MONEY AND BANKING Chapter 24

What is Money? Three functions of money 1. Serves as a medium of exchange- trade money for goods and services 2. Store of value- hold it until we are ready to use it, and it does not lose value 3. Measure of value- used to assign value to a good or service

What is Money? Anything that people are willing to accept in exchange for goods is money Three characteristics of money A. Portable B. Divisible C. Durable Currency is both coins and paper money We accept money because we are sure that someone else will accept its value as well

What is Money? The Financial System Why banks? 1. Used as a safe place to store money 2. Money is put to work by lending it to people or businesses Financial institutions make a profit from the interest they charge on loans 3. Act to bring savers and borrowers together Types of Financial institutions Commercial banks Provide full banking services to businesses and individuals Most important part of our financial system Savings and Loans Traditionally loan money to people buying homes and real estate Credit Unions Work on a not for profit basis Often sponsored by certain business groups Give workers a financial institution with low costs

What is Money? Keeping our financial system safe Two factors that make the U.S. banking system safe Regulation One of the most regulated industries in the country Required to follow rules to minimize risk Insurance When banks fail the federal government insures their deposits up to $250,000 Federal Deposit Insurance Corporation (FDIC) federal corporation that insures accounts Makes customers feel safe wherever they deposit their money

The Federal Reserve System Federal Reserve is the central bank of the US When banks need money they borrow from the Fed US divided into 12 Federal Reserve districts Federally chartered commercial banks are required to be members of the Fed Member banks own stock in the Fed and earn dividends from it

The Federal Reserve System Fed was established in 1913 To raise money they sold stock and required largest banks to buy it The president, with the approval of the Senate, appoints the seven members of the Board of Governors The president appoints one board member as the chairman who serves a four year term Board is independent of politics because they do not rely on Congress for appropriations for operating expenses

The Federal Reserve System Advisory Councils report on the condition of the economy in each district financial institutions issues related to consumer loans Major policy making group is the Federal Open Market Committee (FOMC) Makes decisions by manipulating the money supply Regulatory functions of the Fed Banking regulation Oversees large commercial banks and regulates mergers Regulates American connections with foreign banks and foreign banks in the US Consumer borrowing Requires lenders to spell out terms of loans Specifies what information lenders must provide

The Federal Reserve System Acting as the Government’s Bank 1. Holds the governments money 2. Sells US Bonds and Treasury Bills These help fund government activity When they reach maturity after a period of time they can be exchanged for cash with interest 3. Fed issues the nations currency and controls its circulation

The Federal Reserve System Conducting Monetary Policy Controls the supply of money and the cost of borrowing money Ways the Fed manipulates the monetary supply A. Can raise or lower the discount rate The rate the Fed charges member bans for loans Stimulate economy= lower discount rate Slow down the economy= raises the discount rate B. Can raise or lower the reserve requirement for banks Banks have to keep certain percentage of total deposits in Federal Reserve Banks If they raise requirement banks have less money to lend C. Can change money supply through open market operations The purchase and sale of government bonds and Treasury bills puts money in the hands of investors and the government

The Federal Reserve System Monetary policies are effective because A. They are made by relatively few people B. Decisions can be made quickly if one policy does not work C. They are free of the constraints of politicians

How Banks Operate Banks are started by investors Pool money, property and certificates of deposit to capitalize bank Banks need to attract depositors a) Offer checking accounts b) Savings accounts pay interest based on how much money customer has deposited c) Certificates of deposit customer gives money to bank for specific time and bank pays interest at the end of the time period CDs pay higher interest than savings accounts Making loans This is how banks make a profit Loan money to businesses and consumers Can increase the supply of money

GOVERNMENT FINANCES Chapter 25

The Federal Government Each year the federal government creates a budget Blueprint of how the government will spend its money Created by the president and Congress Budget year is called a fiscal year (FY), lasts from Oct. 1 –Sept. 30

The Federal Government Budget Process President presents a proposed budget to Congress Congress passes a budget resolution Sets targets for revenues and spending and how much will be spent in each category Categories of spending Mandatory spending does not need annual approval Social security, interest payments on government debt Discretionary spending government expenditures that need to be approved each year Military, highway construction, agriculture subsidies, etc. Appropriations Bills Law that approves spending for a particular activity 13 separate appropriations bills Each must be approved by both houses of Congress and the president

