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Money, Banking,
and the
Federal Reserve Bank
(Monetary Policy)
Chapter 6.1
Money
Part I
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
Medium of Exchange
Commodity Money
Unit of Account
Money Supply
Store of Value
Money
Specie
Representative Money
Currency
Fiat Money
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
Money- History
Early European settlers in America
adopted “wampum” – small shells that
American Indians used ceremonially – as
a form of currency.
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
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
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
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
Money- History
In 1861 the U.S. Treasury issued
its first paper currency since the
Continental. The official name
of the currency was “Demand
Deposits,” but people called
them greenbacks because the
were printed with green ink.
(Used during the Civil War).
The Continental, from
American Revolution
issued by the
Continental Congress.
4B
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, and there was a need to build
confidence in the banking system. 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 1913.
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 also called specie coins.
5
Money-History
In the 1870’s the nation adopted a “Gold
Standard” – a monetary system in which paper
money and coins had the value of certain
amounts of gold. (Representative Money)
Set Value: 1 oz. goal = $20
5B
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.
At one time you
could exchange this
Our dollars
were once
backed by
gold. You
could
exchange a
dollar for gold
and silver.
for this
A $1 Silver Certificate is the only piece of
U.S. paper currency (1891) to bear the
portrait of a woman:
Martha Washington
Money-History
In 1929, the severe economic decline and the stock market crash lead to
widespread bank runs (bank panics in which people raced to their banks
to withdraw their deposits). The combination of unpaid loans and bank
runs resulted in the failure of thousands of banks across the country.
After becoming President, Roosevelt acted to restore public confidence
in the nation’s banking system. He declared a “bank holiday” (closed all
banks) as the last resort to restore trust in the nation’s financial system.
Within a matter of days sound banks began to reopen.
Later in 1933, Congress passed the Federal Deposit Insurance
Corporation (FDIC) to insure customer deposits if a bank fails. Today,
deposits are insured up to $250,000.
In an attempt to increase the money supply, Roosevelt also issued an
executive order that effectively ended the nation’s gold standard. Going
off the gold standard allowed the Federal Reserve to maintain a money
supply at adequate levels to support a growing economy (could not
increase money supply with limited gold). These actions helped the
nation recover somewhat but did not end the Great Depression.
6A
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.
6B
Not All Money is the Same
Commodity
Money
Representative
Money
Objects like this gun
powder once served
as commodity
money.
Representative
Money like this
silver certificate
could be exchanged
for silver.
Fiat
Money
Today, Federal
Reserve notes are fiat
money, decreed by
the federal
government to be an
acceptable way to pay
debts.
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
Three Functions of Money
1. Medium of
Exchange
(Acceptable)
As a medium of
exchange, money
measures value
during the exchange
of goods and service.
2. Unit of
Value
3. Store of
Value
(Compares Value)
(Keeps it’s Value)
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
inflation occurs.) 8
Six Characteristics of Money
•
•
•
•
•
•
Acceptable
Portable
Divisible
Durable
Uniform
Scarce
9
What gives Money Value ?
• Acceptability
in exchange gives
money its value.
• It’s scarce.
10
Banking
Part 2
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
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
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
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
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
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 example of “money creation” next)
15
Banking - History
Fractional Reserve Banking – How it works!
10% or $10 of
deposit must be
kept in bank’s
required reserve.
$100
$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
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.
Banking
Today
A bank’s
deposits is
it’s liabilities.
A bank’s
loans is it’s
assets.
Banking Today
Review of
definition
“Money
Supply”
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.
17
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
Banking Today
M2 is M1 plus savings accounts, time deposits,
Review of
and money market accounts.
definitions
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,
19
limited check writing privileges.
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
Bank’s Revenues and Expenses
Most of a
Bank’s income
comes from
interest from
bank loans.
20
B
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
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
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
Banking Today
A mortgage is a loan on real estate.
(Learning the language of banking, a person makes better choices.)
24
The “Fed”
Federal Reserve System
Part 3
Federal Reserve , Washington, D.C
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
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
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…
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)
25
Continued…
B
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.
25
C
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.
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…
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
The Federal Reserve System
Background
Signing of
the Federal
Reserve Act,
1913.
President
Wilson in
signing it.
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
The 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
28
political pressure.
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
The Federal Reserve System
Structure of
the FED
Janet
Yellen
Fed Chairman
Appointed by President Obama,
in 2014, Confirmed by Congress,
and serves a term of 4 years.
Known as the most powerful
person in the world.
30
A
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
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:
-Lower RR Ratio
-Buy U.S. Securities (FOMC)
-Lower Discount Rate (interest)
Decrease the Money Supply:
-Raise the RR Ratio
- Sell U.S. Securities (FOMC)
-Raise Discount Rate (interest)30
B
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)
Federally chartered banks
must be members of Fed,
approximately 4000.
(about 6891 total)
30
C
The Federal Reserve System
Fed is under both public and a private control?
Public Part
Private Part
President nominates
Chair, Senate approves.
Input from Both
Federal
Open Market
Committee
Board of Governors(FOMC)
7 Members committee
12 Members includes the Chair.
Regulates the
Regulates and supervises
money supply
the Federal Reserve System. through Monetary
Policy.
12 District
Banks
With their own 9
board of directors.
Member banks
Local Banks
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
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
The Federal Reserve System
Responsibilities of the FED?
1.
2.
3.
4.
5.
Control the Money Supply
Supply the economy with paper money
Hold bank reserves ($$$)
Provide check-clearing services
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
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.
34
US Treasury: US Mint – coins; Bureau of Engraving and Printing – paper bills.
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
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
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)
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
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
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)
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.
Money, Banking, and the Fed
Test
The End