What’s in This Chapter?
Is money, or the love of money, the root of all evil? Should we eliminate money? If we eliminate money, will all evil disappear? If we eliminate money, what economic consequences will this have? Are we better off with money than without money? What are the functions of money? These questions, among others, are answered in this unit.
Nearly every country or region in the world has a central bank. The most important roles of a central bank are to supervise a nation’s banking system and to control its money supply. Sections 3 and 4 discuss the role of the central banks and the Federal Reserve (the Fed) System in the United States. The Federal Reserve is in charge of monetary policy in the United States. Its aim is to act independently from Congress and the White House. United States citizens do not elect Federal Reserve Board governors or central bank presidents. Governors are appointed by the President, and then approved by the Senate. The disadvantage is that the Fed governors are not directly accountable to the voters. The advantage is, however, that unlike politicians, Federal Reserve Board governors can act regardless of what may be the popular thing to do. They can, therefore, concentrate on long-run policies (they don’t often do this though).
The Federal Open Market Committee (FOMC) is the day-to-day decision-making committee of the Federal Reserve System. Financial markets around the world closely follow every step the FOMC makes. In addition to controlling the money supply, it serves many other functions, as explained in this unit. During the two decades preceding the 2008/2009 economic crisis, consumer price inflation in the United States remained relatively low. However, housing prices rose significantly, in great part due to Federal Reserve injections of money into the economy. This led to much irresponsible borrowing, created a housing price bubble and led to the housing crisis and Great Recession of 2008/2009. After the crash, the Federal Reserve significantly increased the money supply and even started buying Mortgage Backed Securities (in addition to its usual purchases of federal government securities). Recently, consumer price inflation rose to nearly 10% in many countries, fueled by excessive printing of money during the pandemic.
Fractional reserve banking, the Federal Deposit Insurance Corporation, velocity and the quantity theory of money are discussed in the last sections of this unit.