1. Money and Banking 18.1 18.1Origins of Money 18.2 18.2Origins of Banking and the Federal Reserve System 18.3 18.3Money, Near Money, and Credit Cards CHAPTER 18

2. © 2013 Cengage Learning. All Rights Reserved. Learning Objectives LO1Trace the evolution from barter to money. LO2Describe the three functions of money. LO3Identify the properties of ideal money. 18.1ORIGINS OF MONEY 2 CHAPTER 18

3. © 2013 Cengage Learning. All Rights Reserved. Key Terms  medium of exchange  commodity money 3 CHAPTER 18

4. © 2013 Cengage Learning. All Rights Reserved. The Evolution of Money  Problems with barter  The birth of money CHAPTER 18 4

5. © 2013 Cengage Learning. All Rights Reserved. Three Functions of Money  Medium of exchange  Medium of exchange—anything generally accepted by all parties in payment for goods or services  Commodity money—anything that serves both as money and as a commodity, such as gold  Unit of account  Store of value CHAPTER 18 5

6. © 2013 Cengage Learning. All Rights Reserved. Commodity Money  Limitations of commodity money—most falls short of the ideal money  Coins CHAPTER 18 6

7. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 7

8. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 8

9. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 9

10. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 10

11. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 11

12. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 12

13. © 2013 Cengage Learning. All Rights Reserved. Seven Desirable Qualities of Ideal Money CHAPTER 18 13

14. © 2013 Cengage Learning. All Rights Reserved. Learning Objectives LO1Describe how the earliest banks made loans. LO2Based on whom they lend to, identify two types of depository institutions. LO3Explain when and why the Federal Reserve System was created. 18.2ORIGINS OF BANKING AND THE FEDERAL RESERVE SYSTEM 14 CHAPTER 18

15. © 2013 Cengage Learning. All Rights Reserved. Key Terms  check  fractional reserve banking system  representative money  fiat money  Federal Reserve System (the Fed)  discount rate  Federal Open Market Committee (FOMC)  open-market operations 15 CHAPTER 18

16. © 2013 Cengage Learning. All Rights Reserved. The Earliest Banks  Keeping money, such as gold coins, on deposit with a goldsmith was safer than carrying it around or leaving it at home, where it could be easily stolen.  But visiting the goldsmith every time you needed money was a nuisance. CHAPTER 18 16

17. © 2013 Cengage Learning. All Rights Reserved. Bank Checks  Notes instructing the goldsmith to pay someone were the first bank checks.  A check is a written order for the bank to pay money from amounts deposited. CHAPTER 18 17

18. © 2013 Cengage Learning. All Rights Reserved. Bank Loans  Checking account  Medium of exchange  Public confidence  Fractional reserve banking system  In a fractional reserve banking system only a portion of bank deposits is backed by reserves.  The reserve ratio measures bank reserves as a share of deposits. CHAPTER 18 18

19. © 2013 Cengage Learning. All Rights Reserved. Bank Notes  Bank notes were pieces of paper promising the bearer a specific amount of gold or silver when the notes were redeemed at the issuing bank.  Checks could be redeemed for gold only if endorsed by the payee.  Bank notes could be redeemed for gold by anyone who presented them to the issuing bank.  A bank note was “as good as gold.” CHAPTER 18 19

20. © 2013 Cengage Learning. All Rights Reserved. Representative Money  Bank notes that exchanged for a specific commodity, such as gold, were called representative money.  The paper money represented gold in the bank’s vault.  Initially, these promises to pay were issued by banks.  Over time, governments took a larger role in printing and circulating bank notes. CHAPTER 18 20

21. © 2013 Cengage Learning. All Rights Reserved. Fiat Money  Once representative money became widely accepted, governments began issuing fiat money.  Fiat money is money of no value in itself and not convertible into gold, silver, or anything else of value; declared money by government decree. CHAPTER 18 21

22. © 2013 Cengage Learning. All Rights Reserved. Depository Institutions  Commercial banks  Thrifts  Savings and loan associations  Mutual savings banks  Credit unions  Dual banking system  State banks  National banks CHAPTER 18 22

23. © 2013 Cengage Learning. All Rights Reserved. The Federal Reserve System  Birth of the Federal Reserve System  Established in 1913  Federal Reserve System (the Fed)—the central bank and monetary authority of the United States  Powers of the Federal Reserve System  Reserves  Discount rate—interest rate the Fed charges banks that borrow reserves CHAPTER 18 23

24. © 2013 Cengage Learning. All Rights Reserved. The Federal Reserve System  Directing monetary policy  Federal Open Market Committee  Federal Open Market Committee (FOMC)— 12-member group that makes decisions about open-market operations  Open-market operations—buying or selling U.S. government securities as a way of regulating the money supply and interest rates CHAPTER 18 24 (continued)

25. © 2013 Cengage Learning. All Rights Reserved. The 12 Federal Reserve Districts CHAPTER 18 25 Figure 18.2 Source: Federal Reserve Board.

