Function of Money. Money Has Four Purposes.

¶ … function of money.

Money has four purposes. It serves as:

Medium of exchange -- i.e. The currency used for bartering one good for another

it serves as the standard numerical unit of measurement of the market value of goods, the value of the program, or transaction

A store of value -- it can be reliably saved, stored, and retrieved and used whenever it is retrieved. Its value remains unchanged.

A standard of deferred payment. - It is an accepted way to settle a debt ( Mishkin .2007)

• Explain how the central bank manages a nation's monetary system.

The Federal Bank manages the nation's monetary system by virtue of three strategies:

It can change the interest rate on money that it lends to banks. A higher interest rate makes money more expensive. Banks may be, therefore, more reluctant to sign loans to applicants. On the other hand, the Bank by lowering interest rates can encourage banks to more readily lend loans.

The Federal Reserve has the authority to change reserve requirements. (I.e. The percentage that banks have to store in their vaults that represent their total loan portfolio). By the Federal Reserve lowering their requirement for money that banks have to store in their vaults), banks can be more liberal with their loans.

3. The Federal Reserve controls the money supply. This, in turn, has an impact on inflation and interest rates. In other words, when inflation is high, the FR reduces money supply, and increases the money supply when there is poor economic growth and the economy needs it (Mishkin, 2007)

• Outline the stated direction of recent monetary policy in the United States.

Recent monetary policy is working towards supporting housing and helping growth of employment. The problems right now in the housing market are that there are too-tight lending rules and racial discrimination. The FR also concluded that "weaker economic outlook, subdued projected path for inflation, and significant downside risks to economic growth" caused it to take certain steps which would include:

1. To ease monetary policy by continuing its maturity extension program (MEP) up to 2013. The MEP integrates sales of short-term Treasury securities with the same amount of purchases of longer-term Treasury securities. It therefore decreases the supply of longer-term Treasury securities available to the public making these securities more expensive. At the same time, it doesn't affect the size of the Federal Reserve's balance sheet. Furthermore, by removing longer-term Treasury securities from the market, the FR encourages private investors to acquire other longer-term assets, such as corporate bonds and mortgage backed-securities, which help raise prices making the financial situation more livable and optimistic.

2. The FR intends to set a very low interest rate level of federal funds rate consisting of 0 to 1/4%. This is because it expects that economic conditions -- including low rates of spending and a negative outlook for inflation over the coming year -- warrant these low interest levels at least up to 2014. (Chairman Ben S. Bernanke Semiannual Monetary Policy Report to the Congress Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C. July 17, 2012)

• List at least one policy action that the Federal Reserve has taken to confirm that direction.

In September 2012, too, the FR announced a third round of easing the difficult economic situation, which they called QE3. They pledged to act on this program until the economy is significantly improved.

One of the problems is the housing problem, and Federal Reserve Chairman Ben S. Bernanke plans to deal with the housing problem by buying $40 billion a month of mortgage-backed securities. This will also, simultaneously spur growth on the housing market and reduce a 7.9% unemployment rate.

(Zumbrun, J (November 15, 2012).

The Fed has generally used large-scale purchases of long-term bonds to lower long-term interest rates, but in September 2012, it introduced a new twist of buying a new round of bond purchases that consisted of adding $23 billion of mortgage bonds to its portfolio by the end of September and $40 billion as a total each month. Each month, it will announce a new target until the economy has improved, or is showing marked improvement, and until the outlook in the labor market improves. This, at the same time, will keep inflation in check (NY Times. (November 16, 2012)

• Explain the effects of monetary policies on the economy's production and employment

The interest rate level and the amount that the FR loans to banks, as well as the amount that they insist banks store, influence how much banks will loan to companies and individuals, This influences the rate of national spending, as well as consumption and individual's creativity (in innovating and setting up businesses). When money is expensive, fewer companies and fewer individuals will be offered loans and therefore economic production will more likely suffer and there will be a rise in unemployment since money is scarce and few will be able to afford the short-term loans.