money acts as a command in the purchasing process
Money is anything acceptable to be a medium of exchange while making transactions, and it is a unit of accounting and a store of value. Money has got various functions. As per its definition, money is a unit of account. Everything in the economy or the world of business is quoted using money. The prices of any transaction are quoted using it. Every region has a term that is used in measuring the value of the various product; for instance, in the USA, people use dollars. Money is also a store of value. Through money, one can show his/her purchasing powers. It is convenience to carry them from one area to another. Therefore, money acts as a command in the purchasing process. The third function of the money is working as a medium of exchange. Individuals use the money to exchange with their needs and wants. Therefore, it offers the most efficient means of satisfying wants.
The modern monetary system started back in the 19th century. The system was based on a commodity with value, where gold and silver were used. With time gold become the commodity of choice, and it demonetized the usage of silver. After gold, there came paper money known as fiat money. These monies had no product backing them up. The banks started issuing their own paper money known as banknotes, but by the middle 20th century, the government came up with uniform paper money. Banks began acting as a medium of exchange through credit cards. In the case of inflation, then the functions of the money will end up being affected. A high level of infliction will cause a loss of value for the money. Also, people will no longer be willing to accept cash as a form of exchange.
The bank has three main types of assets. These include reserves, bonds, and loans. The reserve is the set minimum deposit. In the United States, the minimum ration needed is about 10% of each deposit. The sanctuary, especially the excess reserve, is used as an investment by the bank at a certain profit. Bonds are mostly said to be liquid since they can be sold out for money to various investors. Primarily they are used to pay for the competitive interest rates. Therefore, the bank can earn money by investing in bonds. Loans are the main assets of the bank. The banks lend money to the individuals, and they receive interests from them. Banks have three liabilities, which include deposits, borrowed money, and capital. They use deposits and borrowed money to finance their loan making. The capital is used as a leverage tool in the business. The first potential problem for banks is a liquidity problem. This happens when the depositors and the credits want to withdraw more money than what is currently available. The other problem is the insolvency problem, which occurs as a result of banks taking significant risks by using leverage to get their loans. A bank run is when depositors and the creditors lose trust in their banks since they feel that their banks will not commit payoff when needed. Due to this, they can pull funds from the banks, and this will lead to financial panic. The Federal Reserve can reduce fear through a lender of the last resort where the Federal Reserve can immediately offer loans to the affected bank. Banks become insolvent in case their investment makes losses more significant than their capital. To solve this issue, the policymakers can liquidate the small banks, and for the significant banks, regulations will allow them to build up their equity until they acquire adequate capital to pay their losses.
There are various monitory controls. To start with, the Federal Reserve board’s come up with reserve requirements for any deposit institution. There is a required percentage of any money deposited that a bank should set and hold in reserve. The banks can hold this cash either as a vault or store it at a local federal reserve bank. In this policy, the percentage that the board set will affect the money available for loans and deposits. The lower rate will lead to an increase in the availability of funds for lending and deposit, and a higher percentage will reduce the funds available. Loan to depository institutions is another monetary control. The Federal Reserve’s boards state that the more credit bank gets from them should correspond in their lending and deposit. When it wants to allow the banks to borrow more, they lower the interest rates, and they are also required to reduce their lending rates to increases the chances of giving more loans to their clients. The third mechanism that is used is an open market operation. This enables the fed to start changes in the banking system reserves. It does this through a simple direct tool. It is so flexible such that it can be used in making daily, weekly, or significant adjustments in the banking industry.
As mentioned earlier, the open market operation is one of the instruments used by the federal reserve in controlling monitory practices in the country. The board likes using this model since its very flexible. The mode helps the board to make short term and long term changes in the market. It is mostly used in the control of government bonds and security. These need policies to be changed now and then to meet the prevailing market conditions. Therefore, open market operations are the most appropriate. In most cases, it is used for short-term securities, and these need a lot of flexibility. Also, the application of this mechanism will initiate a change in the banking system; for instance, if the fed buys government bonds, it will expand the country’s money and credit supply and reduces interest rates.
To expand the country’s money and credit supply, the fed will have to buy the government bonds in the open market. It starts the whole process by buying the bonds from the dealer. Then it will wire the money to the dealer’s account. Therefore, this action increases the deposit of the dealer as well as availing more cash for loaning out. The availability of the reserve that can be used to give out credits will impose an immediate pressure on interest rates to go down. If the fed what to contract the money and credit supply in the country, it will sell the bonds. Through this action, the fed will shrink deposits and reserves in the banking system. The act reduces the money available for credit. The banks are forced to shrink their outstanding loan portfolio to build their reserves. This increases interest rates.
The federal open market committee is involved in making authority in the Federal Reserve System. The committee meets eight times a year. It is made up of seven boards of governors and twelve presidents who represent the regional Federal Reserve banks. In their meetings, they vote for new monetary policies, and the seven councils of governors cast their votes but only five of the twelve presidents of the regional federal reserves who are allowed to vote. However, this committee does not operate the open market operations, but they only give directives.
When applying monetary policies, some issues should be put into action. Before using any of the police, the policymakers should know the operating procedures that should be put into action. Secondary, they should look at the goals that policymakers pursue. In the operation procedures, it refers to the needs to designate indicator variables. Some variables can significantly change macro-economic activity. To explain this, the monetary policies are guided by the Keynesian and monetarist theories. The Keynesian approaches indicate that the fed should apply a short-term interest rate. Therefore, in this, the monetary policy should instruct the open market trading desk to tract a particular standard that needs to be adjusted. For instance, if they have a short term rate of 6% and the rate surpasses 6%, then it indicates that this policy is too high and the FOMC should ease. On the other hand, if the rate goes below 6%, then it means that the plan is a tool loose, and it should be tightened. The primary target of the monetary policy through the application of the Keynesian theory is the long-term and medium-term interest rates. They believe that the long term interest has an impact on macro-economic activities. It does this by influencing the borrowing and spending habits of the individuals and organization by either increasing or reducing the interest rates. Through interfering with the short-term rates, the fed will be looking at changing medium-term and long-term rates since they affect the overall demand. It also affects the outputs, employment, and the prices of commodities and services. Therefore, from this, the fed can successfully apply the interest rate outcomes to target the medium and long term changes in the growth process. By doing this, they can predict future results and how they can monitor them. They can increase short term interest to help the bid up the medium and long term rates that will slow down the rate of borrowing and spending to dampen GDP growth. Also, they can lower the short-term interest to help them produce the opposite result. However, this approach is used when the fed what to maintain increase employment level as well as growing GDP.
Monetarist tradition approach states that they should use “monetary base” as the indicator variable. When applying this model in their policy, the fed should add enough funds in the economy to enable the money supply to grow. However, the growth should be at a stable rate to avoid inflection in the marketplace. A change in the amount of money in the economy end ups affecting the rate of GDP growth, employment, and prices. Therefore, fed comes up with the rate at which they should release money into the economy. By doing this, they control the speed of spending among households. An increase in the supply of money will lead to a rise in borrowing and spending among households.