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MONEY AND BANKING
Chapter 10
MONEY
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Money is anything that serves as a
medium of exchange, unit of account
or store of value
Medium of exchange- determines
value during exchange of goods and
services
Without money goods and services
acquired through barter
As economy becomes more specialized
bartering becomes too difficult and
time consuming
Money as a unit of accountprovides means of comparing value of
goods and services (dollars, Euros,
rubles, pesos)
Money as a store of value- keeps
value if you decide not to spend it,
always recognized as a medium of
exchange
Exception is when there is inflation,
does not work well as a store of value
SIX CHARACTERISTICS OF MONEY
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2.
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6.
Currency- coins and paper bills used as
money
Various objects through human history used
as money
Six Characteristics
Durability- must withstand wear and
tear
Portability- needs to be easily carried
Divisibility- easily divided into smaller
units, needs various denominations
Uniformity- needs to be the same in
terms of what it will buy, be able to count
and measure accurately
Limited Supply- too much in circulation,
it looses value
Acceptability- must be able to be
exchanged for goods and services
SOURCES OF MONEY’S VALUE
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Commodity Money- objects that have value in and of
themselves (salt, cattle, precious stones) and have other
uses as well
Not portable, durable or divisible
Only works in simple economies
Representative Money- objects with value because they
can be exchanged for something else
Paper receipts that could be exchanged for gold or silver
were an early form of money
Fiat Money- money valuable because government said it
can be redeemed for debt
Has value and is limited in supply
AMERICAN BANKING
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Early banks in US were unstable,
money was unreliable
Banks were independent, many
worried that government would own
banks (American tradition of distrust
of central government)
Late 1800’s gold standard gave
money value
It was in limited supply and paper
money could be redeemed for it at
any time
Panic 1907 occurred because not
enough gold to back currency in
circulation, showed economy needed
central banking system to avoid
system in the future
FEDERAL RESERVE SYSTEM
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1913 Federal Reserve Act passed
Federal Reserve System served as nations first
central bank and reorganized banking system
Created regional banks that store cash reserves
for member banks
Regional feds loan money to member banks to
prevent bank panics
Created national currency and allowed Federal
Reserve to regulate money supply
Federal Reserve Board supervises all banks in
the US
Unable to prevent Great Depression (kept money
supply too low to prevent inflation)
1933 banking reform passed during the New
Deal
Glass Stegall Act separated banking and
finance industries, regulated interest rates
Established Federal Deposit Insurance
Corporation that covered losses if banks fail up
to a certain amount ($200,000 today)
BANKING IN THE LATER 20TH CENTURY
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Banks closely regulated from 1930’s-1960’s
restrictions on interest rates and loans to customers
Late 1970’s and early 80’s banks became deregulated
Contributed to Savings and Loan (S&Ls) crisis in the
late 1980’s
S&Ls unprepared to deal with lack of regulation
1980’s interest rates went up and S&Ls had too many
low interest loans
Made risky loans
Many made bad loans to failed businesses
1999 Glass-Stegall Act repealed it allowed banks to
buy and sell stocks and bonds and established new
privacy rules for banks
BANKING TODAY
Money supply- all the money in the
US economy
 Divided into several categories, two
main categories M1, M2
 M1- represents money people have
easy access to
A. Consists of assets that have
liquidity (assets that can be
directly converted into cash)
B. 48% is held by people outside of
bank vaults
C. Money in checking accounts is M1
money
 M2- all assets in M1 and additional
assets
 Additional funds called near money
(deposits in savings accounts,
money market mutual funds)
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FUNCTIONS OF FINANCIAL INSTITUTIONS
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B.
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Banks and financial institutions
essential to managing money
supply, largest source income from
interest received from loans
Storing Money- provide safe
place to store money
Saving money- savings
accounts, checking accounts,
money market accounts,
certificates of deposit
Money market accounts and CDs
pay higher rate of interest than
other accounts
Loans- banks make profit
lending deposits to borrowers and
charging interest
Fractional reserve banking
(keeps a fraction of funds on hand
and lends rest out) banks today
operate under this principle
FUNCTIONS OF FINANCIAL INSTITUTIONS
Loans- more money banks lend out
more money they make
 Failure to payback loan called default
and bank loses money
E. Mortgage- specific type of loan used
to buy real estate
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Terms of loan 15-30 years
E. Credit cards- entitles holders to but
goods and services based on promise
to pay for them
 Simple and Compound Interestinterest is price paid for borrowed
money
 Simple interest paid only on principal
 Compound interest paid on principal
and accumulated interest
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TYPES OF FINANCIAL INSTITUTIONS AND ELECTRONIC
BANKING
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Commercial banks- provide wide variety of
services from checking and savings accounts
to loans
Most are regulated by the federal government
One third are part of the federal reserve
system
Savings and loan associations- originally
chartered to provide funds to members for
home loans
Credit Unions- cooperative lending
associations for employees of a specific group
Finance companies- make installment
loans to customers, usually for people with
poor credit, interest rates are high
Electronic Banking
Use of computers has increased dramatically
in banking since 1970’s
ATMs, debit cards, internet banking,
automatic clearing houses (automatic draft
from bank accounts to pay bills), stored value
cards (gift cards)