How Important is Money?

Economists are fascinated by the idea of money as a social institution— an agreement among individuals—that, if we keep it, makes our economic  lives  better  and  allows  our  economies  to  grow  more rapidly. This contract is as important to modern society as the invention of the wheel, and in this course, you’ll learn much more about this contract and what it means to keep it.

By way of introduction to our study of money, this lecture explores the intimate connection between Wall Street and Main Street; much attention has been focused on this relationship as the United States has attempted to recover from the subprime mortgage crisis and the Great Recession.

Wall Street versus Main Street

  • Our nation’s attempts to recover from the subprime mortgage crisis and the Great Recession were often discussed using the metaphor “Wall Street versus Main Street.”
  • On October 3, 2008, as the subprime mortgage crisis was going from bad to worse and the Great Recession was showing itself to be much worse than the typical downturn, Congress enacted the  Emergency  Economic  Stabilization  Act  of  2008.  That  act created  the  Troubled  Asset  Relief  Program  (TARP),  which provided funds for the bailout of troubled   financial   firms. Over the coming months, the Federal Reserve and the Treasury used TARP funds  aggressively  to  keep  banks  and  non-bank financial firms from failing.
  • At the same time, there was a populist outcry that the federal government should do more for Main Street, that is, for the workers and  terms that were suffering because of the Great Recession.

The important lesson for us is that the “Wall Street versus Main Street” idiom is inherently   flawed because the success of each of  these  entities  is  inextricably  bound  together.  Neither  can “win”  without  the  other.  Economies  require  efficient  and  ever- evolving   financial institutions and markets in order to maximize their potential.

The Connection between Wall Street and Main Street

Why is it that the fates of Main Street and Wall Street are so closely intertwined?  The  reasons  for  this  connection  between financial matters and economic well-being can be boiled down to four:

  • Stable value money is essential to efficient trade: Adam Smith,  in  his  book  the  Wealth  of  Nations,  argued  that  a nation  becomes  wealthy  when  it  organizes  its  productive efforts to take advantage of specialization, but specialization is   an   inherently   social   activity.   Producing   an   excellent product  only  makes  sense  if  we  can  trade  it  for  other things  that  we  want  but  do  not  produce.  Thus,  trade  is essential to wealth creation and improvement in the quality of   life.   Smith   also   tells   us,   however,   that   trade   can be   accomplished   efficiently   only   in   a   society   that   has adopted money.
  • Healthy banks are essential to the process of channeling funds from savers to investors: At its core, a bank is an institution that channels funds from savers to investors. This process  is  fundamental  to  economic  growth.  If  those  with productive ideas had to wait until they accumulated sufficient funds from their own saving before they acted on their ideas, little growth would occur.
  • Efficient asset markets are essential to establishing values for debt instruments, currencies, and shares of stock: It’s important to know the value of  financial instruments. One of the key reasons for the subprime mortgage crisis that led to TARP and contributed to the depth of the Great Recession was the simple fact that banks held large quantities of mortgage- backed securities.
  • A  well-designed  and  well-executed  monetary  policy  is essential for an economy to keep in  ation low and steady and  keep  resources  fully  employed:  Monetary  policy  as we think of it today began with the creation of the Federal Reserve System in 1914. There is still, however, a great deal of disagreement, even among economists, about what constitutes a well-designed and well-executed monetary policy.

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