Q5. What “backs” the money suppl... [FREE SOLUTION] (2024)

Chapter 14: Q5. (page 300)

What “backs” the money supply in the United States? What determines the value (domestic purchasing power) of money? How does the purchasing power of money relate to the price level? In the United States, who is responsible for maintaining money’s purchasing power?

Short Answer

Expert verified

The government backs the money supply in the United States.

The purchasing power of the money can be determined by the total amount of goods and services that can be bought with it. When the price levels are rising, purchasing power falls and vice-versa.

The monetary policy and fiscal policy are responsible for maintaining the purchasing power of money.

Step by step solution

Step 1. Government backs the money supply.

In the United States, the money supply is backed up by the government, which guarantees to keep the value of the money supply relatively stable. Such a guarantee depends mostly upon the effectiveness and management of silks of the government with regards to the money supply.

Step 2. Purchasing power of money

The purchasing power of money depends upon the number of goods and services that a given unit of money can buy. For example, if a dollar can buy two candies, then the dollar's purchasing power is the value of two candies.

As the price level in the country increases, the purchasing power of money falls; say previously, a dollar could buy two candies, but due to the rise in the price levels, only one candy can only be bought with one dollar.

Step 3. The monetary and fiscal policy

The monetary policy is the policy of the Fed through which it controls the money supply in the economy, and fiscal policy is the government’s policy through which stability in the economy is achieved.

Monetary policy controls money supply by regulating interest rates, and fiscal policy achieves stability through spending and taxes. Both these policies play a huge role in maintaining the money’s purchasing power by controlling the price levels in the economy.

Most popular questions from this chapter

Why are federal prosecutors reluctant to bring major charges against large financial firms? What was the main regulatory action of the Glass-Steagall law? Why might having many smaller financial firms be more stable than having fewer larger firms? What argument can be made for the possibility that larger financial firms might be more stable than smaller financial firms?Suppose that a small country currently has $4 million of currency in circulation, $6 million of checkable deposits, $200 million of savings deposits, $40 million of small-denominated time deposits, and $30 million of money market mutual fund deposits. From these numbers we see that this small country’s M1 money supply is _______ , while its M2 money supply is _______.a. $10 million; $280 millionb. $10 million; $270 millionc. $210 million; $280 milliond. $250 million; $270 millionWhich of the following is not a function of the Fed? a. Setting reserve requirements for banks.b. Advising Congress on fiscal policy.c. Regulating the supply of money.d. Serving as a lender of last resort.Suppose the price level and value of the U.S. dollar in year 1 are 1 and $1, respectively. If the price level rises to 1.25 in year 2, what is the new value of the dollar? If, instead, the price level falls to 0.50, what is the value of the dollar?Assume that securitization combined with borrowing and irrational exuberance in Hyperville have driven up the value of asset-backed financial securities at a geometric rate, specifically from $2 to $4 to $8 to $16 to $32 to $64 over a 6-year time period. Over the same period, the value of the assets underlying the securities rose at an arithmetic rate from $2 to $3 to $4 to $5 to $6 to $7. If these patterns hold for decreases as well as for increases, by how much would the value of the financial securities decline if the value of the underlying asset suddenly and unexpectedly fell by $5?

See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept