Money, Banking, and the Federal Reserve Bank (Monetary Policy) Chapter 10, Page 256

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1 Money, Banking, and the Federal Reserve Bank (Monetary Policy) Chapter 10, Page 256

2 Money Part I

3 Money Objectives: In this lesson, students will be able to identify characteristic of money and the advantages of money. Students will be able to identify and/or define the following terms: Barter System Commodity Money Money Supply Money Representative Money Fiat Money

4 Money- History When America was first being settled there was no money system. Colonists used the barter system (people traded for what they needed and didn t have). Trades are made in goods and services instead of money. 1

5 Money- History Early European settlers in America adopted wampum small shells that American Indians used ceremonially as a form of currency.

6 Money- History During the colonial period in America, foreign coins from Spain, England, Portugal, Holland, France, and elsewhere were used in the colonies. The most commonly circulated coin was the peso, or Spanish milled dollar which could be divided into halves, quarters, and eights. When divided into eights, the sections were called pieces of eight or bits - hence the slang two bits to mean a quarter of a dollar. The milled edges were designed to prevent people shaving silver off. Peso 2 bits

7 Money- History Commodities were commonly accepted: furs, tobacco, salt, gun powder, fish hooks, etc. These items were known as commodity money, objects that have value in themselves as well as for use as money. Some goods that evolved into money were gold, silver, and copper. 2

8 Money-History Problems with bartering: A.Difficult to compare worth or value of things. B. Bartering took a lot of time and effort to find the right person to make an exchange. (This was the main problem.) For bartering to work, You have to want what the other person wants and visa versa. 3

9 Money- History In 1789, one of President George Washington s first challenges was to establish a money supply for the new country a uniform standard currency. There were pesos, shillings, talers, and other European coins in the colonies from which to design a new medium of exchange. Money supply is defined as: All the money available in the United States economy. Consisting of coins, currency and Demand Deposits (also called checking accounts and travelers checks). Money supply is important because it affects prices, loans, jobs, and other things. Money is defined as: A good that is widely accepted for purposes of exchange and in the repayment of debt. 4

10 Money-History Later as America developed into a more complex economic system, tobacco, gun powder, and other objects (used as commodity money) were no longer universally accepted as money. The nation needed a more convenient payment system. The U.S. government issued representative money in the form of silver and gold certificates. Used until Representative Money is defined as: Paper money that has value because the holder can exchange it for something else of value, such as gold or silver. 5

11 USA Gold Certificate - In gold coin payable to the bearer on demand The Government stopped converting paper money in to gold and silver in the 1930 s. Our dollars were once backed by gold. You could exchange a dollar for gold and silver. At one time you could exchange this for this

12 A $1 Silver Certificate is the only piece of U.S. paper currency (1891) to bear the portrait of a woman: Martha Washington

13 Money-History From Representative Money to Fiat Money Today, our money is fiat money. (Fiat is an order or decree.) Fiat Money is defined as: Money that has value because the government has ordered or decreed that it is an acceptable means to pay debts, and is called legal tender. It remains in limited supply, and therefore valuable, because the Federal Reserve controls its supply. This control of the money supply is essential for a fiat system to work. 6

14 Not All Money is the Same Commodity Money Representative Money Fiat Money Objects like this gun powder once served as commodity money. Representative Money like this silver certificate could be exchanged for silver. Today, Federal Reserve notes are fiat money, decreed by the federal government to be an acceptable way to pay debts.

15 Are You Better Off Living in a Money Economy? People who live in money economies do more specialized work because transaction costs are low. Instead of spending time bartering, they can focus on producing one thing. They can then sell that one thing (EXP: their labor) for money and use the money to buy other goods and services. The extra time saved in a money economy can be used to produce more goods and services, to consume more leisure, or to do both! Residents of money economies are richer in goods, services, and leisure than the residents of barter economies. 7

16 Three Functions of Money 1. Medium of Exchange (Acceptable) 2. Unit of Value (Compares Value) 3. Store of Value (Keeps it s Value) As a medium of exchange, money measures value during the exchange of goods and service. An expensive price tag tells us something about the good s value. Money holds its value even if it is not used immediately to buy goods and services. (Unless very high 8 inflation occurs.)

