The Monetary System of the United States of America

The monetary system of the United States consists of the U. S. Treasury, the Federal Reserve System, and the system of privately owned commercial banks. These are the three institutions that create the money supply.

The Creation and Management of Money

The U. S. Treasury and the Federal Reserve System can simply strike coins, print paper money, or write checks. They can do this because the Constitution gives Congress the right to do it, and Congress has delegated it to these two institutions.

Commercial banks are able to create bank money (checking accounts), but only under the close supervision of the Federal Reserve. Commercial banks must first have reserves before they can make loans and set up new checking accounts for the borrower. The Federal Reserve controls the dollar amount of these reserves and, through that, the dollar volume of bank loans. The Federal Reserve controls these bank reserves by buying and selling U. S. government securities. When the Federal Reserve buys securities it pays for them with a check written on itself. When this check clears, commercial banks receive new reserves and therefore may make more loans and create new bank money.

The Money Market

The Money Market consists of a number of institutions that bring borrowers and lenders of short-term funds together on an impersonal basis. The money market is highly competitive, and borrowers pay whatever the going interest rate may be.

Commercial banks are the most important source of short-term funds in the money market. The Federal Reserve, working through banks, also supplies funds. At times, life insurance companies, pension funds, savings and loan associations, and mutual funds also are on the supply side in the money market.

The demand side (borrowers) of the money market consists of the demand by business to finance its general short-term needs, as well as by the U. S. Treasury to finance a deficit in the federal budget.

Treasury bills are the major money-market instrument used by the Treasury to finance a deficit. These are short-term obligations sold at a discount and redeemed at face value on maturity. The two major instruments used by corporations to satisfy their short-term needs are commercial paper and bankers' acceptances. They too are sold at a discount and then appreciate to their face value at maturity.

Money Market Instruments
Money Theories

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