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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
Ch. 13 Notes
Section 13.1: Money
• Functions of Money
– Money is anything that people commonly accept in exchange for goods
and services
• Money was developed to overcome the problems associated with
bartering (exchanging goods and services w/out using money)
– In the US, money has three functions:
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– Medium of Exchange
• Any item that sellers accept as payment for goods and services
• Money assists in the buying & selling of goods and services
b/c buyers know that sellers will accept money in payment
for products
– Standard of Value
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– Store of Value
• Money can be saved (stored for later use)
• For money to be a store of value it must be nonperishable
(it can’t deteriorate while being saved) and keep its value
over time (purchasing power must remain mostly constant)
• Characteristics of Money
– The five major characteristics of money are:
• Durability
• Portability
• Divisibility
• Stability on value
• Acceptability
– Durability
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– Portability
• Money’s usefulness may depend on its portability or ability to be
carried from one place to another
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– Divisibility
• Refers to money’s ability to be divided into smaller units
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
• The divisibility of the dollar into cents enables consumers
to compare prices of various products
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– Stability in Value
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• Stability in value encourages savings and maintains
money’s purchasing power
– Acceptability
• Acceptability means that people are willing to accept money in
exchange for their goods and services
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• Sources of Money’s Value
– Money must have and retain value
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– Commodity Money
• An item that has a value of its own (as a commodity) and that is
used as money is called commodity money
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• Commodity money can be the most convenient commodity
available like tobacco (the lead crop) used as money in
Virginia in the 1600s
– Representative Money
• An item that has value b/c it can be exchanged for something of
value is representative money
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• Ex: the Massachusetts Bay Colony gave out bills of credit
to colonists that loaned the colonial government money to
fight in King William’s war
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– Fiat Money
• Value is attached to fiat money b/c a government fiat (decree) says
that it has value
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• The value of fiat money ultimately stems from citizen’s faith in the
US government
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
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• Forms of Money
– Coins and Paper Money
• Coins and paper money make up US currency
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• Paper bills are printed by the Bureau of Engraving and
Printing
• Although the US gov’t held gold and silver as partial
backing for paper money until 1971, today US currency is
not redeemable for gold or silver
– Demand Deposits
• Checking accounts make up the largest segment of the US money
supply
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– Near Money
• Many financial assets are similar to money
• These assets such as savings accounts and time deposits are
referred to as near money and not always counted as part of
the nation’s money supply
• Although such assets are easily accessible, these
accounts can’t be used directly to buy goods or to
pay debts
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Section 13.3: US Banking Today
• Types of Financial Institutions
– The most common types of financial institutions have included:
• Commercial banks
• Savings and loan associations
• Mutual savings banks
• Credit unions
– Commercial banks
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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
– Commercial banks make up almost 40% of all mortgage
loans and 50% of all other loans
– Savings and Loan Associations (S&Ls)
• Were established to lend money & accept deposits
– Members of S&Ls deposit money into a large general fund
and take turns borrowing from that fund and paying it back
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– Mutual Savings Banks
• Created to serve people who wished to make small deposits that
large commercial banks did not want to handle
– Offer slightly lower interest rates than commercial banks
– Credit Unions
• Employees of large businesses and institutions and members of
large labor unions often belong to credit unions
– When credit union members deposit money they purchase
shares that pay interest
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– Credit unions usually offer higher interest rates on savings
and lower interest rates on loans
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• Automation
– The reliance on computers to handle transactions
• Also called electronic funds transfer (EFT), automated banking
increased banks’ efficiency by allowing them to execute banking
transactions electronically by computer
– This process allows transactions to affect accounts
immediately and saves banks money by decreasing the
numbers of workers needed
– The four main types of automated banking are:
• Automated teller machines (ATMs)
• Automatic clearing house services
• Point-of-sale terminals
• Home banking
– Automated Teller Machines (ATMs)
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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
– Automatic Clearing House Services
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– Point-of-Sale Transactions
