1. Money and Banking

2. Chapter 10: Money and Banking
KEY CONCEPT
Money provides a low-cost method of trading one good or service for another. It makes the system of voluntary exchange efficient.
WHY THE CONCEPT MATTERS
Money is important to everyone in our society. What were the last three economic transactions you completed using money? Imagine what it would have been like to make those purchases without paper bills and coins.

3. Money: Its Functions and Properties
Section-1
Money: Its Functions and Properties
Functions of Money
KEY CONCEPTS
Money—anything people will accept as a medium of exchange
— over time, cattle, grain, metals, shells, other objects used as money

4. Functions of Money Function 1: Medium of Exchange
Medium of exchange—means through which products can be exchanged
Barter—exchanging goods or services for other goods or services
— inefficient: both people must want what the other one has to exchange
Money convenient: allows for precise and flexible pricing of products

5. Functions of Money Function 2: Standard of Value
Money serves as a standard of value:
— measure of economic worth of goods, services in the exchange process
In United States, the dollar is the standard of value of all products

6. Functions of Money Function 3: Store of Value
Money acts as a store of value:
— holds its value over time
— can set aside for later use because will be accepted in future
Does not function well as store of value when there is significant inflation

7. Properties of Money KEY CONCEPTS
Item used as money must possess certain properties
— physical properties are characteristics of item itself
— economic properties are linked to role money plays in the market

8. Properties of Money Property 1: Physical
Durability—sturdy enough to last through many transactions
Portability—small, light, easy to carry
Divisibility—divisible so change can be made
— allows for flexible pricing
Uniformity—distinctive features and markings make it recognizable

9. Properties of Money Property 2: Economic
Stability of value—purchasing power should be relatively stable
Scarcity—must be scarce to have any value
Acceptability—users must agree that it is valid medium of exchange

10. Types of Money KEY CONCEPTS
Money derives value from one of three sources
Commodity money—value based on the material from which it is made
Representative money—paper money backed by something tangible
Fiat money—declared by government to have value, accepted by citizens

11. Types of Money Type 1: Commodity Money
Items have value in themselves apart from their value as money
— includes gold, precious stones, salt, olive oil; scarce or useful
Coins most common; precious metal in them worth their face value
If item becomes too valuable, people hoard, don’t circulate

12. Types of Money Type 2: Representative Money
Can be exchanged for something else of value
Beginnings in Middle Ages: people issued promises to pay in metal
— often unsafe or inconvenient to transport gold and silver
Later, governments regulated amount stored of metal needed to back paper
Value changes with metal supply, price; causes inflation, deflation

13. Types of Money Fiat Money
Value based on government fiat, or order, saying the money has value
Coins have token amount of precious metal; paper money has no intrinsic value
Government maintains value by controlling supply—keeping it scarce

14. Money in the United States
KEY CONCEPTS
Narrowest sense, money is item used immediately for transactions
Currency—paper money and coins
Demand deposits—checking accounts; funds become currency on demand
Near money—savings accounts, time deposits; funds become cash easily

15. Money in the United States
Money in the Narrowest Sense
Money in narrowest sense sometimes called transactions money
Currency is about half of transactions money used
Demand deposits are mostly noninterest-bearing checking accounts
— traveler’s checks are small part
— negotiable order of withdrawal (NOW), other checkable deposits are rest

16. Money in the United States
Are Savings Accounts Money?
Near money cannot be used directly to make transactions
Savings account: funds can be moved to checking account, withdrawn
Time deposits:
— funds deposited for specific period to receive higher interest
— include certificates of deposit (CDs), money market accounts

17. Money in the United States
How Much Money?
Most often cited instruments for measuring money are M1, M2
M1—currency, demand deposits, other checkable deposits
— called liquid assets
M2—M1, savings accounts, small time deposits, money market accounts

18. Reviewing Key Concepts
Explain the difference between the terms in each of these pairs:
standard of value and store of value
commodity money and representative money
demand deposits and near money