The Federal Government Federal Revenues Income tax provides nearly half of all government revenue Some paid by April 15 th of each year and some is withheld from paychecks Corporations pay taxes on their profits Payroll Taxes- second largest source of federal income Taxes deducted from workers paychecks to fund Social Security and Medicare

The Federal Government Excise taxes- paid when consumers purchase gasoline, tobacco, alcohol, telephone services Estate Taxes- paid when wealthy people die and pass money on to their heirs Other federal revenues –fees paid at national parks, fees paid by companies to extract natural resources from government property

The Federal Government Forms of Taxation Proportional tax- takes same amount from everyone regardless of how much someone earns Sales tax is an example Progressive tax- taxes increase as income increases Federal income tax is an example Regressive tax- percentage paid goes down as your income rises

The Federal Government Federal Expenditures Social Security is the largest expenditure by the federal government (22.4 cents on every dollar) Will grow in the future as the population ages National defense is the second largest category of federal spending (16.3 cents for every dollar) Each year the government spends a portion of the budget to pay the interest on money the government has borrowed Education, highways and foreign aid account for billions of dollars in spending, but less than most people think

State and Local Governments State and local governments have their own budget approval process, revenues and expenditures State Governments Most important state revenues are intergovernmental revenues (money one level of government receives from another) Federal government gives money to states for highways, education, healthcare, etc. Most states depend on sales tax as a source of revenue Tax levied on consumer purchases of all products Collected by business owners and turned over to state on a regular basis Not all states have sales taxes Third largest source is comes from contributions state employees make to pension and retirement plans State Income tax is the fourth largest source Not all states have state income tax

State and Local Governments Local Governments Also depend on intergovernmental revenues Most of the money is provided by the state Second largest source of local revenue is property tax Taxes paid on land, houses and property owned Real property- land and buildings Personal property- stocks, bonds, cars Most local governments tax only on real property Property taxes based on assessed (estimated) value Revenue from utility companies, sales taxes, fees and fines are other sources of local revenue

State and Local Governments Expenditures Entitlement programs are an important state expenditure States try to provide and maintain basic health and living conditions Entitlement programs provide health, nutritional or payment programs to people meeting eligibility requirements States spend money on higher education States subsidize college education to keep costs reasonable Highway construction States have to maintain local highways and roads Employee retirement, hospitals, education, corrections equal a relatively small amount of state expenditures

State and Local Governments Local Government Expenditures Education Local tax revenue goes to pay for public education Accounts for one-third of local government spending Police and Fire Protection Water Supply Local governments usually in charge of maintaining local water supply (Lake Maumelle) Sewage and Sanitation Responsible for sewage and solid waste disposal Local governments maintain sewage treatment plants and landfills

Managing the Economy  Surplus when the government collects more than they spend  Deficit when the government spends more than they collect  Deficit for 2009 was 1.42 trillion dollars  When federal government needs to borrow money they sell bonds  All money borrowed and not paid back is the government's debt  Huge budget deficits of 1980s, early 90’s and last few years have increased federal debt  Each person in the US now owes $46,000 per person

Managing the Economy Balanced budget is when spending equals revenue Federal government is not required by law to have a balanced budget Many state and local governments are required by law to balance their budgets (Arkansas is required) When revenues go down states are required to make cuts Revenue often goes down during bad economic times, when states need to spend more on entitlements Many states try to maintain an emergency fund to help budget shortfalls

Managing the Economy In theory federal government can stimulate the economy by increasing spending and cutting taxes This increases deficits, drives up debt and creates problems in the future When economy grows government can reduce spending, increase taxes to increase revenue and lower government debt Politics make cutting spending, spending money and raising taxes difficult, if times are good or bad A. Most people want lower taxes and no cuts in government services B. It takes time to pass appropriations bills

Managing the Economy Government action sometimes takes a long time to take effect or sometimes do not have the desired effect The economy has automatic stabilizers to stimulate the economy 1. Unemployment insurance 2. Welfare programs 3. Progressive income tax structure  These programs provide income during hard economic times Automatic stabilizers go into effect faster than discretionary spending measures