14-1 Money is used as a medium of exchange for goods and services, as a unit of account for
expressing price, and as a store of value.
People will only accept money in exchange for goods and services and for the work they perform
if they can be reasonably certain that the medium of exchange—money—will retain its value
until they are ready to spend it. In runaway inflations of the thousands or tens of thousands of
percent a year, people revert to barter.
Again, drastic inflation greatly reduces money’s use as a measure of value, for it is impossible to
adjust instantaneously all prices strictly in line with their relative values. Thus, opportunities are
afforded to speculators to profit at the expense of the less sophisticated who, eventually, will
learn to distrust money’s usefulness as a measure of value.
Finally, and most obviously, money’s usefulness as a store of value is destroyed in a drastic
inflation. The “rule of 70” is instructive here. By dividing the absolute inflation rate into 70, one
can estimate how long it takes one’s dollar savings to lose half their purchasing power. At 7
percent inflation, the dollar will be worth half as much in ten years.
14-2 Commercial banks and thrift institutions offer checkable deposits.
Currency held by banks is not counted in either M1 or M2.
14-4 M1 = currency (in circulation) + checkable deposits. The largest component of M1 is currency
(54 percent), and it is the only part that is legal tender. If the face value of a coin were not greater
than its intrinsic (metallic) value, people would remove coins from circulation and sell them for
their metallic content. M2 = M1 + noncheckable savings deposits + money market deposit
accounts + small time deposits + money market mutual fund balances.
15-1 A balance sheet is a statement of assets and claims (or liabilities and net worth). It must balance
because every asset is claimed by someone, so that assets (the left-hand side) = liabilities + net
worth (the right-hand side).
The major assets of a bank are: cash (including cash reserves held by the Fed), its property, the
loans it has made, and the securities it holds over and above general loans. Its liabilities are the
deposits of its customers. The difference between the assets and liabilities is the bank’s net
worth, which is shown on the liabilities side, thus ensuring that the balance sheet balances.
15-2 Reserves provide the Fed a means of controlling the money supply. It is through increasing and
decreasing excess reserves that the Fed is able to achieve a money supply of the size it thinks best
for the economy.
Reserves are assets of commercial banks because these funds are cash belonging to them; they are
a claim the commercial banks have against the Federal Reserve Bank. Reserves deposited at the
Fed are a liability to the Fed because they are funds it owes; they are claims that commercial
banks have against it.
Excess reserves are the amount by which actual reserves exceed required reserves: Excess
reserves: Excess reserves = actual reserves - required reserves. Commercial banks can safely
lend excess reserves, thereby increasing the money supply.
