Tools and theories of economic policy 557Monetary Policy
What is money? You probably think that you know what the green stuff in your wallet
is. You may wish you had more of it, but you know what it is. But money is much more
than bills and coins. You probably pay for more things with plastic (debit and credit
cards) than with coins and currency. Are those cards “money” as well? Economists
categorize debit cards as money because debit cards represent the money you already
have in your checking account—which is the same as cash. Credit cards are not
considered money because when you use a credit card you are, in essence, getting
a short-term loan. Broader definitions of money also include savings accounts and
certificates of deposit. So far, so good. The tricky part involves understanding where
money comes from. The answer may seem simple: the government prints it. But what
about the banking part? If you’ve never thought this through, it can be confusing or
even unsettling.
Consider this example: You have just graduated from college and you want to
start your own business as a political consultant. You have volunteered on several
campaigns and have even run a few statewide campaigns. Two candidates want to
hire you for the next election cycle, but you need to rent an office and buy computers,
phones, and other office equipment. This will obviously take some money. So you go
to a bank with your business proposal and show them your contracts for the coming
election and your plan for repaying the $100,000 loan that you are requesting. To your
surprise, the loan officer says yes and you leave the bank with a checkbook and debit
card $100,000 strong! The bank just created $100,000, seemingly out of thin air.^46
How can that be? Doesn’t money have to be something more tangible? Doesn’t it have
to be based on gold or other real assets rather than just a contractual promise to repay
the money? No—at least not in this country. In 1933, the United States nationalized
privately held gold and said that contracts must be paid in dollars, not gold; then in
1971, the country completely abandoned the gold standard. Why doesn’t the whole
system fall apart? Because it is based on trust and confidence in the banking system.
After you receive your loan from the bank, you could go directly to the computer store
and purchase $10,000 worth of computers with your new debit card. And because
your debit card purchase will be electronically authorized at the cash register, the sales
staff will have no reason to ask where your money came from. They would just give you
the computers.
Most people rarely think about how the banking system works, simply assuming
that their money is safe. But now that we have gotten you thinking about where money
comes from, we will provide more details about the banking system by examining the
targets and tools of monetary policy.Targets of Monetary Policy The Fed monitors levels of bank lending, the money
supply, and interest rates and tries to meet specific targets in each of these three
categories set at its monthly meetings. Bank lending is important to monitor and
regulate because it is the source of most new money in the economy. It is crucial for
economic growth because businesses borrow money to expand, and as they grow they
add jobs. If credit is tight and businesses cannot borrow money, economic growth will
suffer, as became painfully evident in late 2008 and 2009. Large public corporations
can raise money to expand by selling shares of their company in the stock market, but
small businesses do not have this option.
The money supply is also central to economic growth and directly related to levels of
lending activity. The Fed can influence the amount of money in the system by making
it easier or harder for banks to lend money. According to the monetarist theory of
macroeconomic policy, the amount of money in circulation is the most importantIt is well enough that people of
the nation do not understand our
banking and monetary system,
for if they did, I believe there
would be a revolution before
tomorrow morning.—Henry Fordmonetarist theory
The idea that the amount of money
in circulation (the money supply) is
the primary influence on economic
activity and inflation.In the late 1800s, presidential candidate
William Jennings Bryan railed against
the burdensome “cross of gold” and
argued for a silver-backed currency. But
since 1971, the value of the U.S. dollar
depends not on gold or silver but on
the banking system and international
currency markets.Full_16_APT_64431_ch15_530-571.indd 557 15/11/18 2:34 PM