Question

Based on a Survey of Consumer Payment Choice, researchers from the Federal Reserve Bank of Boston estimated that the average consumer, 18 years of age and older, held about \(\$ 202\) in currency. However, as noted in the chapter, there is actually about \(\$ 4,500\) of currency in circulation for every person in the United States. a. How can the amount of U.S. currency in circulation be so much higher than the amount held by the U.S. population? b. What does the difference in part (a) imply about the measures of the money supply of the United States?

Short answer

The U.S. currecy in circulation is higher than what is held by the populations primarily because it is also held by businesses, financial institutions, government entities, and foreign countries. This implies that in order to measure The U.S. money supply, the total currency in circulation, which includes those held by businesses, government agencies, and international entities, need to be considered, not just individual currency holdings.

Step-by-step solution

Understanding the difference in currency held and currency in circulation

The average U.S. consumer, who is 18 years of age and older, holds in average about \$202 in currency. On the other hand, there is about \$4,500 of currency in circulation per person. The difference suggests that not all the currency in circulation is held by an average U.S. consumer.

Estimating the additional holders of currency

The surplus currency that is not held by the average consumer, could be in possession of businesses, financial institutions, government entities, and foreign countries. Many businesses handle large amounts of cash to meet their day-to-day operations, besides foreign countries also hold U.S. currency because it is seen as a stable and reliable currency.

Implication for measures of the U.S. Money Supply

The difference between currency held by an average consumer and the currency in circulation implies that the measure of money supply in the United States is not solely based on personal holdings. It is also affected by businesses, government agencies and international holders. Therefore, the money supply is far greater than individual holdings of currency.

Key concepts

U.S. Money Supply

The term 'U.S. money supply' encapsulates all of the monetary assets available within the United States economy. These assets can take various forms, such as currency in circulation, which includes all coins and paper money that are not held by the Federal Reserve Banks or the U.S. Treasury, as well as checking accounts and savings accounts. When referring to the money supply, economists often differentiate between narrow measures like M1 (which includes cash and checking deposits) and broader measures like M2 (which adds savings deposits, money market mutual funds, and other time deposits to M1).

The startling difference between the average currency held by U.S. consumers and the total currency in circulation highlights the fact that money supply encompasses not just the money that individuals carry, but also that which is in possession of various other stakeholders in the economy. These stakeholders include banks, who hold reserves; businesses, who need cash for transactions; and even foreign actors who find value in keeping U.S. currency. This diversity in money holders is part of the reason why the Federal Reserve Bank does not just consider cash in individuals' wallets when calculating the national money supply.

Consumer Payment Choice

The concept of 'Consumer Payment Choice' relates to the various ways individuals choose to pay for goods and services. Such choices may include using physical currency, debit cards, credit cards, electronic transfers, mobile payments, and others. The dynamics of these choices are subject to factors such as convenience, security, and personal financial management.

Despite advances in technology that offer a plethora of payment methods, the Survey of Consumer Payment Choice highlights that on average, adults in the U.S. still possess a sum of tangible currency. This persistent use of cash can be attributed to its reliability as a method of payment in instances where digital transactions may not be feasible or preferred. Understanding consumer payment choices is crucial for financial institutions and policy-makers as it affects the demand for currency and hence, impacts the money supply and broader economic policies. The insights provided by such surveys can aid in tailoring services to consumer needs, as well as predicting economic trends based on payment habits.

Federal Reserve Bank

The Federal Reserve Bank, commonly referred to as the Fed, is the central banking system of the United States. With twelve regional Federal Reserve Banks across the country and a Board of Governors in Washington, D.C., the Fed carries out a range of functions essential for the effective operation of the U.S. economy. Among these functions is the regulation of the money supply through monetary policy.

The Fed's monetary policy influences the economy by targeting interest rates and controlling inflation. By adjusting the federal funds rate, for instance, the Fed can make borrowing more or less expensive, impacting spending and saving behaviors. Another important role of the Fed is overseeing the circulation of U.S. currency, making sure there is enough money flowing through the economy to facilitate trade and maintain the value of the dollar. The Fed is also responsible for the distribution of currency to banks, managing reserves, and ensuring the stability of the financial system. The Fed's activities, guided by its dual mandate to promote maximum employment and stable prices, are crucial for the overall health of the U.S. economy.