Federal Reserve Paper
Joshua R. Willis
October 19, 2011
ECO/212
Bhaskar Singh

Federal Reserve Paper

Money, the main topic of the majority of discussions, debates, and arguments in the United States today. These days it seems people in the United States are more focused on who has too much money and who does not have enough. Granted money is required for just about everything these days. It is hard to believe that at times in our country’s history money was not used. At those times people used to trade goods with each other to receive the goods or services they needed. This raises an in interesting question, why is money so important and necessary? Therefore, this paper will look at the purpose and functions of money, how the central bank manages a nation’s monetary system, the direction of monetary policy in the United States, and the effects of monetary policies. “Money is defined as assets that people are generally willing to accept in exchange for goods and services or for payment of debts” (text). Therefore, the main purpose of money is to be a medium of exchange. This also falls in line with the four functions of money, which are medium of exchange, unit of account, store of value, and standard of deferred payment. Medium of exchange refers to the ability to purchase goods or services with money and also to accept money in return for those goods and services. The value in terms of money given to those goods and services is the unit of account. Because not all money is spent on goods or services, the money that people hold onto either in its monetary form or through other assets like stocks and bonds is called store of value. The last function, standard of deferred payment refers to the ability to use money for lending and borrowing purposes. Standard of deferred payment allows individuals or companies to pay for the exchange of a good or service at a later time. Because money is constantly exchanging hands there had to be a way to monitor the monetary system. The central bank is responsible for managing a nation’s monetary system. The central bank is also commonly referred to as the Federal Reserve System. The Federal Reserve System is comprised of 12 regional banks in major cities around the United States. The central bank manages the nation’s monetary system by supervising and regulating banks, implementing monetary policies through the buying and selling of United States Treasury bonds, and determining interest rates. Monetary policies are important will steer the nation in a certain direction. Monetary policies are actions taken by the Federal Reserve to manage interest rates and the money supply in order to follow the objectives of a macroeconomic policy. The direction of monetary policy in the United States is to lower unemployment levels and raise the level of Gross Domestic Product (GDP). Also the housing market is still depressed. Unfortunately, many people still owe more on their mortgages than their houses are worth. Plus the housing market is still loaded with many empty houses. People are just not seeking mortgages the way they did before the recession. The direction that monetary policy is taking is to improve these areas that are still of concern. Monetary policies can also affect an economy’s production and employment. Monetary policies can affect an economy’s production and employment in several ways. Monetary policies can raise and lower interest rates, which will affect demand for goods and services. Changes to interest rates will also affect output, employment, and inflation. As demand for goods and services increases an increase in employment will occur to support the increased production. Both production and employment will increase as the demand for products and services increase. However, if demand decreases due higher interest rates then production will decrease and therefore decrease employment. Inflation changes caused by monetary policy can also decrease demand for goods and services and ultimately decrease production and employment. According to some people money is the key to happiness and also what makes the world go round. However, money has not been the only way to exchange goods and services throughout history. Money is the medium of exchange that is used today. Money functions not only as a medium of exchange but also as the unit of account, store of value, and the standard of deferred payment. The United States’ monetary system is managed by the central bank. The central bank is also known as the Federal Reserve. The Federal Reserve and the monetary policies they produce are responsible for controlling interest rates and inflation. The monetary policies will also affect an economy’s production and employment by either increasing or decreasing those levels.

References

Investopedia. (n.d.). Central Bank. Retreived on October 17, 2011 from: http://www.investopedia.com/terms/c/centralbank.asp#axzz1b8qYJrrc
Hubbard, R. & O’ Brien, A. (2010). How the Federal Reserve Manages the Money Supply. Economics (3rd ed.). Boston, MA: Pearson Hall