Section 1 The Origins of Money

Barter Economy An economy with no money. An economy with no money. Based on trading one item for another. Based on trading one item for another. What makes living in a barter economy difficult is that many of the people you want to trade with don’t want to trade with you. What makes living in a barter economy difficult is that many of the people you want to trade with don’t want to trade with you. Trade is time consuming. Trade is time consuming.

Transaction Costs High in a barter economy. The time and effort you have to spend before you make an exchange. High in a barter economy. The time and effort you have to spend before you make an exchange. Time of discussing the transaction and making a deal. Time of discussing the transaction and making a deal. Once people begin accepting a good because it reduces the transaction costs of exchange, others will follow. Once people begin accepting a good because it reduces the transaction costs of exchange, others will follow.

Money Any good that is widely accepted in exchange and in the repayment of debts. Any good that is widely accepted in exchange and in the repayment of debts. Historically goods that evolved into money included gold, silver, copper, rocks, cattle, and shells. Historically goods that evolved into money included gold, silver, copper, rocks, cattle, and shells.

What Gives Money Value It is accepted. It is accepted. It has value to you because you know that you can use it go get what you want. It has value to you because you know that you can use it go get what you want. Means of exchange Means of exchange

Are you better off living in a Money Economy? The transaction costs of exchange are lower in a money economy than in a barter economy. The transaction costs of exchange are lower in a money economy than in a barter economy. In a money economy, then, people produce more goods and services and consume more leisure than they would in a barter economy. In a money economy, then, people produce more goods and services and consume more leisure than they would in a barter economy.

Three Functions of Money 1. Medium of exchange – anything that is generally acceptable in exchange for goods and services. 2. Unit of Account – common measurement used to express value. Money functions as a unit of account, which means that all goods can be expressed in terms of money. For example, we express the value of a house in terms of dollars.

3. Store of value – it maintains its value over time. But does not mean that it is always constant.

Early Bankers: Goldsmith The person most individuals turned to was the goldsmith, someone who was already equipped with a safe storage facility. The person most individuals turned to was the goldsmith, someone who was already equipped with a safe storage facility. To acknowledge that they held deposited gold, goldsmiths issued warehouse receipts to their customers. To acknowledge that they held deposited gold, goldsmiths issued warehouse receipts to their customers. The receipts simply represented or stood in place of, the actual gold in storage. The receipts simply represented or stood in place of, the actual gold in storage.

Some goldsmiths did lend out some of the gold deposited with them and collected the interest on the loans. Some goldsmiths did lend out some of the gold deposited with them and collected the interest on the loans. Fractional reserve banking – create money by holding on reserve only a fraction of the money deposited and lending the remainder. Fractional reserve banking – create money by holding on reserve only a fraction of the money deposited and lending the remainder.

Section 2 The Money Supply

Components of the Money Supply M1 1. Currency – includes both coins minted by the U.S. Treasury and paper money. The paper money in circulation consists of Federal Reserve notes. 2. Checking Accounts – Accounts in which funds are deposited and can be withdrawn simply by writing a check. Sometimes checking accounts are referred to as demand deposits because the funds can be converted to currency on demand and given to the person to whom the check is made payable.

3. Traveler’s checks – a check issued by a bank in any of several denominations and sold to a traveler who signs it at the time it is issued by the bank and then again in the presence of the person cashing it.

M2 Broader measure including everything in M1 plus savings deposits, small-denomination time deposits, money market deposit accounts, and retail money market mutual fund accounts. Broader measure including everything in M1 plus savings deposits, small-denomination time deposits, money market deposit accounts, and retail money market mutual fund accounts.

