MONEY AND BANKINGChapter 10

MONEY Money is anything that serves as

a medium of exchange, unit of account or store of value

Medium of exchange- determines value during exchange of goods and services

Without money goods and services acquired through barter

As economy becomes more specialized bartering becomes too difficult and time consuming

Money as a unit of account- provides means of comparing value of goods and services (dollars, Euros, rubles, pesos)

Money as a store of value- keeps value if you decide not to spend it, always recognized as a medium of exchange

Exception is when there is inflation, does not work well as a store of value

SIX CHARACTERISTICS OF MONEY Currency- coins and paper bills used as

money Various objects through human history

used as money Six Characteristics1. Durability- must withstand wear and

tear2. Portability- needs to be easily carried3. Divisibility- easily divided into smaller

units, needs various denominations4. Uniformity- needs to be the same in

terms of what it will buy, be able to count and measure accurately

5. Limited Supply- too much in circulation, it looses value

6. Acceptability- must be able to be exchanged for goods and services

SOURCES OF MONEY’S VALUE Commodity Money- objects that have value in and

of themselves (salt, cattle, precious stones) and have other uses as well

Not portable, durable or divisible Only works in simple economies Representative Money- objects with value because

they can be exchanged for something else Paper receipts that could be exchanged for gold or

silver were an early form of money Fiat Money- money valuable because government

said it can be redeemed for debt Has value and is limited in supply

AMERICAN BANKING Early banks in US were unstable,

money was unreliable Banks were independent, many

worried that government would own banks (American tradition of distrust of central government)

Late 1800’s gold standard gave money value

It was in limited supply and paper money could be redeemed for it at any time

Panic 1907 occurred because not enough gold to back currency in circulation, showed economy needed central banking system to avoid system in the future

FEDERAL RESERVE SYSTEM 1913 Federal Reserve Act passedA. Federal Reserve System served as nations

first central bank and reorganized banking system

B. Created regional banks that store cash reserves for member banks

C. Regional feds loan money to member banks to prevent bank panics

D. Created national currency and allowed Federal Reserve to regulate money supply

E. Federal Reserve Board supervises all banks in the US

Unable to prevent Great Depression (kept money supply too low to prevent inflation)

1933 banking reform passed during the New Deal

Glass Stegall Act separated banking and finance industries, regulated interest rates

Established Federal Deposit Insurance Corporation that covered losses if banks fail up to a certain amount ($200,000 today)

BANKING IN THE LATER 20TH CENTURY

Banks closely regulated from 1930’s-1960’s restrictions on interest rates and loans to customers

Late 1970’s and early 80’s banks became deregulated

Contributed to Savings and Loan (S&Ls) crisis in the late 1980’s

S&Ls unprepared to deal with lack of regulation 1980’s interest rates went up and S&Ls had too

many low interest loans Made risky loans Many made bad loans to failed businesses 1999 Glass-Stegall Act repealed it allowed banks to

buy and sell stocks and bonds and established new privacy rules for banks

BANKING TODAY Money supply- all the money in

the US economy Divided into several categories,

two main categories M1, M2 M1- represents money people

have easy access toA. Consists of assets that have

liquidity (assets that can be directly converted into cash)

B. 48% is held by people outside of bank vaults

C. Money in checking accounts is M1 money

M2- all assets in M1 and additional assets

Additional funds called near money (deposits in savings accounts, money market mutual funds)

FUNCTIONS OF FINANCIAL INSTITUTIONS

Banks and financial institutions essential to managing money supply, largest source income from interest received from loans

A. Storing Money- provide safe place to store money

B. Saving money- savings accounts, checking accounts, money market accounts, certificates of deposit

• Money market accounts and CDs pay higher rate of interest than other accounts

A. Loans- banks make profit lending deposits to borrowers and charging interest

Fractional reserve banking (keeps a fraction of funds on hand and lends rest out) banks today operate under this principle

FUNCTIONS OF FINANCIAL INSTITUTIONS

Loans- more money banks lend out more money they make

Failure to payback loan called default and bank loses money

E. Mortgage- specific type of loan used to buy real estate

Terms of loan 15-30 yearsE. Credit cards- entitles holders to

but goods and services based on promise to pay for them

Simple and Compound Interest- interest is price paid for borrowed money

Simple interest paid only on principal

Compound interest paid on principal and accumulated interest

TYPES OF FINANCIAL INSTITUTIONS AND ELECTRONIC BANKING

Commercial banks- provide wide variety of services from checking and savings accounts to loans

Most are regulated by the federal government

One third are part of the federal reserve system

Savings and loan associations- originally chartered to provide funds to members for home loans

Credit Unions- cooperative lending associations for employees of a specific group

Finance companies- make installment loans to customers, usually for people with poor credit, interest rates are high

Electronic Banking Use of computers has increased

dramatically in banking since 1970’s ATMs, debit cards, internet banking,

automatic clearing houses (automatic draft from bank accounts to pay bills), stored value cards (gift cards)