Unit 5 Notes

Money and Monetary Policy 

Money is anything that satisfies the Four Functions of Money, as listed in the text.   Historically, people have used gold, silver, shells, cattle, and all sorts of other commodities as money.  The Native Americans who lived in what is now Massachusetts made wampum, small cylindrical beads, from seashells.  Wampum was used as money and as jewelry.  Contemporary economies like the US use what is called fiat money, which is not associated with historical commodities.  The money supply of an advanced economy like the US consists of currency in circulation and entries in computer databases.   Here is the current "M2" money supply: 

1.7 T (currency) + 2.2 T (checking accounts) + 11.3 T (other bank accounts) = 15.2 T (number rounded, T for trillion )  

To emphasize the point, if you have $1000 in a checking account, the bank does not have a corresponding $1000 in currency stashed away in a vault somewhere.  But it does have $100 in "reserve" in deposit in its account at the Regional Federal Reserve Bank.   

Here is the current  M1 and M2 money supply reported by the Federal Reserve Links to an external site.. 

The current Reserve Requirement is 10 percent, although very small banks are exempted.  The pejorative term for a little bank is a "Mom and Pop Bank," and these are sometimes found in rural towns.   

About banks going bankrupt, the Federal Reserve and state and federal Bank Regulators prevent banks from actually closing down, as happened in the Great Depression.  If a bank is having financial difficulties, then an acquisition or merger is often arranged.  That's why you might find a small local bank suddenly becoming a branch of a larger bank, like Bank of America.  The worst case scenario is that the Bank Regulators operate the bank while it winds down operations and customer accounts are moved to other banks.  

One thing that confuses some people is that the Federal Reserve consists of two separate operations, the Federal Reserve System in Washington plus the Regional Federal Reserve Banks in twelve districts, spread across the US.  The "Fed" in Washington is a government agency and the Regional Banks are public/private partnerships.  Endicott College is in District 1, the Boston District, and the Federal Reserve Bank of Boston is located across the street from South Station, in Boston.  It has a little exhibit in the lobby, but you can't just go in and "wander around" the building.  (I was there for a meeting a couple of years ago, and you need to go through airport-like security to get in.)  

The Federal Reserve Board of Governors meets with the Regional Bank Presidents as the "Federal Open Market Committee" eight times per year, to decide on Monetary Policy, that is, in which direction to move the money supply and interest rates.  The policy is implemented by buying or selling US Treasury Bonds, which is actually done via the New York Fed, since it is located in the US financial hub, New York City.  

Fiscal Policy

The US government has run a deficit for decades, except for a couple of years in the Clinton Administration.  Pres. Clinton, a Democrat, and Fed Chair Alan Greenspan, a Republican, had a good working relationship, and were in sync about policies to lower interest rates.  The issue about interest rates and Fiscal Policy is that when the Federal Government finances its deficit by issuing US Treasury Bonds, they compete with bonds issued by the private sector, which may cause interest rates to be higher, and "crowd out" private investment. 

Economists who lean to a view called "Fiscal Conservatism" would find large deficits only acceptable in cases of war or recession, but bad policy otherwise.  (Note that being a Fiscal Conservative does not mean that one is also a Political Conservative, and vice versa.)  A more moderate view would approve of deficits used to finance factors that bolster long-term economic growth, like investments in physical capital (e.g., infrastructure), human capital (e.g., education), and technology.  Deficit spending to finance tax cuts, as is the current Fiscal Policy (in 2020) is controversial, since it postpones the tax, but does nothing to actually reduce it.  A Fiscal Conservative would regard funding tax cuts through deficit spending as playing "pay me now or pay me later," and choosing to pay later. 

As an aside, the text mentioned spending on K12 public education, and to say a bit more about the relationship between funding and outcomes, the five highest ranked states for K12 education are:  MA, NJ, NH, VT, and CT.  The bottom five states are:  NM, AL, NV, AK, and LA.  (MS is 6th worse.)  The per pupil spending for the top five states ranges from $16K to $19K per year.  In the bottom states, the funding ranges between $9K and $12K.   So to put it simply, the top states spend roughly twice as much as the bottom states, per pupil per year.   Although funding just by itself is not a "magic wand," funding combined with reforms tends to produce results.  (So about specifics, in Massachusetts, the educational reforms were voted in by the Legislature back in the 1990s.  Some elements of the reforms, beyond funding, were that teachers are required to have master's degrees, principals and superintendents are empowered, school committees can't micromanage schools, and students must pass a high-stakes exam to graduate from high school, the MCAS. It is also official state policy in Massachusetts that it has the best-educated workforce in the US.)