Monetary systems

0:00- [Instructor] In other videos, we've talked about money. In this video, we're gonna talk about how that money is actually managed at a national or an international level. And, generally speaking, we can call these systems monetary systems, systems for dealing with money.

0:14And I'm gonna focus at the national level. And in particular, I'm gonna focus on the United States Federal Reserve, which is officially not part of the government. It is a quasi-independent institution, although the government has helped set it up. And it definitely has elements of it that feel government-like, like the Chairman of the Federal Reserve is appointed by the President of the United States.

0:37But the US Federal Reserve is interesting, not just from a US point of view, but because the US is such a large economy in the world, and the dollar is so heavily used around the world that it's important to the entire globe. So what does the Federal Reserve do to manage the US monetary system system?

0:57Well, first and foremost, the most obvious thing is, is that they can print money, or issue money. It's not always physically printed, you could have digital money as well. But when you see a dollar bill, this is actually a Federal Reserve note. It's issued by the Federal Reserve.

1:14As they create money, they can print this. And it's not them that actually do the printing, that is the treasury. But they're the ones that decide what is the quantity of money in the actual system, or at least the quantity of base money. And I'm not going to go into too much detail there, but let me just write that down.

1:31They can print... Actually, maybe let me say create money 'cause sometimes it's not physically printed. It could be digital. They can create money. Now, you might ask yourself, if they print this, or if they create this money, how do they put that into circulation?

1:47Do they just drop this from a helicopter? And you probably have not seen a helicopter literally dropping cash. So no, that is not how they do that, although sometimes people say that figuratively. What they will do is they will go into markets, and usually bond markets, bonds are just a fancy way of saying people have borrowed money, including the US government.

2:08The US government borrows money. And they will say there's an IOU from the US government. It doesn't have to only be from the US government, but it typically is. And they will buy this from other investors. And so one way to think about is they're creating that money, and by buying these IOUs they're lending money to the US government or sometimes other safe parties.

2:31And then that money enters circulation for whoever owned this IOU before, whoever that the US government owed that money to. And these IOUs, they usually don't call them IOUs, they usually call them bonds or T-bills or treasuries when we're talking about the US government.

2:48There's other Khan Academy videos that go into a lot more detail there. Now, when they create money and they buy this type of debt, it can directly affect interest rates, especially short-term interest rates, most typically. And so they set target interest rates.

3:02A lot of times when you listen to the news or the financial press, they're going to talk about where the Federal Reserve is going to set interest rates. And these are target interest rates, and they can directly affect that by printing money and going out there and buying or selling things like government treasuries.

3:21Once again, in other videos, I go into a lot more detail on how they do that. But here, you just have to know that they can target it. They can also, or another major function of the US Federal Reserve, is they provide banking stability. So one of the problems with fractional reserve banking, in our banking system today, if you were to deposit $10, that bank can actually lend out a lot of that money to someone else.

3:46Now, that might introduce a problem because what if they lend out $9 and you show up the next day and say, "Hey, I'd like to withdraw $2." And if they can't give you the $2, they can only give you $1, you might be worried, you might tell your friends, all your friends get worried, and you might have a run on a bank where everyone goes and tries to get their money from the bank, and the bank might fail.

4:06So the way that the Federal Reserve provides banking stability is they can be the lender of last resort. Lender of last resort. So banks that are members of the Federal Reserve, can go and borrow directly from them if they face this type of situation. Lender of last resort.

4:24They also provide insurance. And the most famous one, when you walk into a bank, or even if you see a bank's website, you might see Federal Deposit Insurance Corporation, FDIC. And if a bank is a member of that, that means even if that bank were to go under, that the Federal Reserve has ensured your deposits up to a certain amount.

4:44So you don't have to go and run over to that bank and get all stressed out because the Federal Reserve will have your back there. And that, once again, provides trust and stability in the banking system. Now, I could go into a lot more detail, and there's a lot more detailed videos about the Federal Reserve in the United States, but most countries have a similar institution to the Federal Reserve.

5:04But the Federal Reserve in the United States has a lot of power because the dollar is such an important currency, and the US economy is such an important economy. Now, at an international level, there are institutions that try to provide some stability, even at a country level.

5:20The most famous is the International Monetary Fund. But unlike, say, the US Federal Reserve or the central banks of other countries, the IMF, the International Monetary Fund, it does not directly print money. It does not directly set interest rates. That, once again, is from central banks.

5:39But they might provide loans to countries. And these aren't loans to build dams or to build roads, that might be more of the World Bank type of thing. These are loans to ensure or to help with financial stability. And I won't go into a lot of depth here, but you could imagine a government that has borrowed a lot of money and now is having trouble paying it back.

6:00If they were to default on their loans, it might create a financial crisis. It might create a lot of hardship in that country, and maybe the IMF will provide a loan to that country, or to that government saying, "Well, we'll give you this loan, but you've gotta clean up your house a little bit because we wanna believe that you're going to be able to pay this back, and we want you to become a more efficient country or use your resources better."

6:19But the IMF is an institution that at least attempts to provide more financial stability when a government might default on their debt or a currency is looking really weak, and it looks like that might lead to some type of a financial crisis in that country or in that region.

6:36But like I said, most of the power sits with the central banks, because those are the ones that actually print the money and set interest rates, and especially the US Federal Reserve.