• Involves the direct transfer of money from a buyer’s bank account
to a seller’s bank account
– Ex: Using a debit card
– Home Banking
• Home banking services link personal computers in homes w/ the
bank’s computers allowing people to monitor their accounts,
transfer funds, and pay bills
• Deregulation
– Prior to the 2008 Financial Collapse, the trend of deregulation (reducing
government restrictions on banks was used to increase competition
between banks) was a popular policy with the Federal Government
• Financial Troubles in Banking
– Loan defaults
• When a borrower is unable to repay the funds they had borrowed
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– Bank Failures
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Ch. 14 Notes
Section 14.1: The Federal Reserve System
• Panic of 1907
– Two causes:
• Cause 1: The nation’s monetary system at the time has no
mechanism for expanding the amount of money in circulation
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» As individuals & businesses found themselves
unable to borrow money, they began to withdraw
their savings (bank run) causing banks to fail and a
giant financial panic taking hold
• Cause 2: The system of pyramided reserves failed
– In a pyramided reserves system, virtually all smaller, local
banks deposit some of their reserves at larger city banks
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
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– During recessions, financial panic runs require smaller
banks to withdraw their deposits from larger banks
» As happened in the Panic of 1907, the reserves of
the larger banks could not cover the sudden demand
for cash b/c they had loaned out too much of the
deposits
» Thus, many businesses went bankrupt and many
depositors lost their savings
– Response to the panic
• 1908: the newly created National Monetary Commission
recommends a new central bank
• 1913: Congress passes the Federal Reserve Act, which created a
central bank called the Federal Reserve (The Fed)
• Role of the Fed
– The Fed’s stated goals were “to furnish an elastic currency and…to
establish a more effective supervision of banking in the US
• The Fed achieves this goal through their main purposes
– Supervising member banks
– Holds cash reserves representing funds available for shortterm borrowing by commercial banks or by the government
» The cash reserves guarantees that money is
available in the economy when needed
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• Characteristics of the Fed
– The Fed is not the only central bank in the world, but has several features
that makes it distinct from other countries central banks
– These features include:
• A lack of a single central bank
– The Federal Reserve System relies on district banks to
carry out the banking policies developed at the national
level
• Ownership & control by member banks
– The US government does not own stock in the Fed
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» Thus, the Fed operates w/ a high degree of
independence from political authorities although it
ultimately answers to Congress
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
– Optional membership in the Fed for some banks
» All nationally charted banks are required to join the
Fed, but state-charted banks have the option not to
join the Federal Reserve System
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• Organization of the Fed
– To prevent a single central bank from holding too much power over the
economy, the Fed is organized on two level: national & district
– National Level
• The Fed makes its key decisions at the national level
– The main decision-making bodies are the Board of
Governors & the Federal Open Market Committee (FOMC)
• The Board of Governors is the highest policy making body that
supervises the Fed’s banking services & issues polices designed to
regulate the supply of money in the economy
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– Each governor is appointed to a 14-year term
– The board’s chairperson serves a four-year term
• The seven members of the Board of Governors and the president of
the New York Federal Reserve Bank are permanent members of
FOMC
– The remaining four members are district Federal Reserve
bank presidents who serve one-year terms on a rotating
basis
– District Level
• There are 12 district and separate Federal Reserve banks
– Each of these banks serve a designated geographic region
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» All commercial banks charted by the federal
government are members of the Fed
• The member banks in each Federal Reserve district elect six of the
nine directors of their Federal Reserve bank
– No more than three of the six directors can be bankers
– The Board of Governors selects the remaining three
directors of each bank
Section 14.2: The Federal Reserve at Work
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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
• Services to Banks
– One of the Fed’s main roles is to supervise and provide services to
commercial banks through the 12 Federal Reserve district banks
• The Fed oversees the flow of money between members banks and
its district banks
– It does so though clearing checks and lending reserves to
commercial banks
– Clearing Checks
• The Fed keeps track of the billions of checks written each year
through the service of check clearing
– Check clearing is the method of crediting and debiting
banks’ reserve accounts and in turn checking accounts
– Loans to banks
• When a bank or other depository institution needs a loan, it
contacts its district Federal Reserve bank
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• Most Federal Reserve loans are sought for seasonal factors
(withdrawals by many banks clients to purchase Christmas gifts),
natural disasters, and financial emergencies (recession o0r
depression)
• Services to Government
– The Fed and US Treasury Department work together to manage the $1.5
trillion the federal government raises each year
