MONEY AND BANKING

Chapter 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 Characteristics
1. Durability- must withstand wear and tear
2. Portability- needs to be easily carried
3. Divisibility- easily divided into smaller units,
needs various denominations
4. 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 passed
A. 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 to
A. 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 years
E. 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)