19. The Development of U.S. Banking
Section-2
The Development of U.S. Banking
The Origins of Banking
KEY CONCEPTS
Late Middle Ages, Italian merchants stored people’s money; made loans
American colonial merchants followed same practice
Private banks insecure: if merchant’s business failed, deposits lost
After revolution, state banks chartered by state governments
— many banks issued own currency, not backed by gold or silver held

20. Alexander Hamilton: Shaping a Banking System
The First Bank of the United States
In 1789, became first Secretary of the Treasury; proposed national bank
Against strong opposition, First Bank of the United States chartered in 1791
— issued national currency
— controlled money supply by refusing state bank money not backed
— loaned money to federal government, state banks, businesses

21. 19th-Century Developments
KEY CONCEPTS
1811, Congress refused to renew charter of First Bank of the U.S.
— government had difficulty financing War of 1812
— state banks again issued currency not linked to gold, silver reserves
— increased money supply led to inflation during the war

22. 19th-Century Developments
The Second Bank of the United States
1816, Congress chartered Second Bank of the United States
— more resources than First Bank; made money supply more stable
Opponents thought bank too powerful, too close to wealthy
— 1832, President Andrew Jackson vetoed renewal of charter

23. 19th-Century Developments
Wildcat Banking
Second Bank’s charter lapsed in 1836; no federal oversight of banking
All banks state banks; issued own paper currency called bank notes
States passed free banking laws; resulted in wildcat banks
— susceptible to bank runs leading to panics, economic instability

24. 19th-Century Developments
The Struggle for Stability
In 1863, National Banking Act created national banks chartered by U.S. government
— created national currency backed by U.S. Treasury bonds
— required minimum amount of capital for national banks, to back currency
— taxed state bank notes issued after 1865, taking them out of circulation
1900, United States adopted gold standard—made dollar equal a set amount of gold

25. 20th-Century Developments
KEY CONCEPTS
National banks, gold standard initially brought stability to banking
Economy still experienced inflation, recession, financial panics
United States needed central decision-making body to manage money supply

26. 20th-Century Developments
A New Central Bank
1913, Federal Reserve System created; consists of 12 regional banks,
one decision-making board
— provides financial services to federal government
— makes loans to banks that serve the public
— issues Federal Reserve notes as national currency
— regulates money supply

27. 20th-Century Developments
The Great Depression and the New Deal
1929, many banks failed due to bank runs
Banking Act of 1933 part of President Franklin Roosevelt’s New Deal
— regulated interest rates banks paid; prohibited sale of stocks by banks
— Federal Deposit Insurance Corporation (FDIC) insured people’s savings

28. 20th-Century Developments
Deregulation and the S&L Crisis
1980, 1982 laws lifted federal limits on savings interest rates
Savings and loans associations now operating like commercial banks
— made riskier loans
Many S&Ls failed; Congress funded industry restructuring

29. Financial Institutions in the United States
KEY CONCEPTS
Bank: commercial banks, savings and loan associations, credit unions
State, federal governments charter financial institutions, regulate
— amount of money owners must invest in a bank
— size of reserves a bank must hold
— ways loans may be made

30. Financial Institutions in the United States
Type 1: Commercial Banks
Privately owned commercial banks are oldest type of banks
— initially created to provide business loans
— today, checking and savings accounts, loans, investments, credit cards
All national, about 16 percent of state commercial banks belong to the Fed

31. Financial Institutions in the United States
Type 2: Savings Institutions
S&Ls first chartered by states in 1830s
— took savings deposits; provided home mortgage loans
— today, provide many of same services as commercial banks
Since 1933, federal government also charters S&Ls
— many federally chartered S&Ls call selves savings banks

32. Financial Institutions in the United States
Type 3: Credit Unions
In 1909, first credit union chartered; 1934, federal system created
— offer savings and checking accounts; specialize in auto, mortgage loans
— deposits insured by National Credit Union Association (NCUA)
Credit unions have membership requirements
— cooperatives: nonprofit organizations owned by, operated for members

33. Reviewing Key Concepts
Use each of the terms in a sentence that illustrates the meaning of the term:
state bank
national bank
gold standard