17 Six Characteristics of Money Acceptable Portable Divisible Durable Uniform Scarce 9

18 What gives Money Value? Acceptability in exchange gives money its value. It s scarce. 10

19 Banking Part 2

20 Banking Objectives: In this lesson, students will be able to identify the first bankers and discuss how banking create money without printing it. Students will be able to identify and/or define the following terms: Bank Fractional Reserve Banking Money Supply M1 and M2 Money Interest Default Required Reserve Excess Reserve Mortgage Credit & Debit Cards

21 Banking A Bank is defined as an institution for receiving, keeping, and lending money. Banks are for individuals and businesses. Types: Commercial Banks, Savings and Loan Associations, Mutual Savings Banks, Credit Unions, State Banks, and Federal Banks. 11

22 Banking - History When money was principally gold coins, carrying it was neither easy nor safe. As a result, people wanted to store their gold in a safe place. Most often, people stored their gold coins with goldsmiths because goldsmiths had safe storage facilities. Goldsmiths were the first bankers. 12

23 Banking - History Goldsmiths would give receipts stating the amount of gold stored. People began using receipts in place of actual gold coins because it was easier to do so. People accepted the gold receipts as money because they trusted the goldsmiths and knew the receipts were fully backed by gold. 13

24 Banking - History Then, some goldsmiths began to lend out some of the gold they were storing, and collected interest on the loans. However, instead of lending the actual gold, the goldsmiths gave receipts to the borrowers. As a result, there were more receipts than there was actual gold. The goldsmiths lending activity increased the supply of money. That is, it increased the number of receipts compared with the actual amount of gold. (Credit increased, not gold.) 14

25 Banking - History The goldsmiths activity was the beginning of a process of Fractional Reserve Banking. Under Fractional Reserve Banking, banks are like the goldsmiths of years past. They hold only a fraction of the deposits and lend out the remainder. Fractional Reserve Banking is defined as: a bank keeps only a fraction of deposits on hand and loans out the rest. (See EXP. A and B money creation on your handout) 15

26 Banking - History Fractional Reserve Banking How it works! $100 10% or $10 of deposit must be kept in bank s required reserve. $100 is deposited in the bank Required Reserve Ratio is 10%. This is set by the Fed. 90% or $90 is excess reserves that can be loaned out by the bank to customers. The availability of credit (or loans), is how banks increase the money supply, money creation, without actually printing more money. Raise RRR percentage = decrease in Money Supply Lower RRR percentage= increase in Money Supply 16

27 Money Creation Starts when banks begin to loan out their excess reserves. Formula : Deposit \ RR Rate = Increase in money supply. $10,000 \.20 = $50,000 increase in M.S. $10,000\.10 = 100,000 increase in M.S.

28 Another Example of Money Creation Required Reserves bank keeps 20% RR Ratio $100,000 deposit Running Sums (1) (2) Reserves Deposits $100,000 (3) Loans Excess Reserves bank loans out $20,000 on reserve $80,000 lent out $80,000 deposit $16,000 on reserve $64,000 lent out $20,000 $36,000 $180,000 $80,000 $144,000 $64,000 deposit $244,000 $12,800 on reserve $51,200 lent out $48,800 $195,200 $51,200 deposit $295,200 $10,240 on reserve $40,960 lent out $59,040 $236,160 $40,960 deposit $336,160 $8,192 on reserve $32,768 lent out $67,232 $268,928 And so on... $100,000 $500,000 $400,000

29 Banking Today

30 Banking Today The money supply is all the money available in the United States coins, cash, demand deposits and travelers checks. The money supply consists of M1 and M2. Review of definition Money Supply 17

31 Banking Today M1 is money that people can easily use to pay for goods and services currency, checking accounts (call demand deposits), and traveler s checks (has liquidity). 18

32 Banking Today M2 is M1 plus savings accounts, time deposits, and money market accounts. Savings Account interest-earning account ;some have check-writing privileges. Time Deposits interest-earning account with a specified maturity date. Penalties for early withdrawal. Money Markets Accounts interest-earning account; requires minimum balance, limited check writing privileges. Review of definitions 19

33 Banking Today Facts About Interest: When money is deposited in a bank, the customer receives interest on money. A person who borrows money must pay interest. A Bank s primary revenue is from interest on the loans they make. Interest is defined as the price of borrowed money. 20

34 Most of a Bank s income comes from interest from bank loans. Bank s Revenues and Expenses

35 Banking Today Default: When a person fails to pay back a loan, he/she has defaulted on the loan. Defaulting on a loan leads to bad credit and higher interest rates in the future. By defaulting, a person ruins his/her reputation for repaying a loan. 21

36 Banking Today Credit Cards are not money. Credit Cards create loans. Loans place people in debt. To get out of debt, people have to repay the loan with money. 22

37 Banking Today Debit Cards are considered demand deposits (checking account). They are included in part of the money supply and as part of M1 money. 23

38 Banking Today A mortgage is a loan on real estate. (Learning the language of banking, a person makes better choices.) 24