Savings Account – interest-earning account at a commercial bank. Savings Account – interest-earning account at a commercial bank. Time deposits – an interest-earning deposit with a specified maturity date. (CD) Time deposits – an interest-earning deposit with a specified maturity date. (CD) Money market deposit account – an interest-earning account at bank. (kind of short term investment) Money market deposit account – an interest-earning account at bank. (kind of short term investment)

Money market mutual fund – same as deposit account but with a mutual fund. Money market mutual fund – same as deposit account but with a mutual fund. A mutual fund is an investment in a fund that represents like companies (cereals, technology) Usually for a longer term. A mutual fund is an investment in a fund that represents like companies (cereals, technology) Usually for a longer term.

Are Credit Cards money? No. No. It is a debt that you incur. It is a debt that you incur. You a not giving money over at exact time of purchase. You a not giving money over at exact time of purchase. It is an instrument that makes it easier for the holder to obtain a loan. It is an instrument that makes it easier for the holder to obtain a loan. It is a piece of plastic that allows you to take out a loan from the bank that issued the card. It is a piece of plastic that allows you to take out a loan from the bank that issued the card.

Borrowing, Lending, and Interest Rates Interest rates are determined in the loanable funds market. Interest rates are determined in the loanable funds market. The loanable funds market includes a demand for loans and a supply of loans. The demanders of loans are called borrowers, the suppliers of loans are called lenders. The loanable funds market includes a demand for loans and a supply of loans. The demanders of loans are called borrowers, the suppliers of loans are called lenders. Based on the economy – determined by the Fed. Based on the economy – determined by the Fed.

Section 3 The Federal Reserve System

Federal Reserve System Created in 1913 by the Federal Reserve Act. Created in 1913 by the Federal Reserve Act. Started operation in Started operation in A central bank, which means it is the chief monetary authority in the country. A central bank, which means it is the chief monetary authority in the country. Determining the money supply and supervising banks, among other things. Determining the money supply and supervising banks, among other things. Consist of the Board of Governors and the 12 Federal Reserve district banks. Consist of the Board of Governors and the 12 Federal Reserve district banks.

Board of Governors Controls and coordinates the Fed’s activities. Controls and coordinates the Fed’s activities. Made up of 7 members, each appointed to a 14-year term by the president with senate approval. Made up of 7 members, each appointed to a 14-year term by the president with senate approval. The president also designates one member as chairperson of the board for a 4-year term. The president also designates one member as chairperson of the board for a 4-year term.

District Banks 12 Districts 12 Districts

What does the Fed do? 1. Controls the money supply. 2. Supply the economy with paper money – the pieces of paper money we use are Federal Reserve notes. Federal Reserve notes are printed at the Bureau of Engraving and Printing.

3. Hold bank reserves – Each commercial bank that is a member of the Federal Reserve System is required to keep a reserve account (based on total of accounts on hand). 4. Provide check-clearing services. The numbers on the bottom of the check.

5. Supervise member banks – without warning the Fed can examine the books of member commercial banks to see what kind of loans they made, whether they followed bank regulations. Audit. 6. Serve as the lender of last resort – for banks suffering cash management problems. Bail out

Section 4 The Money Creation Process

Total Reserves Total Reserves = Deposits in the reserve account at the Fed + Vault cash Total Reserves = Deposits in the reserve account at the Fed + Vault cash Deposits in the reserve account = $10 mil Vault cash = $15 mil Total reserves = $25 mil

Required reserves The amount of reserves a bank must hold against its checking account deposits as ordered by the Fed. The amount of reserves a bank must hold against its checking account deposits as ordered by the Fed. Reserve requirement – that bank A hold a percentage of this total amount in the form of reserves. Reserve requirement – that bank A hold a percentage of this total amount in the form of reserves. Required reserves = Reserve requirement X checking account deposits. Required reserves = Reserve requirement X checking account deposits. Reserve Requirement = 10% Checking account deposits = $100 mil Required reserves = $10 mil

Excess reserves The difference between total reserves and required reserves. The difference between total reserves and required reserves. Excess reserves = Total reserves – required reserves Excess reserves = Total reserves – required reserves Total reserves = $25 mil Required reserves = $10 mil Excess reserves = $15 mil

The bank can create new loans with excess reserves. The bank can create new loans with excess reserves.