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Chapter Nineteen
Understanding
Money, Banking,
and Credit
What Is Money?
• Barter System - first exchanges
– stuff for stuff
• Money
– Anything used to
obtain products that
has little value except
in reuse to obtain products
The Functions of Money
• Medium of exchange
– Anything accepted as payment
• Measure of value
– A “yardstick” used to assign values and compare
values of products & services
• Store of value
– A means of retaining and accumulating wealth
• Careful - inflation causes a loss of stored value so
saved money has to gain interest to maintain its value
Important Characteristics of Money
• Divisible
• Portable
• Difficult to counterfeit
• Durable
So, how much money does a country have?
Three main measures of a supply of money
– M1 only 15%
• Currency, demand deposits, and travelers checks
– M2
• M1 plus short term bonds, time deposits ( & CD’s less
than $100,000
– M3
• M1 and M2 plus time deposits of $100,000 or more
• Demand deposit
– An amount on deposit in a checking account
• Time deposit
– Money deposited in an interest-bearing savings account
The Supply of Money
55%
15%
15%
So, who creates and controls all this money?
The Federal Reserve
• The central bank of the U.S. - the bank for banks
Has 12 district banks and 25 branch banks
The Federal Reserve
Main function -regulate nation’s money supply
How?
1) controlling bank reserves requirements
2) regulating the discount rate
3) running open-market operations
The Federal Reserve System
1) Regulation of reserve requirements
– Reserve requirement—% of its deposits a
bank must retain, either in its own vault or
on deposit with its Federal Reserve District
Bank
– More required reserves = less money in
circulation
– Less required reserves = more money in
circulation to stimulate the economy
The Federal Reserve System
2) Regulation of the discount rate
– Discount rate—the interest rate the Fed charges for
loans to its member banks
– Lower loan rates allow banks to lend more and
stimulate the economy
– Higher rates slow the economy and check inflation
The Federal Reserve System
3) Open-market operations
– The buying & selling of U.S. government securities
by the Fed
– To reduce the money supply, the Fed sells
government securities on the open market to take
money out of circulation
– To increase the money supply, the Fed buys
government securities
Other Federal Reserve Responsibilities
– Serving as the U.S. government bank
– Clearing checks and electronic
transfers of funds between banks
– Inspection and replacement of
worn and unfit currency
– Two mints – 1) Denver
2) Philadelphia
One printer – D.C.
Traditional Services Provided by Financial
Institutions
• Checking accounts-money on demand
• Savings accounts– statement savings account - short time deposit
– Certificate of deposit (CD)-bank pays depositor a
guaranteed interest rate for money left on deposit for
a specified period of time
Traditional Services Provided by
Financial Institutions
• Short- and long-term loans
– Line of credit—a short-term loan that is
approved before the money is actually needed
– Revolving credit agreement—a guaranteed line
of short term credit approved when you need it
(credit cards)
– Collateral—real estate or property pledged as
security for a loan
Traditional Services Provided by
Financial Institutions
• Credit card and debit card transactions
– Banks pay the merchant for your purchases, but
deduct a fee for their service.
– Banks then bill you for the full price of the
merchandise, imposing monthly finance charges
on your unpaid balance
– Debit card—electronic subtraction of a purchase
from the cardholder’s account at time of
purchase. No finance charge to user.
If I Leave It, Will It Be There Later?
• Federal Deposit Insurance Corporation
(FDIC)
– created in 1933
– restored public confidence in banking industry
– insures deposits against bank failures
– provides deposit insurance of $100,000 per
account