© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 1 Money and the Banking System What Makes Money Money? 8-1 How Banks Create Money 8-2

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 2 L earning O bjectives 8-1 What Makes Money Money? Identify the three functions of money.LO1-1 Explain two definitions of the money supply. LO1-2

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 3 Vocabulary 8-1 What Makes Money Money? Exactly What Is Money? money medium of exchange unit of account store of value commodity money fiat money Money Supply Definitions checkable deposits time deposit

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 4 Exactly What Is Money? Money is anything that people accept as payment for goods and services. Money is not limited to dimes, quarters, and dollar bills. Precious metals, beaver skins, and wampum (shells strung in belts) have all served as money. 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 5 Exactly What Is Money? The most important function of money is to be widely accepted in trade for goods and services and thus serve as a medium of exchange. In a simple society, barter is a way for participants to exchange goods and services to satisfy wants. Money removes the problems of barter because everyone is willing to accept it as payment. Money increases trade by providing a much more convenient method of exchange than a cumbersome barter system. 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 6 Exactly What Is Money? The unit of account function of money provides a common measurement of the value of goods and services. You can compare the value of two items using money. In the United States, the monetary unit is the dollar. In Japan, the monetary unit is the yen. Mexico has a unit of a peso. All these monetary units serve as a unit of account. 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 7 Exactly What Is Money? Store of value is the ability of money to hold value over time. Money serves as a store of value because it can be exchanged for some time in the future. Money can be saved and spent in the future. However, the value will not necessarily remain constant. Over time prices often rise, and the value of money declines. 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 8 Exactly What Is Money? Commodity money is anything that serves as money that has market value based on the material from which it is made. 8-1 What Makes Money Money? Fiat money is money accepted by law, and not because of its tangible value.

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 9 Money Supply Definitions Checkable deposits are the total money in financial institutions that can be withdrawn by writing a check. Checks eliminate trips to the bank, and they are safer than cash. If lost or stolen, checks can be replaced at little cost—currency cannot. Checkable deposits and currency are considered M1. A checking account balance is a bookkeeping entry. It is often called a demand deposit because it can be converted into cash “on demand.” 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 10 Money Supply Definitions A time deposit is an account with guaranteed interest for a period of time. M2, the broader definition of money, includes small time deposits. M2 is M1, savings deposits, and small time deposits of less than $100,000. A small time deposit is less than $100,000. Time deposits over $100,000 are large time deposits. Certificates of deposit (CDs) are deposits for a specified time, with a penalty charged for early withdrawal. 8-1 What Makes Money Money?

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 11 L earning O bjectives 8-2 How Banks Create Money Explain how banks create money.LO2-1 Understand the calculation of the money multiplier. LO2-2

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 12 Vocabulary 8-2 How Banks Create Money The Money Creation Process fractional reserve banking required reserves Federal Reserve System required reserve ratio excess reserves Multiplier Expansion of Money by the Banking System money multiplier

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 13 The Money Creation Process Fractional reserve banking is a system in which banks keep only a percentage of their deposits on reserve and lend out the remainder. The medieval goldsmiths were the first to practice fractional reserve banking. In a 100 percent reserve banking system, banks would be unable to create money by making loans. However, holding less than 100 percent on reserve allows banks to make loans. These loans create money in the economy. 8-2 How Banks Create Money

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 14 The Money Creation Process Required reserves are the minimum balance of money that the Fed requires a blank to hold in cash or on deposit with the Fed. 8-2 How Banks Create Money The Federal Reserve System is the central banking system of the United States. The Fed is the popular name for the Federal Reserve System.

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 15 The Money Creation Process The required reserve ratio (RRR) is the percentage of deposits the Fed requires a bank to hold in cash or on deposit with the Fed rather than being loaned. 8-2 How Banks Create Money Excess reserves are potential loan balances of reserves held on deposit with the Fed in excess of required reserves. Excess reserves play a starring role in the banking system’s ability to change the money supply.

© 2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. chapter 8 16 Money Supply Definitions The money multiplier gives the maximum change in the money supply (checkable deposits) due to an initial change in the excess reserves held by banks. Economists use the money multiplier, or deposit multiplier, to derive the change in the money supply initiated by an initial deposit or withdrawal. The money multiplier is equal to 1 divided by the required reserved ratio. 8-2 How Banks Create Money