• The Treasury Department pays out all the bills owed by the federal
government, collects taxes through the IRS (under the Authority of
the Treasury Department), prints money and produces coins
• The Federal Reserve:
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– Supervisees the Fed member banks
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– Serving as the government’s bank
• The Fed’s banking services to government are similar to those that
banks provide to individuals
– The Fed serves as the depository for federal revenues
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– The Fed holds a Treasury checking account on which the
Treasury writes checks to cover tax refunds, social security
checks, and any other government payments
– The Fed records the deposits and withdrawals of federal
funds and conducts the purchase and sale of government
securities like US Treasury bills
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
– The Fed advises the legislative and executive branches on
developing economic policy
– Supervising Member Banks
• The Fed functions as the banking system's “watchdog”
– Each of the 12 Federal Reserve banks has a staff of bank
examiners that supervises the financial activities of member
banks
• These examiners monitor loans & investments &
conduct reviews of bank records
– Regulating the Money Supply
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• The Fed distributes the coins and bills that make up our currency
– New currency is put into circulation for two reasons: to
replace old and worn out notes & to increase the amount of
money in circulation, thus expanding the pool of cash the
Fed banks can loan out
• The Fed increases or decreases the money supply by
selling and buying US government securities
• Money Supply
– The Fed must determine how much money is circulating in the economy
– M1
• The narrowest and simplest measure of the money supply
– M1 economists believe that the money supply should
consist only of funds that are easily accessible and in actual
circulation
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– M2
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– In addition to all the money counted in M1, M2 includes
money market accounts, money market mutual fund shares,
and other savings deposits (like CODs) in amounts under
$100,000
– M3
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– M3 includes the money in M2 as well as large time
deposits (like CODs) with a value over $100,000,
repurchase agreements, and US dollars deposited into US
banks by Americans oversee (Eurodollars)
Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
Section 14.3: Monetary Policy Strategies
• Monetary Policy and Aggregate Demand
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• By regulating the money supply and the interest rates charged for
credit, the Fed influences aggregate demand (the total demand for
all products in the economy)
– Easy-Money Policy
• Designed to expand the money supply, increase aggregate demand,
create jobs, and thus reduce unemployment & promote economic
growth
– Achieved by reducing the interest rate the Fed charges
banks to borrow money thus allowing those banks to
charge lower interest rates for individuals
– Tight-Money Policy
• Designed to slow business activity and help stabilize prices to
decrease inflation rates
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• Components of Monetary Policy
– Open-Market Operations
• The buying and selling of government securities
– When the Fed sells securities, bank reserves shrink and
demand decreases resulting in a contracted money supply
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– Discount Rate
• The interest rate that the Fed charges member banks for the use of
its reserves
– When the Fed lowers the discount rate, banks are
encouraged to borrow from the Fed, which increases bank
reserves and expands the money supply
– When the Fed increases the discount rate, banks are
discouraged from borrowing from the Fed which decreases
bank reserves and contracts the money supply
– Reserve Requirement
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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
– When the Fed lowers the reserve requirement, banks hold
fewer reserves and extend more loans, interest rates fall,
demand increases, and the money supply expands
– When the Fed increases the reserve requirement, banks
hold more reserves and extend fewer loans, interest rates
rise, demand decreases, and the money supply contracts
– Margin Requirements
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– Ex: Te Fed requires investors to have 60% of the cost of
buying stock on hand and only use credit for the other 40%
– Credit Regulation
• The Fed has the power to regulate consumer credit in times of
national emergency
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– Moral Suasion
• The unofficial pressures that Federal Reserve Policy makers exert
on the banking system such as direct appeals to banks or
testimonies before Congress
• Policy Limitations
– The main challenges of the Fed:
• Economic Forecasting
– To develop monetary policy, the Fed must make a
prediction (forecast) of future business activity and
consumer spending
• Incorrect forecasts can lead to inappropriate policy
• Time Lags
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• Demand and production activity rarely react
instantly to Fed actions
• Lack of Coordination
– The lack of coordination between the Fed and other
government agencies concerning economic priorities can
hinder economic activity and send mixed signals to the
markets
• Priorities and Trade Offs
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Name:______________________
Economics: Money and Banking and the Federal Reserve
Notes Packet: Ch. 13 and 14
• Conflicting Opinions
– The disagreement over the goals off US monetary policy
among politicians and government officials leaves the Fed
in the middle trying to please both sides and do their job in
an effective way