stomach. To pay for this service, you might hand the restaurateur several worn-out pieces of greenish paper decorated with strange symbols, government buildings, and the portraits of famous dead Americans. Or you might hand her a single piece of paper with the name of a bank and your signature. Or you might show her a plastic card and sign a paper slip. Whether you pay by cash, check, or debit card, the restaurateur is happy to work hard to satisfy your gastronomical desires in exchange for these pieces of paper, which, in and of themselves, are worthless.

Anyone who has lived in a modern economy is familiar with this social custom. Even though paper money has no intrinsic value, the restaurateur is confident that, in the future, some third person will accept it in exchange for something that the restaurateur does value. And that third person is confident that some fourth person will accept the money, with the knowledge that yet a fifth person will accept the money … and so on. To the restaurateur and to other people in our society, your cash, check, or debit card receipt represents a claim to goods and services in the future.

The social custom of using money for transactions is extraordinarily useful in a large, complex society. Imagine, for a moment, that there was no item in the economy widely accepted in exchange for goods and services. People would have to rely on barter—the exchange of one good or service for another—to obtain the things they need. To get your restaurant meal, for instance, you would have to offer the restaurateur something of immediate value. You could offer to wash some dishes, mow her lawn, or give her your family’s secret recipe for meat loaf. An economy that relies on barter will have trouble allocating its scarce resources efficiently. In such an economy, trade is said to require the double coincidence of wants—the unlikely occurrence that two people each have a good or service that the other wants.

The existence of money makes trade easier. The restaurateur does not care whether you can produce a valuable good or service for her. She is happy to accept your money, knowing that other people will do the same for her. Such a convention allows trade to be roundabout. The restaurateur accepts your money and uses it to pay her chef; the chef uses her paycheck to send her child to day care; the day care center uses this tuition to pay a teacher; and the teacher hires you to mow her lawn. As money flows from person to person in the economy, it facilitates production and trade, thereby allowing each person to specialize in what she does best and raising everyone’s...
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