39 The Fed Federal Reserve System Part 3 Federal Reserve, Washington, D.C

40 Federal Reserve System Objectives: In this lesson, students will be able to explain how it came into existence, and what it does. Students will be able to identify and/or define the following terms: Bank Panics Federal Reserve Act Federal Reserve System FOMC Lender of Last Resort

41 BANKS and THE FEDERAL RESERVE BANKS are -- Institutions for receiving, keeping and lending money. Banks for individuals and businesses. Types: Commercial Banks, Savings and Loans Associations, Mutual Savings Banks, Credit Unions, State Banks and Federal Banks. THE FEDERAL RESERVE is -- The nation s central banking system. This means that it is the chief authority on money in the country, commonly referred to as The Fed. The U.S. s bank and a bank s bank. 25

42 Before the Federal Reserve System Background As stated earlier, banks were informal and not completely safe. After the American Revolution, the leaders of our new nation agreed that one of their main goals must be to establish a safe, stable banking to restore confidence in the bank system. Such a system was also important for increasing trade with other countries and ensuring the economic growth of the new United States. The nation s leaders did not agree on how these goals should be accomplished. Continued

43 Before the Federal Reserve System Background The nation s leaders debated during the 1780 s and 1790 s on banking and the role of the government in our young country. As you may remember from your study of American History, there were two political views on the creation of a National Bank: Anti- Federalist - led by Thomas Jefferson (against) Federalist led by Alexander Hamilton (for) Continued

44 Before the Federal Reserve System Background Thomas Jefferson Anti-Federalist Believed in a bank system run by the States. He worried that a National Bank would lend to only wealthy people or businesses and ordinary people (farmers) would be refused loans. Alexander Hamilton Federalist Believed in a strong central Government bank. He proposed a National Bank with one single national currency, managed by the National Government.

45 Before the Federal Reserve System Background The Federalist were successful (by one vote) and in 1791 Congress set up the first Bank of United States, granting a 20 year charter. This bank brought order and stability. Anti-Federalist pointed that the National Bank was unconstitutional. After the charter expired, state banks began issuing bank notes again. Many state banks were not stable or trustworthy. People lost confidence in banks again. In 1862, Congress passed the National Bank System (with uniform currency that was backed by gold). Continue

46 Before the Federal Reserve System Background Before the founding of the Federal Reserve, the nation was plagued with financial crises. At times, these crises lead to bank panics, in which people raced to their banks to withdraw their deposits. Continued 26

47 The Federal Reserve SystemSigning of the Federal Reserve Act, President Wilson in signing it. Background A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act, defined as chief authority on money in the U.S. (Initially created to address these banking panics, the Federal Reserve is now charged with a number of broader responsibilities, including fostering a sound banking system and a healthy economy.) Continued 27

48 he Federal Reserve System Background Establishing the nation s first central bank was no simple task. What emerged with the Federal Reserve System was a central bank under pubic/private control, with countless checks and balances. Congress oversees the entire Federal Reserve System. And the Fed must work within the objectives established by Congress. Yet Congress gave the Federal Reserve autonomy (self-rule) to carry out its responsibilities insulated from political pressure. 28

49 The Federal Reserve System Purpose of FED? It is responsible for Monetary Policy Controlling the money supply and the availability of credit. The Fed can expand or contract the money supply to support the following: 1. Maintain stable prices 2. Keep employment high 3. Stimulate economic growth 29

50 The Federal Reserve System Structure of the FED Janet Yellen Fed Chairman Appointed by President Obama, in 2014, Confirmed by Congress, and a term of 4 years. Known as the most powerful person in the world 30

51 The Federal Reserve System Structure of the FED 2. Board of Governors (7) *Regulates and supervises the Fed. *Controls Fed activities. (Term-14 yr) 3. Federal Reserve Banks (12) Monitors and reports on economic and banking conditions in its district to the Board of Governors. 30

52 The Federal Reserve System Structure of the FED 4. FOMC (12) makes decisions on Monetary Policy (growth of money supply). Fed uses 3 tools: 1. Interest Rate (called Discount Rate) 2. Bank s Required Reserve 3. Buying/Selling Gov. securities (FOMC) Increase the Money Supply: Decrease the Money Supply: -Lower RR Ratio -Buy U.S. Securities (FOMC) -Lower Discount Rate (interest) -Raise the RR Ratio - Sell U.S. Securities (FOMC) -Raise Discount Rate (interest) 30

53 The Federal Reserve System Structure of the FED 5. Federal Advisory Council(7) Consults with and advises the Board of Governors. 6. Member and Non-Member Banks (about 6891 total) (about 6891 total) Federally chartered banks must be members of Fed, approximately

