Question

“The Federal Reserve sets U.S. monetary policy in accordance with its mandate from Congress: to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy”.

“The Federal Reserve achieves these goals by managing the level of short-term interest rates—specifically, by setting a target (or target range) for the federal funds rate, which is an overnight, unsecured, interbank borrowing rate. The level of short-term interest rates then influences the availability and cost of credit in the economy, and, ultimately, the economic decisions made by businesses and households.” (Federal Reserve Bank of New York)

What is money in the context of the United States economy?

What is the link between bank credit and the supply of money (M1)?

Answer 1

Money in the context of US economy is the medium of exchange and is the legal tender. It includes currency, cash at bank and also fiat money.

M1 is the initial level of money supply which includes, cash, currency, coins and bank checking accounts. Bank is able to create credit i.e. loans only on the basis of checking accounts. The higher that people save and put money in the bank the more the bank will be able to lend and the cycle goes on.