Introduction
The US monetary system is a complex entity regulating the country’s financial assets. It is overseen by the Federal Reserve System, which functions as a central bank. This organization conducts the implementation of monetary policies and practices. This essay provides definitions and discusses the most important characteristics of the US monetary system, the Federal Reserve System’s functions, and procedures to identify the advantages and disadvantages of such a system.
Money
For something to be called money, it has to have a certain value equivalent to a commodity that might be accepted in exchange for goods or services as payment. In other words, money and currency are units used to establish economic relations and mediate the exchange process. In addition, to be called money, the item should have particular characteristics. Firstly, money should be uniform, which implies that it should be accepted by a state or the people as a reliable and the only possible means of economic interaction (“FAQs,” n.d.). Secondly, money should be divisible, which holds that money should be represented as a unit that might be divided into smaller units.
Thirdly, money should be usable, meaning that one should be able to carry it and use it for a long time since it is an exchange object. In this regard, the currency is used in paper or metal forms, which allows for the convenient use of money (“FAQs,” n. d.). Furthermore, for something to be called money, it has to be limited by the equivalent of the commodity that represents its value. For example, the gold supply of a country is used as a limit to the quantity of money it possesses. In this regard, dollars have value because they represent the quantity of gold the USA has.
The Money Supply
The money supply is an important economic concept that explains how money exists and is used. In particular, the money supply consists of “the total amount of money—cash, coins, and balances in bank accounts—in circulation” (“FAQs,” n. d., para. 1). The Federal Reserve System defines this term as “a group of safe assets that households and businesses can use to make payments or to hold as short-term investments” (“FAQs,” n. d., para. 1). In the United States, two measures of the money supply stock are used, namely M1 and M2 (Mankiw, 2021).
In particular, M1 includes currency, demand deposits, traveler’s checks, and other checkable deposits, which is $3,737 billion (Mankiw, 2021). M2, on the other hand, includes everything from M1 and savings deposits, small-time deposits, money market mutual funds, and several minor categories (Mankiw, 2021). The total amount for the M2 measure is $14,467 billion (Mankiw, 2021). Thus, the money supply might be measured in several ways, which indicate how much supply is available in the country.
Functions of the Federal Reserve System
The Federal Reserve System of the United States is an official banking system of the United States. The country’s central bank is responsible for providing the nation with a reliable and safe financial system (“FAQs,” n. d.). This organization has several functions that enable the existence of that monetary system and its control. Firstly, the FED is responsible for “conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices” (“FAQs,” n. d., para. 2).
Secondly, the FED supervises and regulates the operations of banking institutions to protect consumer’s rights. Thirdly, the function of the FED is to maintain the financial system’s stability and eliminate market risks. Finally, it provides financial services to the government and financial institutions.
The Federal Open Market Committee (FOMC) is an important segment of the Federal Reserve System. It is “the monetary policymaking body of the Federal Reserve System” (“About the Fed,” n. d., para. 1). This committee consists of twelve members who make monetary system-related decisions. In particular, they hold regular meetings to monitor the developments in the financial sphere, assess risks, and make necessary adjustments (“About the Fed,” n. d.). This body is essential for the US economy since it performs the FED’s direct duties to oversee the economic system’s safety and stability.
Financial Institutions
The United States’s financial system consists of many financial institutions, such as banks, credit unions, and others. The functioning of such institutions is justified by their essential role in driving the economic processes and moving “the economy’s scarce resources from savers (people who spend less than they earn) to borrowers (people who spend more than they earn)” (Mankiw, 2021, p. 530). Financial institutions enable the use of the money supply to its fullest without disrupting the monetary system. Savers bring their resources to financial institutions, where they are stored and used to meet the loaning needs of the borrowers. In such a manner, without these institutions, the US financial system would be inefficient and would not be sustainable. One of the factors enabling such sustainability is the system of fractional reserve banking.
Fractional-Reserve Banking
Fractional-reserve banking is a system of using the resources in the bank accounts by involving the money in the bank vault. Contrary to 100 percent reserve banking, which implies saving money for liabilities, fractional-reserve banking means financial institutions use their assets to loan consumers and charge them for loans (Mankiw, 2021). In other words, since “leaving all that money idle in their vaults seems unnecessary,” banks allow borrowers to utilize this money, thus earning from the charges paid as interest (Mankiw, 2021, p. 598). When viewed from the perspective of consumers, such a banking system allows individuals to obtain the missing resources when needed while being obligated to repay with interest in the future. Furthermore, consumers can save their money in the bank as a deposit to increase their savings. Such a system is effective in the contemporary economy because it enables efficient usage of all money in the financial system while generating profit. Thus, it benefits both the financial institutions and the citizens of the United States.
Tools for Controlling the Money Supply
Since controlling the money supply is one of the functions of the Federal Reserve System, it has several tools that enable performing this role. In particular, as stated by Mankiw (2021), the FED uses open-market operations as one of the tools to control the money supply. It is the most effective and most frequently used tool (Mankiw, 2021). The purchasing of government bonds contributes to the money supply, making it larger, while selling government bonds allows for a decrease in the money supply (Mankiw, 2021). In such a manner, the FED can control the amount of the money supply. Another set of tools relates to the interaction between the FED and the financial institutions. For example, the FED can lower or increase the interest or discount rates and alter the reserve requirements, ultimately affecting the money supply.
Money Multiplier
Another important concept in the US financial system is the money multiplier. As defined by Mankiw (2021), the money multiplier is “the amount of money the banking system generates with each dollar of reserves” (p. 794). In particular, it is an essential element in implementing the monetary policy since it allows for influencing the money supply through the changes in the money multiplier. In particular, the amount considered in the money multiplier changes depending on the deposit. The availability of money as an outcome of the increased money multiplier allows for adjusting the banking system’s rates. In addition, the money multiplier serves as a reserve of money since it is composed of the charges for loans and interests, which, when accumulated, can be further used within the banking system (Mankiw, 2021). Thus, the money multiplier enables the implementation of the monetary policy and regulation of the money supply.
The Monetary Policy Advantages and Disadvantages
The monetary policy is characterized by advantages and disadvantages compared to the fiscal policy depending on its effect on the economic processes. On the one hand, monetary policy is a highly effective tool that enables central banks to control the money supply and manage it as needed. The monetary policy is more transparent than the fiscal policy and allows for clear and non-biased policies and practices implemented by the central financial institutions. Furthermore, the FED can control inflation by regulating the currency and interest rates (Mankiw, 2021). On the other hand, fiscal policy has a quicker effect regarding the time the policies and practices are implemented (Mankiw, 2021). Furthermore, the monetary policy is restricted to general effects for the country without enabling local changes.
Conclusion
Money is durable, valuable, and divisible units that mediate the exchange of goods and services. The money supply comprises all the assets available in the country in the form of deposits, cash, and money-market funds. The FED is responsible for controlling, monitoring, and adjusting the monetary system policies. Financial institutions enable fractional-reserve systems to function when borrowers use idle money in vaults. The monetary system is better than the fiscal system because it enables transparency, clarity, and controllability of inflation, while the fiscal system is localized and more flexible.
References
About the Fed. (2017). Federal Reserve. Web.
FAQs. (n. d.). Federal Reserve. Web.
Mankiw, G. N. (2021). Principles of economics (9th ed.). Cengage.