54 The Federal Reserve System Fed is under both public and a private control? Public Part President nominates Chair, Senate approves. Board of Governors- 7 Members committee includes the Chair. Regulates and supervises the Federal Reserve System. Input from Both Federal Open Market Committee 12 Members - Regulates the money supply through Monetary Policy. Private Part 12 District Banks With their own 9 board of directors. Member banks Local Banks

55 The Federal Reserve System The 12 Federal Reserve Districts: Each of the 12 Fed Reserve District is made up of more than one state ensuring that one single District does not dominate or exploit the central bank s power at the another s expense. Each District has 9 directors and a President. 31

56 The Federal Reserve System Districts #11 Dallas, Texas: Texas is in District #11, along with part of two other states, New Mexico and Louisiana. Our District Reserve Bank is located in Dallas, Texas. Texas has 3 branches in El Paso, Houston, & San Antonio. 32

57 The Federal Reserve System Responsibilities of the FED? 1. Control the Money Supply 2. Supply the economy with paper money 3. Hold bank reserves ($$$) 4. Provide check-clearing services 5. Supervise member banks to ensure they are following bank regulations. 6. Serve as the lender of last resort for banks suffering cash management problems. This means that the Fed may lend banks money when no one else will. 33

58 The Federal Reserve System How the Fed Serves the Government: 1. It functions as the Government s banker, called the U.S. central bank. It maintains a checking account for the U.S. Treasury Dept. and processes payments, such as: Social Security checks and IRS refunds. 2. Acts as an agent of the government and sells, transfers, and redeems Gov. securities (through the FOMC): Bonds, Notes, and Bills (called securities) 3. The Fed issues paper currency (does not print it) and takes worn or torn bills out of circulation. US Treasury: US Mint coins; Bureau of Engraving and Printing paper bills. 34

59

60 Review True/False 1. Banks are allowed to print currency. False Only U.S. Treasury s Bureau of Engraving and Printing 2. Checking accounts are called demand deposits. True 3. Credit cards are a form of money. False (they are a form of debt) 4. Money has value because it is accepted and scarce. True

61 Review True/False 1. The first bankers were blacksmiths. False Goldsmiths 2. The central banking system has 10 Federal Reserve District Banks. False (12) 3. Debit cards are considered checking accounts. True (they are demand deposits & are part of M1) 4. If $300 was deposited a bank and the required reserve ratio was 10%, the amount placed in required reserves would be $30, & excess reserves would be $270. True

62 Review True/False 1. The problem with bartering is its difficult to compare worth and it takes time and effort to find the right person to make the exchange. True Prevents individual specialization, too. 2. Commodity money consists of objects that have value in themselves as well as for use as money. True 3. M1 does not include savings accounts. True (currency, checking accounts, traveler s ck.) 4. The Fed s activities are controlled by the U.S. Treasury. False (Fed s Board of Governors)

63 Review True/False 1. Our money is fiat paper money backed by gold. False Fiat money is not backed by gold. 2. We refer to the Fed as the central bank because it is the chief monetary authority in the country. True 3. Monetary Policy is the action by the Fed to control the money supply and available credit. True (FOMC makes decisions about growth of money supply) 4. A barter economy in an economy with no money. True

64 Review True/False 1. Fed Open Market Operation has 5 tools it uses to control the growth of the money supply. False (3) Interest rates; banks Required Resv; buy/selling Gov. securities 2. The functions of money include the unit of interest. False (Med. Of Exchg., Unit of Value, & Store of Value) 3. The money creation process begins when banks loan out their excess reserves. True 4. The goldsmiths lending activities (had more receipts than there was gold) was the beginning of increasing the money supply by a process called fractional reserve banking. True

65 Review True/False 1. Credit cards are the same as money. False Debt 2. Banks make most of their income from interest on loans they make. True 3. Representative money was commonly accepted commodities, such as, salt and fish hooks. False (salt/hooks are commodity money) 4. The Fed issues paper money, acts as our nation s bank, holds bank reserves, supervises bank, and serves as the lender of last resort. True (and many other things)

66 Review Questions 1. Who is Janet Yellen? Chairman of the Federal Reserve Bank. 2. What did Alexander Hamilton (Federalist) and Thomas Jefferson (Anti-federalist) debate about? A centralized National Banking System 3. How is the Fed both privately and publicly run? President appoints/congress approves (Bd. of Gov.) - Public District Bank, Member and Local Banks- Private Both have some influence, however, Congress gave the Fed autonomy (self-rule) to carry out its responsibilities insulated from political pressure. 4. The first National Bank (1791) was successful, so why did it close? The 20 yr. charter ended and Anti-Federalist continued to debate that it was unconstitutional.

67 Money, Banking, and the Fed Test

68 The End

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