The Role Of Money In The U.S. Economy

Topics: Monetary policy, Central bank, Federal Reserve System Pages: 7 (2441 words) Published: February 1, 2008
The Role of Money in the U.S. Economy If you ask the average person what money is, you are undoubtedly going to receive some very strange looks. Money is a concept that many people take for granted. We know that money allows us to acquire goods and services, but what is its source of value? Money is paper, which is for all practical purposes; no different than the paper this text is written on. How then would anyone in his or her right mind trade a tangible object (like a new stereo or television) for it? Money plays a key role in our lives, but few people are totally free of misconceptions about it.

In the booklet, The Federal Reserve System, Purposes & Functions, the Federal Reserve (or Fed) defines money as "Anything that serves as a generally accepted medium of exchange, a standard of value, and a means of saving or storing purchasing power. In the United States, currency (the bulk of which is Federal Reserve notes) and funds in checking and similar accounts at depository institutions are examples of money." In a barter economy, the buyer must offer real goods of the same value as the goods purchased. If the seller agrees to deliver the goods in exchange for a promise to receive equivalent value later, he has accepted an IOU. That IOU is a credit for the seller and a debt for the buyer. If the IOU is negotiable (if it can be used in exchange for goods sold by others) then the IOU is evidence of a monetary system. In essence, money is credit that is widely accepted as a medium of exchange.

For credit to be accepted as a medium of exchange, it must be seen as having some value. This doesn?t mean that money must have a constant fixed value. As long as it retains enough value to be widely accepted as a medium of exchange, it will qualify as money. Another function of money is as a means by which the value of one good or service is measured against the value of another. How many gallons of milk are worth a visit to the movie theater can only be determined in a marketplace, based on prices measured with the value of money. Money is a token that is widely accepted as a tool for the exchange of goods or services. This token can be physical like a coin or a note, or an intangible like credit in a bank deposit. If the token is exchangeable into a commodity like an ounce of gold or a bushel of grain, then the token is called commodity money. The value of commodity money can change, but it is never less than its value as a commodity. A precious metal coin is a token exchangeable into the material that it is made of. This type of token has an intrinsic value due to the fact that value of the token coincides with its value as a commodity (for instance a gold coin).

Money that is not directly exchangeable is known as fiat money. This type of money does not have any intrinsic value, and it depends on some other mechanism to maintain an exchange value. All modern money systems employ fiat money. When commodity money was used, the issuer of the money was limited by the requirement to hold a sufficient amount of the underlying commodity. There is no such requirement in the case of fiat money. The viability of a fiat money system depends largely on the policy and actions of the issuer, which is normally the central bank of a country.

The Federal Reserve, the central bank of the U.S, issues all fiat money. Its value is derived from the fact that it is the only money acceptable in payment of taxes and for settling private debts in court. Those who have no tax liability have reason to acquire fiat money because it is of value to those who do. Fiat money can be viewed as a tax credit that is widely accepted as a medium of exchange. Banks greatly expand the capabilities of fiat money by issuing credit through lending. The value of bank credit money is based on the promise that it can be converted to fiat money. Banks must hold a certain amount of fiat money to accommodate those who want to exchange credit for money.

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Cited: Schiller, Bradley R. _The Macro Economy Today_. 8th Edition. N.p.: McGraw-Hill, 2000.
The Federal Reserve website ?The Federal Reserve System, Purposes & Functions? .
Tresuary direct website http://www.publicdebt.treas.gov/sec/sectrdir.htm The Federal Reserve website Alan Greenspan Bio .
About.com website ?Greenspans Briefcase? . Febuary 3, 2000 Fed101 website ?The federal reserver today? < http://www.kc.frb.org/fed101/indexflash.cfm>.
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