COPYRIGHTED MATERIAL
Controlling the $upply of Money The U.S. money supply consists of two kinds of money : 1) all of the coins and bills in circulation; and 2) non-physical money held in electronically in savings, checking, and other accounts. Obviously, the Federal Reserve Bank can order the Treasury Department to print and distribute currency to increase the money supply. Controlling the supply of non-physical money is different. The Fed operates through twelve district branches called Reserve Banks . They are located in major cities around the country. Again, these are not the kind of banks you can walk into and make a deposit or use the ATM. They act as banks for banks . Reserve Banks are important because they are like tentacles through which the Fed moves money into the money supply, or pulls money out of the money supply. Remember, the goal is to maintain an optimal supply of money – scarce, but not too scarce, so that the value of money is stable . Here are a few tools the Fed uses to move money in and out of the money supply to keep the economy stable: Bank reserves . To maintain the integrity of the banking system, all commercial banks like Bank of America, U.S. Bank, or Wells Fargo are required to reserve a certain percentage of their total deposits with the Reserve Bank in their district (hence the name Reserve ). The Fed can order commercial banks to increase their reserves, which effectively removes money from the money supply, or decrease reserves, which puts money back into the money supply. Increasing loans. Through its Reserve Banks, the Fed makes loans to commercial banks. In turn, commercial banks lend money to consumers. When the Fed increases the amount of money available to commercial banks, there is more money to lend to consumers for things like cars and houses, or to expand their businesses. Through consumer purchases, the money makes its way into the money supply. When the Fed reduces the amount of money it lends to commercial banks, there is less money available for consumer loans. That tightens the money supply. Adjusting the discount rate. The interest rate changed by the Fed on loans to banks is called the discount rate . If this rate is high, the bank’s loans to consumers will, in turn, have a high interest rate. That makes the loans unattractive to consumers. The money will not make its way into the economy, making money more scarce. If the discount rate is low, the commercial bank’s loans will be attractive, and consumers will seek credit for buying all sorts of things. That pumps money into the money supply and stimulates the economy. Another important method by which the Fed controls the money supply is buying and selling government bonds . (Advise students they will learn more about government bonds in a later lesson.) These transactions are called Open Market Operations . They involve huge sums of money – billions . To increase the money supply, the Fed buys back government bonds from the public. The money the Fed uses to buy the bonds increases the money supply because people trade in their bonds for money. To decrease the money supply, the Fed (through the Treasury Department) sells bonds to the public. The money investors use to buy bonds goes to the government, and is effectively removed from the money supply. Money supply concepts are very complex. This lesson barely scratches the surface. For purposes of 21st century financial literacy you should understand that the Fed’s actions on bank reserves, money availability, and SLIDE 4J PRODUCT PREVIEW
58
Lesson 4 | The Money Morph
Made with FlippingBook flipbook maker