26. © 2013 Cengage Learning. All Rights Reserved. Organization Chart for the Federal Reserve System CHAPTER 18 26 Figure 18.3

27. © 2013 Cengage Learning. All Rights Reserved. Learning Objectives LO1Describe the narrow definition of money. LO2Explain why distinctions among definitions of money have become less meaningful over time. 18.3MONEY, NEAR MONEY, AND CREDIT CARDS 27 CHAPTER 18

28. © 2013 Cengage Learning. All Rights Reserved. Key Terms  M1  checkable deposits  M2 28 CHAPTER 18

29. © 2013 Cengage Learning. All Rights Reserved. Narrow Definition of Money: M1  Money aggregates are various measures of the money supply.  The narrow definition, called M1, consists of currency (including coins) held by the nonbanking public, checkable deposits, and traveler’s checks. CHAPTER 18 29

30. © 2013 Cengage Learning. All Rights Reserved. Currency in Circulation  Dollar bills and coins in circulation are part of the money supply as narrowly defined.  Money in bank vaults or on deposit at the Fed is not in circulation as a medium of exchange and so is not counted in the money supply.  Currency makes up about one-half of M1. CHAPTER 18 30

31. © 2013 Cengage Learning. All Rights Reserved. U.S. Currency Abroad  More than half of all Federal Reserve notes, particularly $100 notes, are in foreign hands.  Wealthy people around the world, especially in unstable countries or countries that have experienced high inflation, often hoard U.S. currency as insurance against hard times.  Some countries, such as Panama, Ecuador, and El Salvador, even use U.S. dollars as their own currency, a process called dollarization. CHAPTER 18 31

32. © 2013 Cengage Learning. All Rights Reserved. Checkable Deposits  Checkable deposits—deposits in financial institutions against which checks can be written and ATM, bank, or debit cards can be applied  About half of checkable deposits are demand deposits.  In recent years, banks have developed other types of checking accounts.  Checkable deposits make up about one-half of M1. CHAPTER 18 32

33. © 2013 Cengage Learning. All Rights Reserved. Traveler’s Checks  Users sign traveler’s checks twice.  Once at the bank at the time of purchase  Again when the check is spent  A merchant compares the two signatures to confirm the user is the rightful owner.  Traveler’s checks are safer than cash because they can be replaced in the event of loss or theft.  Traveler’s checks are a tiny part of the money supply—only a fraction of 1 percent of M1. CHAPTER 18 33

34. © 2013 Cengage Learning. All Rights Reserved. Broader Definitions of Money: M2  M2—a broader definition of the money supply, consisting of M1 plus savings deposits, small-denomination time deposits, and money market mutual fund accounts owned by households CHAPTER 18 34

35. © 2013 Cengage Learning. All Rights Reserved. Savings Deposits  Savings deposits earn interest but have no specific maturity date.  This means that you can withdraw them any time without a penalty. CHAPTER 18 35

36. © 2013 Cengage Learning. All Rights Reserved. Time Deposits  Time deposits earn a fixed rate of interest if held for a specified period.  The holding period ranges from several months to several years.  Holders of time deposits are issued certificates of deposit, or CDs for short.  Early withdrawals are penalized by forfeiture of several months’ interest. CHAPTER 18 36

37. © 2013 Cengage Learning. All Rights Reserved. Money Market Mutual Fund Accounts  Money market mutual fund accounts are another component of the money supply more broadly defined as M2.  Funds deposited in these accounts are used to purchase a collection of short-term interest-earning assets by the financial institution that administers the fund. CHAPTER 18 37

38. © 2013 Cengage Learning. All Rights Reserved. Debit Cards but Not Credit Cards  A credit card itself is not money.  Using a credit card is a convenient way of obtaining a short-term loan from the card issuer.  You don’t use money until you pay your credit card bill.  The credit card has not eliminated your use of money.  It has merely delayed it.  When you use a debit card, you draw down your checking account—part of M1. CHAPTER 18 38

39. © 2013 Cengage Learning. All Rights Reserved. Electronic Money  Much of modern money consists of electronic entries in bank computers.  So, money has evolved from a physical commodity to an electronic entry.  Money today not so much changes hands as it changes computer accounts through electronic funds transfers. CHAPTER 18 39

40. © 2013 Cengage Learning. All Rights Reserved. M1 and M2: Alternative Measures of the Money Supply, Week of June 20, 2011 CHAPTER 18 40