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CHAPTER 14
MONEY AND THE BANKING SYSTEM
CHAPTER GOALS
This chapter deals with money and the banking system. After reading this chapter, students should be able
to:
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Define money and identify the functions of money.
Identify the components of our basic money supply.
Describe the collection process a check goes through.
Describe the major depository institutions in our economy.
Compare the various types of savings accounts that banks offer to their customers.
Explain how banks attempt to make a profit for their stockholders.
Discuss the process of money creation by the banking system.
Identify the purposes of the Federal Deposit Insurance Corporation.
LECTURE HINTS AND IDEAS
This chapter starts by defining money and its functions. The various components of the U.S. money supply
are explained, including background information on currency and the check-clearing process. The Federal
Reserve System, discussed in detail in Chapter 15, is briefly introduced here. Next, different types of
depository institutions and savings accounts are presented, along with a look at bank balance sheets. The
money creation process is illustrated, and the need for confidence in the banking system via deposit
insurance follows naturally.
This is a comprehensive chapter that requires a mix of skills for students: memorizing definitions,
applying economic reasoning, learning to read a balance sheet, doing calculations and applying the
multiplier formula. Yet the material flows well and can be very rewarding to teach, since money and
banking is a topic to which everyone can relate. The most abstract concept here, that of money creation, is
best taught by following through several examples with the class and getting them to do some calculations
on their own.
BREAK-THE-ICE DISCUSSION STARTERS
1. “We use credit cards to make purchases, just like cash and checks. Why aren’t credit cards counted as
part of the money supply?” Because they represent a loan being made to the user, credit cards do not
satisfy the store of value function of money.
2. “Is your bank a commercial bank, savings and loan, mutual savings bank, or a credit union? Does it
matter much which type you have?” Students may not be aware what type of banking institution they
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use, because many of the previous distinctions are no longer in place. Most now can do everything—
make consumer, business, and mortgage loans, offer CDs and credit cards, and so on.
3. “Why do banks have to be involved in the money creation process? Can’t the government just print
more cash as needed?” Students need to be aware that most of the money supply is in the form of
checking accounts, not currency, so the banking system is crucial to money creation.
4. “What happens to the money creation process if people withdraw large amounts of cash from their
bank accounts?” The money multiplier process works in reverse and there will be a multiple
contraction in the money supply unless the Federal Reserve takes steps to offset it.
5. “The establishment of the FDIC served to stabilize the banking system and prevent runs. Should the
FDIC coverage be extended to the stock market?” This question looks at issues of risk and the special
nature of the banking system relative to the economy.
BRIEF ANSWERS TO STUDY QUESTIONS AND PROBLEMS
1. a.
b.
c.
d.
e.
f.
g.
Medium of exchange
Medium of exchange, unit of account, store of value
Store of value
Store of value
Store of value
Medium of exchange, unit of account, store of value
Medium of exchange, unit of account, store of value
2. The M1 money supply equals $255 billion.
3. a.
b.
c.
d.
e.
f.
g.
Liability
Liability
Asset
Asset
Asset
Liability
Asset
4. The size of the money multiplier decreases.
5. Required reserves will increase by $5 and excess reserves will increase by $95. The bank can use the
excess reserves to make loans.
6. Checking deposits can expand by a maximum of $66.67 million.
7. Excess reserves equal $40,000.
8. The money multiplier equals 4.
9. Checking accounts increase by ($1,600)(5) = $8,000.
10. a.
b.
Required reserves equal $11,000.
Excess reserves equal $44,000.
INSTRUCTOR’S MANUAL
c.
d.
The maximum amount that the bank can increase the money supply by lending is $44,000,
which equals its excess reserves.
The maximum that the banking system could increase the money supply by lending equals
$440,000.
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