34. Innovations in Modern Banking
Section-3
Innovations in Modern Banking
What Services Do Banks Provide?
KEY CONCEPTS
Banks are like stores where money is bought (borrowed), sold (lent)
Customers can store money, earn money, borrow money
Banks earn money by charging interest or fees

35. What Services Do Banks Provide?
Service 1: Customers Can Store Money
Banks store currency in vaults; insured against theft, other loss
Customers also store
— money in bank accounts; insured against bank failure
— papers and valuables in safe deposit boxes

36. What Services Do Banks Provide?
Service 2: Customers Can Earn Money
Savings accounts, some checking accounts pay interest
Money market accounts, CDs pay higher interest rate

37. What Services Do Banks Provide?
Service 3: Customers Can Borrow Money
Banks lend money through fractional reserve banking
— percent of deposit banks must keep is set by Fed
Banks make loans to customers it approves
— loans have set time period and interest rate; property is collateral
Credit card purchases are loans; interest charged after one month

38. Banking Deregulation KEY CONCEPTS
Before 1980s, government regulated interest rates paid and charged
— required banks to operate in one state; some states limited branches
In 1980s, 1990s, deregulation ended restrictions, changed banking

39. Banking Deregulation Bank Mergers
Deregulation led to mergers; no more restrictions on interstate banking
Advantages: more competition meant low interest rates, more services
— also more branches; economies of scale, especially for technology
Disadvantages: fewer banks to choose from
— fear larger banks uninterested in small customers, local communities

40. Banking Deregulation Bank Services
Financial Services Act of 1999 lifted last restriction on banks
Banks, insurance companies, investment companies compete
— sell stocks, bonds, insurance, traditional banking services
Customers continue to use different companies for different services

41. Technology and Banking
KEY CONCEPTS
Technology has led to electronic banking
Automated teller machines (ATMs)—use special cards
— customers make transactions without bank officers
Debit cards—used to withdraw cash or make purchases
Stored-value cards—represent money holder has on deposit with issuer

42. Technology and Banking
Automated Teller Machines
ATMs—data terminals linked to a bank’s computer network
— customer needs personal identification number (PIN)
— check balances, make deposits, withdrawals, transfers, loan payments
All ATM networks connected; some banks charge fees
Save banks money: cheaper than human tellers; more “bank” locations

43. Technology and Banking
Debit Cards
Debit cards are linked to a bank account
Can be used at ATM machines to make transactions
Can be used to make purchases at retail outlets; also called check cards
— price of purchase is immediately deducted from the account
— unlike credit cards, can only spend as much as have in account

44. Technology and Banking
Stored-Value Cards
Also called prepaid cards—pay for card, use it to pay for products
— include transit fare cards, gift cards, telephone cards
— convenient: no need to have exact change
Need to compare to cost of checking account or check-cashing service
Not always covered by FDIC insurance that protects customer deposits

45. Technology and Banking
Electronic Banking
Electronic banking transactions performed through the Internet
— direct deposit, transaction review, transfers, bill paying
Information security and identity theft are problems for banks
— must reveal privacy policies; let customers decide what data is shared
— developing more sophisticated information security systems

46. Reviewing Key Concepts
How are these three terms related? How are they different?
automated teller machine
debit card
stored-value card

47. Student Loans Background What’s the Issue?
The high cost of a college education forces 10 million students and 800,000 parents to take out loans to pay for at least part of college.
Federally guaranteed loans are the main source of funding for college, not banks, S&Ls, or credit unions.
What’s the Issue?
What is the current situation with student loans? What are the future ramifications of the increasing cost of paying for college?

48. Student Loans {continued}
Thinking Economically
Compare the financial news presented in documents A and C. What bearing do you think the information in document A might have on what you learned from document C?
Document B humorously points to the prominence of student loans in U.S. higher education. Specifically, what parts of documents A and C support this view?
In document A, what does the federal government seem to be saying about who should pay for a college education? With this in mind, what does Figure 10.7 mean for students and parents?

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