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Chapter Review Chapter 28: Money, the Price Level, and the Federal Reserve

  1. In the long run, the full-employment model implies that money is neutral. Changes in the quantity of money affect the price level and the level of nominal wages but leave real output, real wages, and employment unaffected.
  2. Money is anything that is generally accepted in a given society as a unit of account, a medium of exchange, and a store of value.
  3. The Federal Reserve is the central bank of the United States. Its policy actions affect the level of reserves and the money supply.
  4. There are many ways of measuring the money supply. The most common measures in the United States are M1, M2, and M3. All include currency and demand deposits (checking accounts); M2 and M3 also include assets that are close substitutes for currency and checking accounts.
  5. Financial intermediaries, which include banks, savings and loan institutions, mutual funds, insurance companies, and others, all form the link between savers who have extra funds and borrowers who desire extra funds.
  6. Government is involved with the banking industry for two reasons. First, by regulating the activities banks can undertake and by providing deposit insurance, government tries to protect depositors and ensure the stability of the financial system. Second, by influencing the willingness of banks to make loans, government attempts to influence the level of investment and overall economic activity.
  7. By making loans, banks can create an increase in the supply of money that is a multiple of any initial increase in the bank’s deposits. If every bank lends all the money it can and every dollar lent is spent to buy goods purchased from other firms that deposit the checks in their accounts, the money multiplier is 1 divided by the reserve requirement imposed by the Fed. In practice, the multiplier is considerably smaller.
  8. The Federal Reserve can affect the level of reserves by changing the reserve requirement, by changing the discount rate, or by conducting open market operations.
  9. The chief tool of the Fed is open market operations, which affect the supply of reserves.
  10. The reserve requirement, capital requirements, the Fed’s status as lender of last resort, and deposit insurance have made bank runs rare.
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