Money & banking

Chapter 10

Money • Money – anything people will accept as

payment for goods and services.

• Money itself has changed over time: salt, paper money, gold coins, beads, shells, etc.

Functions of Money

1. Money must serve as a medium of exchange.

People must be willing to accept your money for goods and services.

Contrasts with bartering- trading goods and services for other goods and services.

Functions of Money , cont.

2. Money also serves as a standard of value—a set value that allows people to measure the relative cost of goods & services.

Functions of Money , cont.

3. Store of value-something that holds its value over time.

People understand that money will be accepted wherever and whenever it is presented to purchase goods and services.

Inflation (a general rise in overall prices) causes money to have less stored value.

Properties of money

1. Physical properties: • Durability-should be sturdy to

last throughout many transactions

• Portability –must be small and easy to carry

• Divisibility-must be divisible in order to make change

• Uniformity-must be identical, having features that make it identifiable

Song Dynasty Jiaozi, the world's earliest paper money

Properties of money , cont.

2. Economic properties (how valuable it is) :• Stability of value-purchasing power should be

stable• Scarcity- when supply outstrips demand, there

is a surplus and that item loses value • Acceptability-people recognize that your

money has value and they are willing to accept it as payment

Types of Money

1. Commodity money- something that has intrinsic (built-in) value.

Commodity money is something that is considered valuable on its own. Precious metals, jewels, etc.

Types of Money, cont.

2. Representative Money- money that can be exchanged with something of value.

Rep. money is backed by something of tangible value.

Types of Money, cont. 3. Fiat money – money that has value simply

because the government has issued an order (a fiat) declaring it has value.

Governments help to maintain the value of its fiat money by controlling the supply.

Can be greatly affected by political instability.

US money

Money consists of what can be used immediately for transactions. “transactions money”

Currency-paper money and coins (about half of transactions money). US currency is the dollar.

Demand deposits-checking accounts bc funds can be converted into currency “on demand.” Most are non-interest earning accounts.

Near money Money that cannot be used directly to make

transactions. These monies can be easily transferred into a checking account or removed from an ATM. Ex.:

• Traditional savings accounts • Time deposits-funds people place in a financial

institution for a specific period of time for a higher interest rate. Usually placed in cds-certificates of deposit

• Money market accounts-require a min. and limit your # of transactions.

How much money? Economists use the terms M1 and M2 to measure the

money supply. • M1=currency and liquid assets-that which can easily

be transferred into currency. • M2=M1 + near money.

M1

M2

M2

M1

M2

M1 or M2?

• Dollar bill?

• Savings account?

• Money market account?

• Traveler’s check?

• $50,000 cd?

Review questions

1. Why are economic transactions easier with money than with barter?

2. What aspect of fiat money allows it to have more stability than representative money?

3. The US govt has tried to get people to use dollar coins rather than dollar bills. Consumers would rather use bills. Why would each feel this way?

4. Why is there more near money than transactions money in the US money supply?

10.2-the development of US banking

1. Modern banking is thought to have originated in Italy in the mid to late 1300s. Merchants would store money an valuables for nobles and merchants would loan some of those deposits and earn interest on these loans. This pattern continued for centuries.

2. US banking: After the Revolutionary War, many state banks were chartered by state governments. Many issued their own currency. What are some problems that may arise from this practice? • Bc there was few currencies backed by gold or silver,

nothing to give money its value• A system with multiple currencies can be confusing

and chaotic

To fix these problems, the Constitution allows only the national government to print/ coin money

3. Founding Father Alexander Hamilton proposes a national bank, which becomes the First Bank of the United States. The Bank would 1) help bring stability to the economy, 2) establish credit for the new nation, 3) establish a useful national currency. The First Bank was chartered in 1791, but Congress refused to renew its charter in 1811.

4. Problems that arose after the non-renewal of the national bank: • It was difficult to fund the War of 1812• States returned to the practice of issuing its

own currency not necessarily backed up by gold or silver

• This increase in the money supply leads to inflation

5. These problems lead to the creation of The Second National Bank in 1816. This leads to more stability but there are many opponents, including President Andrew Jackson. Opponents say the Bank is too powerful and too closely aligned with the wealthy.

Jackson vetoes the Bank’s charter renewal in 1836.

6. After the charter is not renewed again, there is no national oversight (“Free Banking Era”) and wildcat banks spring up.Wildcat banks were banks set up in remote locations where those banks themselves were the only places where their notes were redeemable.

7. Free Banking Era ended in 1863 with the passage of National Banking Act to issue a common currency, finance the war effort, and stabilize the economy. Provisions of the Act: • Create a common currency• Regulated the minimum amount of capital and

reserves a bank has to have in order to operate

• Heavily taxed state notes, thus driving them out of business

8. In 1900, the US adopts the gold standard: a system in which the basic monetary unit is exchangeable for a certain amount of gold.

Money is now uniform and backed by something with intrinsic value.

9. The gold standard brings more stability to the country, but the US still experiences periods of inflation and recession. Why? Due to the fact there was no central institution to manage the money supply in a flexible way to meet country’s needs.

10. To fix these economic issues, the US passes the Federal Reserve Act in 1913, which creates the Federal Reserve System (the Fed). The Fed’s functions: • The national govt’s bank• Makes loans to other banks• Issues the national currency • Regulates the money supply

11. 1929: The Great Depression. Many banks failed due to bank runs, where people panicked and withdrew their money. Part of Roosevelt’s New Deal program was the Banking Act of 1933. It created the FDIC-Federal Deposit Insurance Corporation which provides federal insurance to back up a bank’s deposits. Begins federal regulation of banks.

12. In the early 1980s, Congress reduces regulations on savings and loans institutions. Banks could now take more risks in loans bc of the ease on interest rate regulation. As a result, many S&Ls lost their depositors’ money.Despite the S&L crisis, the US continued its policy of deregulation.

Types of banking institutions

Role of banks: 1. Take deposits2. Make loans3. Manage customers’ money

GOAL of banks: 1. Make a profit

Types of banking institutions, cont.

A. Commercial banks-• provide basic banking services• checking and savings• make loans• FDIC insured

Types of banking institutions, cont.

B. Savings and Loans-• originally chartered by states as

“mutual societies” • take savings deposits • provide home mortgage services• today, they also offer many

commercial services

Types of banking institutions, cont.

C. Credit Unions• offer many of same services as commercial

banks• most specialize in mortgages and auto loans• Cooperative= membership requirement and

nonprofit